We maintain our OVERWEIGHT call on the sector. 2QFY24 earnings remained strong, with 50% of the stocks under our coverage exceeding expectations, particularly those in the offshore support vessel (OSV) subsegment and midstream companies. Petronas’s 1HFY24 results remained largely stable YoY despite headwinds from lower LNG prices and weaker downstream spreads, as its upstream division continued to experience stronger production. While any reduction in Petronas capex spending of RM60b is being closely watched (1H25: RM25.7b), we have seen higher domestic allocation YoY by 18%, which reinforces the idea that it will be able to allocate more towards domestic spending. This is especially so given the added flexibility of Canadian LNG capex cycle expected to conclude by year-end. Amid other regional demand as well, we expect activity of upstream service providers especially to increase amid tight supply given still increasing regional demand. Top picks of the sector are DIALOG (OP; TP: RM3.37), DAYANG (OP; TP: RM3.80 and WASCO (OP; TP: RM1.70).

Decent report card delivered. Overall, 2QFY24 was strong for the sector, with 50% of our coverage posting stronger-thanexpected results and 13% exceeding consensus expectations. Moving forward, upstream service providers remain bullish on their near- to medium-term outlook (stretching into 2025), as they continue to see an increase in bidding for service contracts in Malaysia as Petronas and other oil producers aim to catch up with their upstream capex plans. KEYFIELD remains a highlight for the results season (for the second consecutive time), as daily charter rates (DCRs) sustained their upward momentum due to the tightening OSV supply market. DAYANG also maintained an upbeat outlook, as the next cycle of umbrella topside maintenance and maintenance, construction, and modification (MCM) projects are expected to be awarded by Petronas and other oil producers. These contracts typically span 4-10 years and are valued at RM8-10b in total, awarded on a call-out basis.

VELESTO remains confident that rig utilisation will at least be maintained YoY in FY25F, despite recent concerns over PETROS taking over the gas aggregator role, which could discourage Petronas from ramping up exploration in Sarawak waters. This is because regional demand for jack-up rigs has continued to rise. The midstream outlook remains robust, with DIALOG anticipating further recovery in its EPCC margins as cost structures realign, while demand for tank terminal storage in the ASEAN region remains strong due to ongoing geopolitical tensions (e.g., Red Sea attacks by the Houthis) and the lack of expansion in tank terminal capacity in the region. The only exception to the otherwise positive outlook is PCHEM, where the near-term earnings outlook remains tepid due to the full commencement of operations at the Pengerang Integrated Complex (PIC). However, some early signs of recovery were observed in recent results, as the specialty chemicals division showed improved margins due to more favourable product spreads, supported by an early but uneven recovery in the European industrial and construction sectors.

Petronas results largely stable. In 1HFY24, Petronas Group’s core profit grew by 4% YoY, driven by higher production of barrels of oil equivalent (+2% YoY) and increased natural gas production. The gas and new energy division posted weaker PAT due to lower average realised LNG prices amid higher global LNG supply. The downstream division also reported weaker PAT YoY due to narrower product spreads. Cash flow from operations remained largely stable in 1HFY24, with only a 5% YoY decline amid challenges in the gas and new energy and downstream divisions. Petronas spent RM25.7b in capex during 1HFY24, a 20% increase from last year. Domestic capex surged 18% YoY, driven by near-shore floating LNG projects in Sabah and the Gansar & Integrated Bekok oil project in Peninsular Malaysia. Outside the domestic space, foreign investments included an LNG export facility in Canada and Gentari’s spending on green ammonia projects in India.

Remains disciplined on capex spending but with head-room for domestic spending. Petronas has maintained a cautious approach to spending amid macroeconomic uncertainties, committing to preserving value through cost rationalisation and valuefocused investments. With its operating cash flows intact and an approved dividend of RM32b for FY24 (compared to RM40b in FY23), we believe the group can still ramp up its domestic investments, even if it underspends on its RM60b annual capex target. The new energy capex is expected to remain manageable at 18%, while foreign capex, particularly for the Canada LNG project, is expected to enter its final phase by the end of FY24. According to Business Times, the Canada LNG project is expected to start generating cash flows in 2025.

Sarawak remains a key strategic area for the group. We believe these developments will allow Petronas to redirect more of its capex budget into the domestic market, which has been under-invested in the last five years, to prevent a steep natural production decline in Malaysia. Regarding ongoing discussions between Petronas and Sarawak over the state’s gas distribution, Petronas has emphasised that both parties remain strategic partners in the development of hydrocarbon resources. Therefore, we expect upstream capex in Sarawak’s offshore areas to remain intact in the longer term, although slight delays may occur in the short term as the details of the agreement are still being finalised. In our view, this would be a short-term hiccup for upstream service providers in Malaysia and they remain in a favourable position in the domestic upstream market due to tightening availability of contractors, and we anticipate a ramp-up in activities in 2025 overall.

We maintain our sector call to at OVERWEIGHT with the same emphasis placed on upstream service providers and midstream player due to favourable macro-outlook. In our view, the upstream services industry is already in the middle of an upcycle with contract terms improving for the upstream service providers due to higher demand from Petronas and significantly lower contractor availability (compared to 2013-2014). We expect the bullish trend to sustain throughout 2024 and even 2025 as there are still no clear signs of entry in the market by new players yet. Downstream outlook remains tepid due to overcapacity globally and slow recovery in global demand but the specialty chemical market is showing early recovery signs. However, the further improvement in downstream product prices still hinges on the outlook of major economies particularly China and Europe.

Our sector top picks are: -

i. DIALOG given the recovery in the spot tank terminal markets, gradually improving prospects of further expansion in capacities under Pengerang Phase 3 and turnaround in margins for its EPCC, plant maintenance and specialist product businesses,

ii. DAYANG is well-positioned due to its exposure to brownfield maintenance activities in the upstream sector, specifically in hook-up & commissioning and topside maintenance. Its earnings growth will also be boosted by its marine division, which benefits from the booming offshore support vessel (OSV) subsegment.

iii. WASCO remains attractive as its pipe-coating business is largely driven by global capex investments, which are still on an upward trend. In our view, the recent sell-down is overdone, with its FY25F PER at 6.8x, significantly below its 5-year historical average of 11.3x.

Source: Kenanga Research - 6 Sept 2024