Wednesday 17 Apr 2024
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Extracts of a report by OSK Research

KUALA LUMPUR:  The share prices of oil and gas (O&G) stocks are undergoing a re-rating, largely fuelled by positive market sentiment and strong news flow.

Going forward, we think that partnerships or actual contract awards will be the main ‘push’ factor for further share price upside and the lucky companies will continue to outperform those which lack news flow.

Our average sector PER valuation is raised from 13.2 times to 16.6 times. Maintain Overweight on the sector, with our top picks being Kencana Petroleum, Alam Maritim, Petra Perdana and Petra Energy.

Sector undergoing a re-rating. Recently, the share prices of most O&G stocks have been on an uptrend, fuelled by a wave of positive news, including:

i) the Government’s efforts to promote the development of marginal oil fields; ii) expectations of new O&G contracts being announced soon; iii) oil price having broken past US$70-US$80/barrel, and iv) the sector being “ripe” for a re-rating after a 13-month consolidation.

JVs the next ‘push’ factor. We believe that any bigger companies resulting from M&As or partnerships will garner valuations that are higher by 20%-50%, depending on their combined size and the potential synergy to be derived from the mergers.

Our educated guess for potential partnerships include: i) Kencana Petroleum with Petrofac; ii) Alam Maritim with Coastal Contracts; iii) SapuraCrest Petroleum with Petra Perdana and Alam; iv) Coastal with Ramunia; v) Tanjung Offshore with oil majors, and vi) Wah Seong with KNM.

Note that these are purely conjecture on our part, and are based on potential synergy or market rumours, rather than any indication from company management.

The strong shall prevail, the weak will fall. We believe that the re-rated share prices of O&G stocks will consolidate at current levels. Any further upside would depend on actual contract awards and the flow of potential JV news, whereby the stocks involved would have their earnings re-rated upwards.

However, the share prices of companies that lack such catalysts may fall back. Hence, investors should be selective in their stock picks.

Maintain Overweight. We believe there is more upside potential for most O&G stocks despite the recent upswing in their share prices. We also think that the days of dishing out massive contracts are back.

Given the positive sentiment and potential for more news flow inthe sector, we raise our PER valuation for a number of companies under coverage.

Our average PER valuation (ex Dialog) is raised from 13.2 times to 16.6 times. We also upgrade our calls on a number of companies including Alam Maritim, Dialog Group, Petra Perdana and Petra Energy. On the flip side, companies with rather loftier valuations have been downgraded to Trading Buys including Kencana Petroleum and MMHE.

Nonetheless, Kencana Petroleum remains our top pick. Aside from Kencana, we now include Alam Maritim, Petra Perdana and Petra Energy as our other top buys.

Government promoting marginal oilfield developments. This move is in line with Petroliam Nasional Bhd’s objective of increasing oil output in the immediate term.

Examples of government support take the form of: i) giving encouragement and support for potential tie-ups between local O&G service providers with international oil majors, and ii) giving attractive tax incentives to attract efforts and new investment into these fields.

Some of the recently announced tax incentives include: i) a 60%-100% investment tax allowance on capex spent on capital intensive-projects such as enhancing oil recovery etc, ii) a lower tax rate of 25% (from 38% previously); iii) accelerated capital allowance to 5 years (from 10 years previously) to improve project viability, and iv) a waiver of export duty on oil produced and exported from marginal oil field developments to improve a project’s commercial value.

Other factors are that more O&G contracts to be announced soon while crude oil price has successfully broken above the US$70-US$80/barrel consolidation band since 4Q10, with the quarterly average at US$85 a barrel.

We believe that crude oil price will continue to go up before consolidating at US$80-US$90 a barrel for 2011 and USD90-USD100/barrel for 2012. Also, we think that these higher levels are likely to be sustainable given the recovery in the global economy, which will spur oil demand.

Potential joint ventures

It’s purely conjecture. Firstly, note that our guesstimates stem from our view of the potential synergy or market rumours rather than based on direct information from management. Having said that, it is the guessing game that keeps the news flow interesting and the momentum of share prices going, as we believe the situation would likely be one of “buy on rumour and take profit on fact”, unless there is a material synergistic earnings re-rating for the combined entities.

