Worst is over for oil & gas sector: Affin Hwang Capital

PETALING JAYA: The oil and gas sector is expected to fare better this year, said Affin Hwang Capital, which upgraded the sector to “neutral” based on a better risk-reward profile.

“We believe the worst is now over for the sector as the supply-demand dynamics are poised to rebalance earlier than expected, which we think should mitigate downside risk for oil prices. We expect contract flows to recover, which we think would then drive higher corporate earnings in the longer term,” it said in its report.

As of Dec 30, 2016, total contract value announced stood at RM1.683 billion in Q4 16, which was at a slightly higher level than in Q2 16, where contract values bottomed at RM1.51 billion. Total contract flows for the full year were RM12.5 billion, 49% lower than RM24.5 billion in 2015.

Based on its market research on prospective tenders in the pipeline, Affin Hwang Capital expects 2017 to be a turnaround year, with a few sizeable contracts likely to be up for grabs in the coming quarters.

These include the replacement contract for Pan Malaysia transportation and installation contracts, which come with another two-year extension option and could be worth up to RM10 billion; six packages of modification, construction and maintenance work valued at up to RM5 billion over five years; and onshore plant maintenance contracts involving 48 plants worth up to RM2.5 billion.

For 2017, Affin Hwang Capital expects more mergers and acquisitions (M&A), with UMW Oil & Gas Corp Bhd kick-starting the year with the first sector M&A with Icon Offshore Bhd.

“It has been four years since we witnessed the last major M&A activity, when SapuraCrest and Kencana Petroleum merged, resulting in a massive RM12 billion entity. With the improving oil price environment providing a better window of opportunity, we expect to see more M&A activity, especially on distressed companies,” it said.

The expectation gap between the “bid-ask spread” would be narrowed, leading to more deals emerging and offshore support vessel (OSV) companies have been hot targets for acquisitions such as Perdana Petroleum Bhd and Icon Offshore, which tend to have high gearing due to capital-intensive business models.

Affin Hwang Capital expects higher risk of default among companies this year and believes investors should avoid companies with high immediate-term risk, particularly in the small-mid cap space.

“We continue to favour companies that focus on the production space (versus exploration) and have a resilient earnings business model which tends to be recurring in nature, like Bumi Armada Bhd,” it said.

Affin Hwang Capital’s average Brent oil price assumptions for 2017 and 2018 are US$55/bbl and US$60/bbl respectively, on expectations of a faster-than-expected drawdown in inventories following the OPEC and non-OPEC joint effort in cutting production levels.

“We look for an overall sector earnings decline of 14% year-on-year in 2016 as well as a gradual recovery of 4% year-on-year in 2017 and 11% year-on-year in 2018, based on prevailing consensus views,” it said.

Its large-cap top pick is Bumi Armada while its small-cap top pick is Petra Energy Bhd.