This article first appeared in The Edge Financial Daily, on March 2, 2016.

Oil and gas sector
Maintain neutral: Petroliam Nasional Bhd’s (Petronas) fourth quarter of financial year 2015 (4QFY15) profit after tax excluding identified items came in at RM9.9 million, down 21% year-on-year (y-o-y) due to lower upstream earnings in conjunction with a crude oil price plunge. Crude oil, condensate and natural gas production volumes dropped 1.4% y-o-y to 2.326 million barrels of oil equivalent (boe) per day from 2.359 million boe per day due to lower production entitlement from Iraq and natural declines.

Liquefied natural gas (LNG) sales volumes were 4% higher due to higher third-party sales despite lower production by the LNG Complex in Bintulu, Sarawak. Petronas’ downstream flourished with profit after tax rising by 33% y-o-y despite a slight drop in petrochemical product sales volumes due to stronger refining and marketing margins on the back of favourable crude oil and chemical product prices. Putting it into perspective, the downstream profit after tax margin improved to 6.3% from 1.1% in the corresponding quarter a year ago.

For FY15, Petronas’ capital expenditure (capex) spent by the group was down by 9.1% to RM64.6 billion, lesser than the expected 20% cut as announced earlier. The majority of capex was spent on the acquisition of Statoil ASA’s Shah Deniz assets, the refinery and petrochemical integrated development (Rapid) project and smaller amounts of upstream investments.

We believe with the absence of further upstream asset acquisitions and cuts in upstream development, Petronas’ target of RM50 billion capex cut per annum over the next four years could be met. Anticipated capex per annum for Rapid is about RM24.3 billion (assuming a total project cost of RM97 billion over the next four years).

Assuming a RM12.5 billion cut in capex and a RM16 billion dividend commitment, the group is left with only RM11.8 billion to be spent on upstream, whereby most of it is expected to be channelled into production enhanced on existing fields to prevent natural declines in oil production. In our opinion, all of the upstream-related service players including rigs, offshore supply vessels (OSVs), installation and fabricators would be adversely affected by this situation with more cost cuts expected to feed into their existing contracts.

Asset-heavy players (jack-up rigs and OSVs) remain as the most exposed to this development due to their high fixed-cost structure which is difficult to be adjusted downwards in a short span of time. We still prefer floating production storage and offloading (FPSO) players in view of robust FPSO contract terms and downstream fabrication players on expectations of news flows in the downstream sector.

We maintain our “neutral” rating on the oil and gas sector. Its positive is a capex plan from oil operators to continue to maintain oil and gas production, with the negative being a delay in contract roll-outs and a low-oil price environment lead to competition and margin compression. Our top picks are Bumi Armada Bhd for the big-caps and KNM Group Bhd for the small- to mid-caps. — HLIB Research, March 1