New contracts just around the corner.

Some of the potential new O&G contracts in the pipeline are:

(i) the RM1.0bn hook-up and commissioning contracts from Petronas and its PSC contractors; (ii) RM2.0bn maintenance contracts from Petronas and its PSC contractors; iii) ExxonMobil’s USD3.0bn spending in new O&G assets to rejuvenate mature facilities and enhance oil recovery in the Tapis field starting 2013; iv) Shell’s USD1.6bn to upgrade and build facilities in the upstream, midstream and downstream segments, including the expansion of Shell MDS’ wax plant in Bintulu, a new diesel processing unit at Shell Refinery in Port Dickson and Gemusut deepwater development offshore

Sabah; v) Kebabangan and Malikai deepwater development projects; vi) Tapis, Sepat, Berantai and a few other marginal oilfields development projects, and vii) vessel contracts to support marginal oilfield developments.


Valuations and recommendations

Maintain Overweight. Despite the recent strong run-up in the prices of most O&G shares, we believe there is still more upside potential and hence are maintaining our Overweight call on the sector. We are also re-rating upwards our PER valuations for most of the O&G stocks under our coverage. As we mentioned earlier in this report, we believe there may be a pullback in the short term after the recent price surge. However, we view such share price retracement as a good opportunity to buy and going forward, we believe that the actual awarding of the contracts and the emergence of news related to

JVs among the local players or with overseas players would add fuel to the rally.

Are the laggards worth investing in?

Given the recent run-up in O&G stocks, we believe this sector

is now being closely watched by the investment community. Hence, the likely next step of action is to go for laggards but will they perform in the coming months?

On the surface, we have 2 schools of thoughts on this: i) if a mass of new O&G contracts are awarded in the coming weeks, we think it would be a good strategy to invest in the laggards as there has been speculation that many companies would benefit since such huge  contracts cannot be handled by a single company. The sentiment on the sector as a whole would improve rather than just on specific stocks, as seen in 2009 and 2010; ii) otherwise, we think the laggards will continue to be laggards while the performers will continue to outperform as they are likely to get more new O&G contracts to spur a re-rating of their earnings.

O&G stock picking strategy. We believe that the new O&G contracts to be awarded by Petronas and its PSC contractors this time would be to the mass market, rather than simply to one company, although we do not discount the possibility that the award of the main contractor package will continue to be selective as we gather from industry sources that this is will be Petronas’ future approach to empowerment, where it also imposes on the selected company the responsibility of expanding and managing other O&G supporting companies. We also think that the days of awarding mass contracts are back, as can be seen from the RM400m hook-up and commissioning contract awarded to Petra Energy, which we understand is part of a contract worth RM1.5bn. Hence, we think there is still a

piece of the pie left for peers like Dayang and Kencana but again, we hope this would be the beginning of Petronas giving out a mass of contracts, compared with the past 2 years when the notable huge jobs like the Sabah O&G Terminal (SOGT) worth RM2.4bn and offshore installation works worth over RM4.0bn were awarded to only a few parties. Amid this scenario, we are adding a few more companies to our stock picks this time.

Kencana remains our favorite sector pick. Despite its strong share price rally since 2H10, we believe there is still upside potential for Kencana once the highly anticipated job to develop marginal oil fields, which it is tipped to undertake together with its strategic partners, is finalised.

This will provide even better earnings visibility for the company and not only boost its earnings going forward but also transform the company into a bigger O&G service provider from just a traditional fabricator.

However, given the recent strong share price surge without an actual contract materialising, we are  downgrading our call from Buy to Trading Buy although we have raised our target price to RM3.37 based on a higher PER of 23x FY12 EPS (previously RM2.93 based on a PER of 20x FY12 EPS). We will probably upgrade our call back to Buy once Kencana confirms its participation in marginal oilfield developments, and when management is able to provide better future earnings guidance.


