This article first appeared in The Edge Financial Daily on August 13, 2018

KUALA LUMPUR: An unexpected bright spot this year, the oil and gas (O&G) sector is expected to continue on a recovery path with upstream companies gradually stepping up production and boosting other firms involved in the industry.

The coming quarterly results over the next two to three weeks are expected to give a clearer indication of the state of the sector.

“I think the oil and gas sector is likely to be one of those bright spots that analysts are looking for,” Rakuten Trade Sdn Bhd vice-president of research Vincent Lau said. Although the recovery has been gradual, he believes it should meet market expectations.

As the improved earnings outlook for the O&G sector has only taken place recently, the coming earnings season will signal if improved oil prices have finally translated into better earnings for most of these companies.

Take Velesto Energy Bhd — formerly known as UMW Oil & Gas Corp Bhd — as an example. Twelve months ago, the consensus view was Velesto Energy would record an average estimate net loss of about RM140.1 million for financial year ending Dec 31, 2018 (FY18). But as oil prices continue its steadily climb to above US$70 (RM286.02) per barrel, the earnings outlook also improved. Prior to the announcement of its first-quarter (1Q) results for the period ended March 31 where it posted a net profit of RM5 million, the market had already reduced the expected net loss in FY18 to about RM14.2 million.

Earnings upgrades over the past few months have come on the back of announcements of drilling contracts won as they have reaffirmed the analysts’ view that rig utilisations are improving. The current consensus estimate for Velesto Energy’s FY18 net profit is RM12.3 million, an improvement of 20.6% from the average estimate of RM10.24 million just a month ago.

Tan Jianyuan, an analyst at Affin Hwang Investment Bank Bhd, said in his report last Friday that Velesto Energy had secured two short-term drilling contracts for its Naga 3 and Naga 5 jack-up rigs from Petronas Carigali Sdn Bhd for a combined contract of US$10.8 million. “We are positive about this batch of contracts as it further solidifies our view of improving second half 2018 rig utilisation rates,” Tan said, adding that the post-impairment lower depreciation and finance cost with the restructured balance sheet will also lift the burden off the group.

A fund manager with a local asset management company agreed that the outlook for Velesto Energy has improved but said the group’s earnings in the second quarter are unlikely to impress. Still, he acknowledged that some of the new contracts won will contribute to its earnings in the second half of FY18.

Other than Velesto Energy, other O&G-related companies such as Petronas Dagangan Bhd, which is the marketing arm of Petroliam Nasional Bhd (Petronas), has also seen earnings upgrades.

Prior to 2018, the consensus earnings for Petronas Dagangan for FY18 hovered below RM1 billion. However, the latest data saw an average estimate net profit of RM1.026 billion. Hong Leong Investment Bank analyst Yip Kah Ming, who was the least optimistic, expected the group to record a net profit of RM909.0 million while TA Securities Holdings Bhd’s Kylie Chan, has the highest estimate net profit of RM1.13 billion.

Dialog Group Bhd, which has been one of the few listed O&G companies that have continued to record strong growth since the oil price plummeted in the second half of 2014, has remained solid. Its net profit jumped by 71.7% to RM370.6 million in its financial year ended June 30, 2017 (FY17) against RM215.9 million in FY14. The group has also registered a total return of 127.6% over the last three years or an annualised return of 31.6%. In 3QFY18, Dialog recorded a net profit of RM395.5 million, which is about 87.9% of the full-year consensus estimate. Given its consistent growth in the last few years, analysts have been revising upwards their earnings estimates for Dialog since the beginning of 2017.

One of the key drivers for the improved earnings outlook is the resilience of oil prices, which have climbed far above US$70 per barrel since April this year. Prices have managed to sustain above the level despite recent volatility arising from concerns of an oversupply as Saudi Arabia and other large producers ramp up production.

The danger of high expectations

Of the 16 O&G companies covered by analysts, 11 of them are expected to turn profitable in their current financial year. However, the earnings upgrades seen in the last couple of months for most of the O&G players have lifted expectations and could lead to disappointment if the companies fail to deliver.

Malaysia Marine and Heavy Engineering Holdings Bhd, a global marine and heavy engineering solutions provider, saw a decline in its share price after its 2Q financial results failed to meet expectations when it posted a second successive quarter of losses. Prior to that, analysts were expecting the group to be in the black in FY18 with a net profit of RM25.1 million. Following the disappointing quarter, its earnings were downgraded to an average net loss of RM30.9 million.

A look at the 32 companies that have announced their financial results and the analysts’ expectations show that 15 companies have received an earnings downgrade after their second-quarter results while 14 have been upgraded. The remaining three companies’ earnings expectations were maintained for their current financial year.

Earnings for the quarter were less than exciting as 14 companies failed to meet expectations while only six companies exceeded analysts’ expectations. The remaining 12 managed to meet expectations.

Decent 2Q for semiconductor players?

As most of the companies are only expected to announce their 2Q earnings beginning next week, it may be too early to determine if growth can be sustained. As E&E continues to remain one of the drivers of economic growth in the first half of the year (1H), many believe that semiconductors which form part of the E&E products, might be able to sustain decent earnings in the 2Q, and improve in the 2H.

Semiconductor companies that have announced their 2Q earnings so far include Globetronics Technology Bhd, ViTrox Corp Bhd and Unisem (M) Bhd. Both Globetronics and ViTrox have met analysts’ expectations and saw earnings upgrades but Unisem has underperformed, leading to an earnings downgrade.

Kevin Low from Affin Hwang believes that there is upside potential for Globetronics, as despite a weaker 2QFY18 earnings — largely anticipated — the group’s core net profit for 1HFY18 rose 85% year-on-year.

“We expect 2HFY18 to be significantly stronger, driven by sensor volume normalisation and on added capacity,” Low said.

However, there are concerns the trade conflict between US and China may derail growth and disrupt businesses despite the development of 5G technologies.