Oil and gas (O&G) sector
Maintain “neutral”: This sector was the main casualty of the market selldowns on the back of: i) uninspiring crude oil prices; ii) Organization of Petroleum Exporting Countries’ decision to maintain its production at 30 million barrels per day at end-November; iii) Petroliam Nasional Bhd’s (Petronas) statement that it will cut 2015 capital expenditure (capex) by 15% to 20%; iv) the dismal third quarter of 2014 (3Q14) results season; and v) Saudi Arabia’s cut in January prices to US and Asian buyers.

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 US$70 (RM245) per barrel for 2015. Based on our simulation studies; at the crude oil price of US$70 per barrel, the sector average forward trading price-earnings ratio (PER) stands at 12 times. Despite the significant sector derating, we still believe the underlying environment remains unsupportive of a meaningful near-term rebound. The short-term crude oil price trend is still volatile while sluggish contract award flows (a major catalyst for share price reratings for domestic stocks) with Petronas already stating capex cuts will cap sentiment as well.

Sector valuations rejigged and earnings forecasts trimmed. In lieu of our neutral outlook, we have adjusted our target calendar year 2015 (CY15) PER on large-cap stocks to 13 to 19.5 times (from 16 to 22.7 times previously) and small- and mid-cap stocks to seven to 10 times (from 10 to 12 times previously). We have also reviewed and trimmed the financial year 2015 net profit estimates of selected companies as we opt to be conservative on activities for the time being. 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 one to two 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 capex-centric segments (that are  fabrication or speculative asset buildings) and take note of those which are exposed to the exploration and production segment.

For the big-cap space, we favour SapuraKencana Petroleum Bhd for its improved risk-to-reward dynamics post the significant share price decline and Petronas Gas Bhd 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- and mid-cap space, we see value emerging for Barakah Offshore Petroleum Bhd again given the attractive CY15 PER of 4.7 times (a significant discount to other peers which trade at six to eight times CY15 PER). — Kenanga Research, Dec 30

This article first appeared in The Edge Financial Daily, on December 31, 2014.