O&G sector still has upside on further capex spending by oil majors

TheEdge Mon, Mar 06, 2023 02:00pm - 2 months View Original

BURSA Malaysia-listed oil and gas (O&G) companies have seen more activity and interest in the past half year than most sectors, buoyed by the reopening of China, elevated global crude oil prices and higher capital expenditure (capex) spending by oil majors, particularly Petroliam Nasional Bhd (Petronas).

Even so, some analysts are of the view that there is still a lot of gas left in the tank for the sector as they say the recent activity only marks the start of an upcycle because average crude oil prices are projected to go higher in 2023.

Already in the past six months, a substantial number of O&G counters have rebounded to their 20-month high, as reflected in the Bursa Malaysia Energy Index, which rose to as high as 907.57 points on Feb 5. The index was at 861.44 points last Wednesday, 43% higher than last year’s low of 604.64 points on July 15, 2022.

The index, which comprises 24 O&G companies, has surged more than 40% during the past six months, led by top gainers that include Bumi Armada Bhd, Velesto Energy Bhd, Malaysia Marine and Heavy Engineering Holdings Bhd (MHB), Uzma Bhd and Dayang Enterprise Holdings Bhd.

Bumi Armada has gained almost 60% to 57 sen per share in the past six months, MHB has surged more than 73% to 71 sen apiece while Velesto has almost tripled to 25 sen per share, and Uzma and Dayang have jumped 88.9% and 40.56% to 68 sen and RM1.46 a share respectively.

A number of analysts remain bullish on the sector as they expect the momentum to be sustained by stable global crude oil prices, with the reopening of China projected to support demand and continued capex spending by oil majors.

Maybank Investment Bank Research analyst T J Liaw observes that the industry has been benefiting from the strength of crude oil prices over the last 24 months, especially with the Organization of the Petroleum Exporting Countries (Opec) and its allies (Opec+) taking an active role in setting the direction of the oil market.

“This has led to an increase in capex spending [by oil majors] and overall lift in sentiment. Some O&G companies have experienced improved earnings, rates and order book, a testament to the upcycle in the industry,” he tells The Edge.

While the sector has delivered incredible share price appreciation, analysts such as Liaw believe the recent O&G rally still has legs. He reckons it is “just the start of a new upcycle” as he believes that Brent crude oil could touch US$100 per barrel this year — a fourth more than its current price of about US$80 a barrel.

“This sector [still has legs]. We reiterate that this is just the start of an upcycle. In general, there is increased interest in O&G counters, which is rightly so [because of] improved earnings, increase news flow, valuations, reratings and so on.”

He observes that Malaysian O&G players were underperforming vis-à-vis their regional peers and are now playing catch-up.

Earnings improvement to continue

MIDF Research head Imran Yassin Md Yusof is also optimistic as he expects crude oil prices to be more stable this year, which could lead to more room for earnings improvement as oil majors continue to increase their capex spending.

“In fact, we observed the interest in O&G stocks around November 2022 and this has continued since then.”

However, he expects Brent crude to average slightly lower at about U$92 to US$96 per barrel this year on the basis of a stabilised supply output to demand globally, amid lower discoveries and the replenishment of inventories, the lasting impact of geopolitical tensions on energy security, refinery throughputs and freight rates, inflationary pressures on material cost and consumer demand, and lower crude oil production by Opec+.

“In line with the robust projection on the sector, we believe that the increase in exploration, drilling and production activities is good for our OGSE (oil and gas services and equipment) companies. As such, we believe that 2023 will see the Bursa Malaysia Energy Index resume the trend,” Imran says.

RHB Research analyst Sean Lim is particularly positive on upstream service providers for two reasons: continuous capex spending by oil majors and higher charter rates from new contracts.

“Share prices [of the O&G counters] have rallied quite aggressively, especially in the beginning of the year, reacting to the positive catalysts. This also explains why service players seem to perform better than exploration and production players, whereby their revenue has a direct correlation to oil prices,” he says.

Lim recently raised his target price on Dayang, after the Sarawak-based O&G service provider’s financial year ended Dec 31, 2022 (FY2022) came in within expectations.

He has raised Dayang’s FY2023 and FY2024 earnings forecast by 3%-9%, driven by its maintenance, construction and modification (MCM) work orders and the higher utilisation rate of its vessels. Dayang’s target price was raised to RM1.73 a share based on 14 times FY2023 forecast price-earnings (PE) ratio.

Dayang’s subsidiary Perdana Petroleum Bhd, which is in the business of providing offshore service vessels (OSV), is also seeing better days after almost seven years of losses due to low utilisation and charter rates.

In mid-February, Perdana Petroleum announced its first profitable year since 2014, declaring a net profit of RM11.39 million in FY2022 versus a cumulative net loss of RM328.27 million the year before, on the back of higher revenue of RM196.63 million from RM153.47 million previously.

For years, local OSV operators faced low charter rates, starting from around 2015 when Petronas took on cost-cutting measures after Brent crude prices swung wildly from above US$100 per barrel in 2014 to US$26 in February 2016. The measures, dubbed Petronas’ Cost Reduction Alliance 2.0 or Coral 2.0, reportedly resulted in a cost savings of RM5 billion for the national oil company.

