MARKET SENTIMENT on oil and gas (O&G) stocks seems to have changed drastically, judging by the recent heavy selldown in them.

Only a year ago, the sector was much sought after by fund managers and the stocks were a “screaming buy” on Bursa Malaysia.

So, what has gone wrong in the industry?

Falling crude oil prices are seen as the cause of the selling pressure, but analysts opine this is only an “excuse” for investors to take profit in O&G stocks, most of which had surged to multi-year highs, if not new peaks.

“The continued drop in crude oil has surely dampened sentiments. But there is unlikely to be any major hit on the local O&G companies’ earnings as most of them have already secured contracts that could last them two years,” says an  insurance fund manager.

He believes disappointing earnings are the main cause of the selling, partly because some of the major contracts awarded by Petroliam Nasional Bhd (Petronas) have not been reactivated.

“Earnings delivery wasn’t there …  so far the figures are either in line with or below expectations. None has announced a pleasant surprise,” says the fund manager, noting that there would be bargain-hunting opportunities should share prices slide further.

“Corporate earnings will pick up next year. However, visibility will get blur beyond the two-year horizon when the existing contracts end,” he adds.

Analysts believe the upstream players in the O&G industry have more to worry about than the downstream players.

The upstream segment is expected to see a slowdown in contract flows while the downstream segment will continue to be driven by jobs in the Refinery and Petrochemical Integrated Development (RAPID) project.

Kenanga Research’s Teh Kian Yeong, who has a “neutral” rating on the sector, says the upstream segment has been sluggish, adding that foreign awards fuelled the bulk of the RM5.6 billion worth of contracts in the third quarter this year.

“Some of the anticipated upstream contracts, such as fabrication, offshore support vessels and inspection, repair and maintenance (IRM), may only emerge at the very end of 2014 and run the risk of spilling over into 2015.”

Nevertheless, Teh says it is not all gloom and doom for the O&G industry. He is of the view that the downstream segment will continue to shine, thanks to the rollout of jobs.

“Only about RM27 billion worth of contracts out of an estimated RM51 billion have been dished out thus far. More is expected from the downstream segment in the medium term,” he says, adding that some of the awards have already been priced into the stock prices.

Industry analysts advise investors to stay away from stocks that have not locked in long-term contracts.

RHB Research’s Kong Ho Meng has downgraded four stocks so far — Perisai Petroleum Teknologi Bhd, Muhibbah Engineering (M) Bhd, Daya Materials Bhd and Malaysia Marine and Heavy Engineering Holdings Bhd.

He says the common themes of these four downgrades were a slow order book replenishment rate, underutilised assets and operational uncertainties, resulting in low margins.

Kong has also turned cautious on the O&G sector as he believes the current valuations are unsustainable.

“We believe that as players expand abroad, the big gap in valuations (compared to their regional and global peers) should narrow and Malaysian O&G stocks should shed their premiums.”

Currently, Malaysian O&G stocks are valued higher than their regional and global peers, albeit on a lower earnings base and market share, says Kong.

Amid investors’ cautious approach, analysts expect the focus to primarily be on subcontractors and suppliers, such as KNM Group Bhd and Pantech Group Holdings Bhd.

Other counters that are favoured include Wah Seong Corp Bhd, Dialog Group Bhd, Dayang Enterprise Holdings Bhd and Alam Maritim Resources Bhd.

Among the O&G stocks that have been falling since August are Yinson Holdings Bhd (-22.3% to RM2.70), Coastal Contracts Bhd (-21.2% to RM4.20), Bumi Armada Bhd (-20% to RM1.64),  UMW Oil & Gas Corp Bhd (-19.2% to RM3.30) and SapuraKencana Petroleum Bhd (-16.5% to RM3.68).

Besides falling crude oil prices and less-than-impressive earnings, some analysts and fund managers are also concerned about Petronas cutting its capital expenditure (capex).

They observe that the negative sentiment began when Petronas president and CEO Tan Sri Shamsul Azhar Abbas guided that the national oil company could reduce its 2015 capex.

He also cautioned upstream O&G players against going on a buying spree, as there are insufficient contracts to go around. This statement was a cautionary message to the industry, especially upstream players.

A fund manager tells The Edge that there are uncertainties on the horizon, because of speculation about a possible change of the guard at the national oil company. Should that happen, it would mean changes to Petronas’ capex policy and so on. “Will the new chieftain spend as much or less? Will he want to continue efforts on reviving mature fields, meaning EOR (enhanced oil recovery)?” asks the fund manager.

This year, Petronas has spent the bulk of its capex on its floating liquefied natural gas facility and the implementation of chemical enhanced oil recovery (CEOR) projects.

Crude oil prices slid below the US$90 per barrel level last week amidst concerns about oversupply as demand is expected to grow at a slower pace.

The persistent decline surprised many as the geopolitical tension in the Middle East and Russia was expected to drive the prices up.

The benchmark Brent crude fell to US$89.05 per barrel last Friday, a level not seen since November 2010, while West Texas Intermediate (WTI) dropped to US$84.62 per barrel.

Crude oil prices have tumbled by almost a third from their peak of US$115 per barrel in June, at which point they had remained above US$100 for a year.

Analysts attribute this to muted demand and ample supply.

“In recent weeks, the market has remained focused on the supply and demand fundamentals, which look overwhelmingly bearish,” Vandana Hari, editorial director at Platts McGraw Hill Financial Asia, tells The Edge.

“These factors, especially on the demand side, are not going to change anytime soon. In my view, there is a lot of uncertainty in the oil market, especially when it comes to geopolitical problems.”

She reckons that crude will only rise above US$100 per barrel after its recent fall if there is a major disruption in supply.

The Organization of the Petroleum Exporting Countries (Opec) has been pumping more than 30 million barrels per day, which is a collective target agreed to by each of its members. But now that crude has dropped below the benchmark of US$90 per barrel, many expect Opec to intervene to stabilise prices.

According to the organisation’s oil market report for September, world demand this year is expected to reach 1.05 million barrels per day (mbpd) and supply 1.68 mbpd. For 2015, Opec forecasts a demand of 1.19 mbpd and higher supply of 1.24 mbpd.

Moving forward, Credit Suisse believes Brent crude will remain in a new range of US$97 per barrel in 2015 while WTI will average US$89 per barrel. It predicts that prices will grind down to US$86 and US$80 per barrel respectively in 2016 and 2017. — By Madiha Fuad and Fatin Rasyiqah Mustaza

This article first appeared in The Edge Malaysia Weekly, on October 13 - 19, 2014.

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