This article first appeared in The Edge Financial Daily, on April 15, 2016.

Oil and gas sector
Maintain neutral: It is a volatile period for crude oil whereby prices plunged to a low of US$26 (RM101) per barrel (bbl) and have rebounded to more than US$40/bbl within the span of four months despite largely unchanged oil market fundamentals. 

Oil surplus of close to two million bbls per day is still anticipated for 2016. The recent surge in oil prices seemed to have priced in potential production control to be agreed upon among the Organization of the Petroleum Exporting Countries (Opec) and non-Opec countries in the Doha meeting on Sunday, of which its outcome would be the key driver of oil price movements going ahead.

We maintain our bearish view for 2016 on oil prices as: i) oversupply is still expected to persist; and ii) oil inventory is still at an all-time high despite a recent inventory draw. The target for this year remains at US$30 to US$35/bbl, while the 2017 target for Brent would be US$45 to US$50/bbl. Premature recovery in oil prices, in our opinion, would stifle the long-term recovery of the industry. The market is able to reverse back to its oversupplied level swiftly from restarts of US shale drilling.

In 2015, we had seen RM3.6 billion worth of impairments done by local asset players. However, we believe it is not sufficient given that charter rates have plunged 30% to 40% with some assets completely unutilised. For readjustment to the new rate norm, cash cost savings (staff costs, contractor costs) are not sufficient for the group to maintain profit and loss positive. Asset players need to impair their assets to a greater extent to bring down their overall cost structure through lesser depreciation. Asset value is, in our opinion, expected to stay in the level lower than seen before during the US$100/bbl oil era as the oversupply situation is still present.

Overall, the local oil and gas (O&G) companies still look rather healthy from the cash flow perspective with operating cash flow/sales at more than 20% on average, while operating cash flow/interest remains healthy at more than three times. Dayang Enterprise Holdings Bhd is singled out as the ideal long-term pick with high cash generation, coupled with a balanced business mix. Investors are advocated to buy on weakness of its share price in the coming quarters as weaker earnings are posted. Icon Offshore Bhd and Malaysia Marine and Heavy Engineering Holdings Bhd also appear to have strong cash positions rendering them more stable than the others amid industry headwinds.

The O&G sector remains primarily as a trading sector for shorter-term traders due to high volatility in share prices and oil prices. SapuraKencana Petroleum Bhd remains as the best trading stock with volatile share prices correlated to oil prices. But investors have to take note that the near-term share price overhang remains given the risk of it being taken off as a FBM KLCI constituent in the upcoming review. 

This year would be even tougher for O&G counters with a full-blown impact of the downturn on earnings to be reflected. Longer-term investors could buy strong cash-generative companies on weakness throughout the year to position for industry recovery in 2017.

Overall, we remain “neutral” on the sector given that the fundamental shift in the sector is not imminent to a price-earnings ratio rerating in the meantime. — Hong Leong Investment Bank Research, April 14