Introducing 3 new picks: Alam, Petra Perdana and Petra Energy

Since mid-2010, we have been promoting Kencana as our one and only pick for the O&G sector and the company’s earnings and share price have indeed performed up to our expectations.

We are now starting to introduce more stock picks since sentiment in the sector is positive and based on our prediction on the potential flow

of new contract awards, we believe that Petronas and its PSC contractors would next be looking at the hook-up and commissioning works as well as maintenance, which should benefit players like Petra Energy. Of course, when this happens, the full support of vessel operators would be needed to assist in carrying the fabricated structure, workers, food, water, chemicals and so on, which should benefit players like Alam and Petra Perdana.


Re-rating the sector valuation upwards. Given the number of positive indicators such as:

i) positive sentiment on the local O&G stocks among the local and foreign investors; ii) continuous support from our government to develop the industry such as by providing various tax incentives; iii) potential new contracts from Petronas and its PSC contractors, and iv) finally, potential partnerships, either among themselves or with foreign O&G operators to bring them up to the next level, we believe all these would in combination shore up sentiment on O&G stocks.

As such, we are raising our average sector PER valuation (ex Dialog) from 13.2x to 16.6x and upgrading a number of our calls including Alam, Dialog, Petra Energy, Petra Perdana and Tanjung Offshore. On the other hand, rather lofty valuations lead us to downgrade Kencana and MMHE to a Trading Buy.

Alam (Buy, TP: RM1.50). We are upgrading Alam to a Buy from Neutral. We downgraded Alam to Neutral in 2010 when we found out that there is a potential provision for doubtful debts from Vastalux of about RM30m.

However, we noted that investors have recently chosen to ignore this fact as they look towards new O&G contracts which could potentially increase the demand for Alam’s vessels, which are only about 30% utilized, and also fetch higher charter rates of above USD1.70/bhp. That said, we are now looking on the brighter side as we expect, other than higher vessel utilization and charter rates, we see the company securing some basic pipe laying jobs via its recent MoU with Yayasan Sabah Shipping SB (YSS), 100%-owned by Yayasan Sabah Group, for the Sabah Oil and Gas Terminal (SOGT) project.

Coastal (Buy, TP: RM4.41). We maintain a Buy on the company mainly due to its attractive valuation.

The company also has a good delivery track record of delivering quarter after quarter. Its orderbook is also still strong at close to RM1bn, which should keep the company busy for at least the next 12 months. However, we note that Coastal will continue to trade at a discount to its peers as investors still see the company as a shipbuilder, rather than a pure O&G player. However, we are monitoring closely its developments such as the potential JV with Ramunia, to turn the company into a fabricator,

or even with Alam, which could enhance its presence in the O&G market in Sabah, although it already owns a shipbuilding yard in Sandakan.


Dialog (Buy, TP: RM2.51). We are upgrading Dialog to a Buy from Neutral. We impute the potential earnings contribution from its Pengerang CTF of about 1.5m cubic meter for Phase 1. Going forward, we think the 2 catalysts to move the share price further would be the commencement of

construction on the Pengerang CTF, and the second one (based on market rumour), could potentially arise due to its involvement in marginal oilfield development, for which talk has it that a consortium could be formed among Dialog, SapuraCrest, Kencana and Petrofac. Nevertheless, we continue to like Dialog’s its stable business model, which provides the company with good recurring income, even without news flow on the marginal oilfield.

Kencana (Trading Buy, TP: RM3.37). We are downgrading the stock to Trading Buy from Buy, simply because its recent strong share price rally and the still pending announcement of its involvement in marginal oilfield developments.

Nevertheless, we see ourselves upgrading the company back to a Buy once management provides further earnings guidance as we see its involvement in this oilfield as being very significant since it would transform the company from a pure fabricator to oilfield manager. Kencana would then be able to reap the benefit of high oil prices.

KNM (Trading Buy, TP: RM3.95). We are keeping our Trading Buy call unchanged for the company.

