Oil and gas sector
Maintain neutral: The results of companies under our coverage have improved as out of the eight companies under our coverage, six came in within expectations.

Dialog Group Bhd’s results were stronger than expected due to lumpy contingency cost write-back from its Pengerang Phase 2 developments which are nearing completion while Sapura Energy Bhd’s poor performance stemmed from provisions for its marine vessels amid declines in crude oil prices.

Core net profit declined 35% quarter-on-quarter (q-o-q) and 30% year-on-year (y-o-y) to RM714 million largely due to Sapura Energy’s cost provisions for its marine assets which drove down the sector’s earnings before interest, taxes, depreciation and amortisation margins by three percentage points (ppts) q-o-q and 5ppts y-o-y to 36%. Sector revenue slid 3% q-o-q to RM7.6 billion due to lower earnings days for the tanker division and reduced construction recognition for the heavy engineering segment, while rising 7% y-o-y from two additional short-term liquefied natural gas charters and higher petroleum charter rates.

Notwithstanding crude oil price having risen by 17% since the beginning of the year to US$62 per barrel currently, balance sheet risks linger with Barakah Offshore Petroliam recently joining Perisai Petroleum Teknologi Bhd, Daya Materials Bhd and Sumatec Resources Bhd into Practice Note 17 financial distress status. We note that while Bumi Armada Bhd’s has successfully refinanced its unpaid US$380 million debt, the possibility remains that the group will still need to undertake a highly dilutive equity-raising exercise amid a depressed share price given that it has secured a 30% equity stake in an India-based floating production storage and offloading which could cost over US$1 billion (RM4.16 billion).

With US crude inventories up 8% since the beginning of the year to 476 million barrels and Brent crude prices declining to US$61 per barrel while averaging US$66 per barrel to date, we maintain 2019 to 2020 price forecast at US$65 to US$70 per barrel, which has been our forecast since Dec 3 last year. Over the past three months, the Energy Information Administration (EIA) has raised its Brent oil projection to US$70 per barrel from US$61 per barrel for 2019 and US$67 per barrel from US$62 per barrel for 2020 on tighter global markets in mid-2019 amid increasing supply disruption risks in Iran and Venezuela.

We highlight that the EIA’s constant price forecast revisions affected high market volatility given multiple demand-supply dynamics amid global demand expectations that are likely to be depressed with the US recently declaring new tariffs on Mexico and the withdrawal of India’s preferential trade status.

Contract awards declined 20% y-o-y and 27% q-o-q to RM3 billion in the first quarter of 2019 (1Q19), largely due to Sapura Energy securing lumpy central processing platform jobs for the Pegaga project off Sarawak in 1Q18 together with developments for the Hokchi field in the Gulf of Mexico and KW-DWN 98/2 block off India in 4Q18. Nevertheless, offshore projects in Brazil, Mexico, the Middle East and West Africa may be still poised to gain traction with Sapura and Malaysian Marine and Heavy Engineering Holdings Bhd being selected for Saudi Aramco’s long-term agreement programme, which allows them to bid for the kingdom’s massive offshore projects that could reach US$150 billion over the next 10 years.

We are “neutral” on the sector given the likely continued volatility in the oil price direction over the next six months, lingering balance sheet risks of Malaysian operators, unresolved US trade dispute, deteriorating global economic growth outlook and easing of US pipeline constraints.

Our top picks are still companies with stable and recurring earnings such as Serba Dinamik Holdings Bhd and Dialog. We like the recurring income business model of Dialog and Serba Dinamik, which are involved in operation and maintenance services while Dialog’s earnings visibility is further secured by the Pengerang Deepwater Terminal project with its enlarged buffer zone.

We may upgrade the sector to “overweight” if rising geopolitical tensions drive crude prices above US$70 per barrel amid an easing of US trade war sanctions and a resurgence of global economic growth expectations.

On the other hand, we may downgrade to “underweight” due to: i) higher-than-expected shale production and earlier-than-projected transportation bottleneck alleviation; ii) slower-than-expected global economic growth against the backdrop of worsening trade tensions; iii) accelerated adoption of fuel-efficient-cum-electric vehicles that could reduce consumption and lead to “peak oil demand”; iv) non-compliance by Opec members to their agreed quotas, which will again lead to aggressive measures to regain market shares; and v) increasing exit from oil and gas stocks by environmental, social, and governance-compliant global funds. — AmInvestment Bank, June 4