The oil & gas sector was the main casualty of the recent heavy stock selldown following the plunge in crude oil prices and the dismal 3QCY14 results season. Not of help was Petronas announcing 15%-20% capex cut for 2015, which spooked the market even further. The biggest question now is the direction of crude oil price. Our Monte Carlo Simulation Study suggests a high chance that the ICE Brent Futures (spot month contract) could trade at an average of USD70/bbl for 2015; implying that the sector should trade at an average forward PER of 12x. Given such outlook, coupled with the fact that there could be continued sluggishness in contract flows (which is also imperative for domestic sector re-ratings); we have adjusted our target CY15 PER for stocks under our coverage. In such uncertain times, we continue to favour stocks that have strong order books and/or companies with exposure to the brownfield/rejuvenation segment. Our Top Pick is SKPETRO.

A lacklustre year-end. This sector was the main casualty of the market selldowns on the back of: (i) uninspiring crude oil prices, (ii) OPEC’s decision to maintain its production at 30.0mb/d in end-Nov, (iii) Petronas’ statement that it will cut 2015 capex by 15-20%, (iv) the dismal 3Q14 results season, and (v) Saudi Arabia’s cut in January prices to U.S. and Asian buyers.

USD70/bbl in 2015, implies sector average forward trading PER of 12x. Our Monte Carlo Simulation Study suggests that there is a high chance for the ICE Brent Futures (spot month contract) to trade at an average of USD70/bbl for 2015. Based on our simulation studies; at crude oil price of USD70/bbl, the sector average forward trading PER stands at 12x.

Still NEUTRAL for now. Despite significant sector de-rating, we still believe the underlying environment remains unsupportive of a meaningful near-term rebound. Short-term crude oil price trend is still volatile while sluggish contract award flows (a major catalyst for share price re-ratings for domestic stocks) with Petronas already stating capex cuts will cap sentiment as well.

Sector valuations re-jigged and earnings forecasts trimmed. In lieu of our neutral outlook, we have adjusted our target CY15 PERs on large-cap stocks to 13-19.5x (from 16-22.7x previously) and small-&-mid cap stocks to 7-10x (from 10-12x previously). We have also reviewed and trimmed the FY15 net profit estimates of selected companies as we opt to be conservative on activities for the time being.

Favour order book and brownfield-centric stocks. We may sound like broken records, but in light of the sector uncertainty, we favour companies with: (i) strong existing order-books as they provide some form of earnings certainty over the next 1-2 years, and/or (ii) companies that have exposure to the brownfield/rejuvenation segment which will be relatively unscathed from capex-cut impacts. We would avoid companies that are related to capexcentric segments (ie. fabrication or speculative asset buildings) and take note of those which are exposed to the E&P segment (as crude oil prices continue to be volatile).

Top picks. For the big cap space, we favour SKPETRO (OP; TP: RM3.03) for its improved risk-to-reward dynamics post the significant share price decline and PETGAS (MP; TP: RM22.14) should be a core-holding for portfolio-benchmarking purposes albeit it is fairly valued for now, given its sustainable earnings that are derived from concession assets. Within the small-&-mid cap space, we see value emerging for BARAKAH (OP; TP: RM1.34) again given the attractive CY15 PER of 4.7x (a significant discount to other peers which trade at 6-8x CY15 PER).

3Q14 setbacks. The 3Q14 earnings report card was a big disappointment with 7 results coming in below, 6 within, and only 2 above, our estimates. The largest disappointment came from PERISAI which barely scratched 1% of both our, and consensus’ estimates as higher-than-expected mobilisation and commissioning costs for its maiden jack-up rig (that started to contribute in 3Q14) ate into margins. This was a significant hit to the company's bottomline which was already suffering from two idle vessels (E3- pipelay barge; and Rubicone - MOPU). Meanwhile, for the other stocks within our coverage; most of the results disappointments were mainly due to slower-than-expected project performance and/or lower-than-expected margins. We believe the 4Q14 results season will be similarly uneventful given the onset of monsoon season where offshore asset utilisation is typically slower. Hence, it might be a quiet ending for 2014.

Petronas makes good on its previous capex-cut warnings. In our previous strategy reports we mentioned that Petronas has hinted of CY15 capex reductions since 2QCY14. On Nov-27, it made good on its hints and declared that: (i) it is going through with a 15-20% capex cut, (ii) Petronas will not proceed with contracts to award new marginal oil fields unless the crude oil price settles above USD80/bbl, and (iii) projects in Pengerang that have yet to receive the final investment decision (FID) will be affected by the cut-backs. Whilst we were mildly negative on this statement earlier, it is now loud and clear that the segment will see slower contract flows as Petronas reins in spending; especially on its new project commitments. For 4Q14, local oilfield companies saw c.RM4.6b of contracts; but this was skewed towards the Pengerang LNG project that was awarded to consortium members PETGAS and DIALOG. Worth RM2.7b, this implies that contracts other than those in RAPID have dwindled by 65.1% qoq, largely because of slower activity and/or projects are going to international bidders (instead of domestic players). Overall, CY14 saw contract wins of RM53.9b (versus RM44b in CY13). However 51% of CY14’s contract wins were from the downstream segment; where-else for CY13 it was mainly upstream contracts.

Source: Kenanga