We believe this is one company which would not be left out whenever the entire O&G sector re-rates and hence we have also increased our target price based on a higher PER valuation. However, going forward, we are looking forward for its orderbook replenishment and also closely track the recovery of the global O&G industry, especially on the US and Europe side, as KNM is a global O&G player with earnings contributions from across the globe.

Also, rising oil price is a good thing for KNM since this would induce the global oil majors to spend more capex, which will create new process equipment jobs for KNM. The company is still supported by a strong orderbok of above RM4.0bn, which should keep it busy for the next 2 years. Also, its tenderbook now exceeds RM16bn.

MMHE Holdings Bhd (Trading Buy, TP: RM6.68). We continue to like the company for being the top fabricator in Malaysia and it is also indirectly owned by Petronas. Hence, we believe the company would be one of the main beneficiaries of new contract awards from Petronas and its PSC contractors.

Finally, we also think that it could potentially get a slice of the action in marginal oilfield developments, given its capability in converting VLCCs, Aframax tankers and offshore rigs into floating structures such as FPSOs, FSOs and MOPUs for the marginal oilfield use.

Petronas Chemicals (Neutral, TP: RM6.20). We maintain Neutral on the company as we believe investors should take advantage of the positive sentiment in the O&G industry by looking at other O&G companies which may be in for exciting news.

As for Petronas Chemicals, we understand from Nexant’s market research report that the petrochemical industry is to remain under pressure as further capacity is forecast in the immediate term and will only peak in 2015, although it is now seeing a gradual recovery in terms of utilization rates and margins. Hence, we think it would be time to look at this company when the other O&G companies are fully re-rated since they have been consolidating given the trickling news flow in the past 12 months.

Petra Energy (Buy, TP: RM2.16). We are upgrading the stock to a Buy from Neutral. With Petronas’ emphasis on rapidly increasing Malaysia’s oil production, we think the refurbishment of existing platforms would a key emphasis besides extracting oil from marginal oilfields. Petra Energy would benefit from these 2 developments since its core business is in the provision of brownfield services. It has a fleet size of 5 vessels comprising 3 work barges and 2 workboats to participate in these activities.

Petra Perdana (Buy, TP: RM1.57). We are upgrading to Buy from Trading Buy as we believe its low vessel utilization rate would soon be addressed with the new contract awards coming out soon.

To recap, earlier we had strongly promoted the stock with a Trading Buy call despite the company

falling into the red in 3QFY10 as we noted that the share price had been consolidating at between RM0.735 and RM0.83 and back then, we were expecting a breakout anytime, which was later proven right. Now, we think there will be further re-rating in its share price soon arising from its projected improved vessel utilization (to above 50%) and charter rates (to above breakeven level of USD1.30/brake horse power (bhp) for its 10-12k bhp AHTS) and of course, the potential M&A angle.

Tanjung Offshore (Trading Buy; TP: RM2.18). We are upgrading to Trading Buy from Neutral as we believe Tanjung Offshore may not be left out from the marginal oilfield development since its core businesses and assets are suitable for this development; its vessels are mostly 5k bhp without dynamic positioning (DP) technology and hence are suitable for marginal oilfield use while its has experience in managing rigs, for which it gets an agency fee.

However, we do not have a convincing buy call because we are still concerned over the possible loss from its UK subsidiary, Citech Energy

Recovery Systems UK Ltd, which could erode its 16 vessel earnings. Having said that, we are positive on the entry of the private equity fund for bumiputras, Ekuiti Nasional Berhad (Ekuinas), who has emerged as a substantial shareholder of the company with an equity stake of about 24%. This could also potentially open up new business opportunities or even M&As with common shareholder.

Wah Seong (Neutral; TP: RM2.29). We maintain Neutral on the company, for which we think it would be business as usual. Its earnings may probably improve due to a higher percentage of coating the Gorgon pipes (50%-60% expected in 2011 versus 10%-20% in 2010). Also, we expect some recovery

in its gas compressor business. Other than that, the company could also benefit from the re-coating of old pipelines off the coast of Terengganu.

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