More headwinds for oil and gas sector

  • Business
  • Thursday, 03 Sep 2015

Investors advised to limit their exposure to the sector

PETALING JAYA: Despite the recent decline in share prices in the oil and gas (O&G) sector, it has not bottomed out yet and more earnings disappointments are expected, says Kenanga Research in a report.

The research house pointed out that while the overall sector’s valuation had come down in the past six months due to the general market selldown, it believed more earnings disappointments and an expected volatility in crude oil prices would continue to hamper the sector.

It noted that big market capitalisation companies in the sector were trading at an average of 14.2 times earnings, while smaller capitalised ones are at a 12 times earnings average.

Kenanga said these valuations were still higher than its targeted price-to-earnings ratio (PER) of 10 times and 7 times respectively for oil and gas stocks, based on its analysis using an assumption of a US$40 per barrel oil price.

“Investors should limit their exposure to the sector, for the time being, unless they adopt a longer investment horizon (more than 1-year) to justify the bottom-fishing approach.

“For now, we prefer players with more resilient earnings profile namely Dialog Group Bhd, Yinson Holdings Bhd and Bumi Armada Bhd. Notwithstanding, oil prices and sector’s valuation should be continuously monitored for suitable entry opportunities,” Kenanga said.

It reiterated its “neutral” call on the sector.

It said after rallying to US$60-US$70 per barrel in the second quarter of 2015, Brent crude prices resumed the downtrend post the peak US summer driving season.

The research house said this reflected the market’s fear of persistently high oil inventory levels, the slowdown in the Chinese economy and the sanction lifting on Iran’s oil exports, which would flood more oil to the already oversupplied crude oil market.

“This has sent the local O&G sector market valuations (excluding downstream and Petronas stocks) down to an average of 9.2 times of 2016 PER,” the report by Kenanga stated.

Kenanga believed that the low oil price environment would remain at least until late 2016 after considering several factors.

The factors include the incoming Iranian oil supply, which could add 400,000-600,000 barrels per day to the market in six months after the sanction lifting, the slowdown in China oil demand, high US crude inventory, and OPEC’s will to maintain or maybe even increase its output to defend market share.

Given the scenario, Kenanga said oil and gas players had to realign their costing structure and business model to survive in a prolonged oil price slump for the medium-term instead of hoping for a sharp rebound in oil prices.

“Beyond 2016, however, a turning point in world oil supply could be seen as effects of capital expenditure cuts by oil majors in the world starts to set in, resulting in oil production decline in the longer run,” it said.

Meanwhile, Kenanga said that eight out of 18 oil and gas players under its coverage reported earnings below expectations, particularly offshore support vessel (OSV) players and jack-up rig asset owners, owing to reduction in asset utilisation and discounts in charter rates amid a slump in the O&G industry.

zon the flipside, it said downstream-related players fared better in the quarter, such as Dialog and Yinson.

The research house also pointed out that Petronas Dagangan Bhd beat expectations in the quarter due to the favourable Mean of Plats Singapore (MOPS) movement.

“Overall, things could get worse in the second half of 2015 as more assets reach the tail-end of their contracts with poor prospects of contract renewals amid the approaching monsoon season,” Kenanga said.

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