Highlights

Oil price plunged below US$80/bbl level… WTI fell to US$66/bbl and Brent dropped to US$70/bbl after OPEC’s decision to not cut output. We have mentioned if Brent fell below US$80/bbl, oil companies might reduce capex on new projects. Petronas is forecasting Brent to average US$70- 75/bbl next year. Given the oversupply issue will only adjusted if there is any reduction from US shale’s production, we now expect oil price to continue remained weak for next 6 months before seeing price rebound in 2H15.

Petronas cut capex but RAPID will continue … Petronas announced that it will cut capex by 15% to 20% next year amidst low oil price. However, the RAPID project worth US$27bn that have received FD I will not be affected and new RSC contracts will only be awarded if oil price is above US$80/bbl albeit breakeven cost of US$65/bbl.

Dry spell for O&G sector in near term… Capex will remain to prevent production from falling. But decreasing oil price coupled with lack of near term sizeable contracts newsflow for local upstream sector will continue to dampen investor’s sentiment.

Further P/E De -rating… Given that oil price is likely to continue stay low for next 6 months (previously we assumed mid-term of US$80-90), negative sentiment, capex cut and lack of sizeable contract news flow for upstream sector, we further reduced target P/E for big cap from 16x to 14x with small and mid-cap reduced from 12 -14x to 11x. Thus, TPs were reduced by average 12% across our universe.

Selective play with focus on RAPID and brownfield development. In a declining oil pric e environment, exploration activities will be impacted first with number of drilling decreasing. Apart from E&P companies such as SPAC which will be affected directly by lower oil price, service providers such as drilling and OSV will see decreasing order from lower exploration activities. Hence, we prefer to be selective and favour companies that have exposure to RAPID and brownfield development. Favourite picks for RAPID are KNM (BUY;TP RM0.83), Dialog (Non- Rated) while Dayang (BUY;TP: RM3.21) and Perdana (BUY; TP: RM1.54) will benefit from increasing brownfield development s.

Rating

NEUTRAL

• Positives: Capex plan from oil operators to continue to maintain oil and gas production.
• Negatives: Delay in contract rollout and low oil price environment lead to competition and margin compression.

Valuation

• Recommendation changes after reduced target P/E Downgrade: UMW O&G from Hold to Sell, Scomi Energy from Buy to Hold. Upgrade: Uzma from Hold to Buy
• Top picks: Big Cap: Dayang / Mid to Small cap: KNM and Perdana

Source: Hong Leong Investment Bank Research - 1 Dec 2014