A five-year cost optimisation programme, Coral 2.0 involved Petronas working with its petroleum arrangement contractors (PACs) and OGSE providers as it needed to tighten its own belt given the gyrating oil prices, which plunged more than 65% to US$20 a barrel in April 2020 — the lowest since early 2002.

Several analysts expect Petronas to ramp up capex spending and activities this year, as indicated in the Petronas Activity Outlook 2023-2025.

In a report last month, Kenanga Research said it expected Petronas to continue with its RM60 billion annual capex this year, with the upstream sector remaining the largest area of investment that will sustain the activity level.

“Petronas’ current net-cash position remains strong at RM103 billion — the highest it has ever been since end-FY2018, further helped by the current strong oil prices, and as such, we see little difficulty in Petronas meeting both its capex and dividend commitments, even if it were to raise its dividends in 2023 from the originally intended RM35 billion (from RM50 billion in 2022),” it said.

“Prime beneficiaries of higher Petronas capex, and in sustained local activity levels, include the likes of Dayang from higher demand for offshore maintenance and hook-up and commissioning works, Uzma on higher brownfield activities, as well as Velesto from the pick-up in demand for jack-up drilling rigs,” it highlighted.

According to the Petronas Activity Outlook 2023-2025, drilling, fabrication, OSV, pipelines and maintenance ops are expected to see an increase in activity in the next three years.

The national oil company is slated to announce its fourth quarter and full-year FY2022 financial results on March 13.

Debt remains an obstacle

Over the past years, low oil prices have forced many debt-laden local O&G companies to undertake major restructuring exercises, including debt restructuring, cost-cutting measures and asset disposal.

Even so, a number remain highly indebted, making them vulnerable to the cyclical nature of the sector, which still has far too many players for Malaysia’s market size. As earnings are highly correlated to movements in global crude oil prices, any shock — a looming recession, for instance — is likely to lead to lower demand and hence lower energy prices.

For instance, Velesto had a net debt of RM420.9 million as at Sept 30, 2022, while Sapura Energy Bhd’s net debt stood at RM10.21 billion as at Oct 31, 2022.

It is worth noting that Velesto’s share price has tripled over the past six months on the back of improvement in regional charter rates and demand for jack-up rigs.

For the third quarter ended Sept 30, 2022 (3QFY2022), Velesto returned to the black with a net profit of RM14.97 million, against a net loss of RM52.04 million in the same quarter last year, with an average jack-up rig utilisation of 78% (based on a capacity of six rigs) compared with 51% previously.

However, the group was still in the red in 9MFY2022 with RM74.40 million in losses, albeit lower than the RM96.25 million losses sustained in the same period the year before.

In an interview with The Edge last month, Velesto president Megat Zariman Abdul Rahim said a breakeven range of asset utilisation is at 60%, and at the time of writing, all six of Velesto’s rigs were on charter.

However, Liaw of Maybank suggested in a report that Velesto consider monetising some of its jack-up rig assets during the current upcycle to help the company arrive at a net-cash position, “de-risk from the volatile cyclical market for jack-up rigs”, and recycle its capital and diversify into a new business.

“Most of the positives (the chase for higher earnings) have been priced in, in our view. To catalyse growth and remain relevant, Velesto should take the lead to monetise some of its jack-up rigs (which are currently in demand), with a replacement value of US$85 million to US$100 million per unit,” he added.

Sapura Energy, which has experienced a number of torrid years after oil prices tanked from end-2014, is nearing the completion of its debt exercise with its creditors, it said in a recent filing with Bursa Malaysia. Last year, Sapura Energy proposed a hefty 75% haircut from its nine creditors that were owed over RM10 billion.

Interestingly, the recent oil rally has led to some differences in valuations. For instance, oil producing companies such as Hibiscus Petroleum Bhd and upstream player Bumi Armada are trading at a single-digit PE of 4.5 times and 4.95 times respectively, while service providers such Perdana Petroleum, MHB and T7 Global Bhd are trading at higher PE valuations of 33.65 times, 16.16 times and 20 times respectively.

Imran of MIDF attributes the difference in valuation to risk or stability of earnings. “Infrastructure-related companies are typically given low PE by investors, either due to relative earnings stability or capex intensity, hence possibly lower free cash flows.”

Can oil touch US$100 per barrel in 2023?

The International Energy Agency (IEA) expects global oil demand to hit a record high in 2023, averaging 101.9 million barrels per day (bpd), which is two million bpd higher than the year before.

The agency attributes the surge in demand to the reopening of China’s borders, especially for jet fuel after almost three years of lockdown, and expects Asia-Pacific to dominate global growth.

“World oil demand growth is picking up after a marked slowdown in the second half of 2022 and a year-on-year contraction in the fourth quarter. China accounts for nearly half the two million bpd projected increase this year, with neighbouring countries also set to benefit after Beijing ditched its zero-Covid policies,” the IEA said in its Feb 15 Oil Market Report.

Despite the robust demand, US-based JPMorgan is not expecting Brent crude oil prices to reach US$100 per barrel this year, unless there is a major geopolitical event.

According to a Reuters report quoting JPMorgan, the latter said Opec+ may add a new supply of oil into the market and is unlikely to defend the US$80 floor price.

However, Goldman Sachs expects Brent crude to hit US$100 per barrel this year, but only in December compared with its earlier expectations of US$100 oil in mid-2023.


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