OIL and gas stocks are on fire again with many of them having surged since the Organization of the Petroleum Exporting Countries (Opec) announced last November that it would cut crude oil output from January — its first reduction in eight years.

However, the recovery in these stocks belies the unexciting outlook for the sector. The issues that have plagued O&G players since crude oil prices began to crumble, for example a dearth of contracts and depressed charter rates, are still there, say fund managers and analysts.

A glance at 25 Bursa Malaysia-listed O&G players reveals that the majority of them saw double-digit percentage gains in December alone with some advancing as much as 46.4% in that month. The rally continued for some of the stocks in January as the Opec output cuts began.

Market observers whom The Edge spoke to see this as an indication of improving sentiment, spurred by Opec’s decision. To recap, the cartel aims to cut production by 1.2 million barrels a day between January and June this year as it seeks to reduce a supply glut that has depressed global prices since mid-2014.

The improved sentiment has boosted valuations to more reasonable levels so far compared with a year ago, comments Areca Capital CEO Danny Wong Teck Meng. “[However] I don’t think the current prices reflect real value as confidence hasn’t fully returned,” he says, adding that the depressed valuations of a year ago were partly due to panic.

Reports say Opec may have cut output by 900,000 barrels in January.

Unsurprisingly, Brent crude has stabilised above US$53 per barrel since the output cut began, after dipping to a low of US$29 in January last year.

According to The Wall Street Journal, compliance with the output cut among Opec members is around 88% on a net basis compared with 50% to 60% seen in previous reductions.

This May, Opec is scheduled to meet and decide whether its output cut will continue during the July-December period. A pressing consideration influencing the decision will be whether the lower incoming supply from its cut will be mitigated by higher production elsewhere. For example, the US is expected to see its oil production rebound 1.3% to over nine million barrels a day this year, according to an estimate by the US Energy Information Administration.

A local analyst expects the rally in oil stocks to lose momentum unless crude prices somehow breach the US$60 per barrel threshold. However, it must be noted that some of the counters surveyed had rallied due to company-specific reasons, such as a looming privatisation offer in Icon Offshore Bhd’s case.

“There are no short-term catalysts apart from improving crude oil prices, which has already happened,” says the analyst, who declined to be named.

Wong opines that the current crude prices are acceptable and does not think they will breach US$60 on a sustained basis in the near future. What is more critical, he says, is stability as it would help O&G players make clearer projections and plan ahead. “The only worry is the upstream players who are highly geared. This [how they manage borrowings] is an area to carefully watch,” he adds.

While the newfound bottom — for now — for crude prices may have improved investor sentiment, many listed O&G players remain in choppy waters and must navigate carefully to survive.

An assessment of 39 O&G-linked stocks on Bursa, using Bloomberg data and calculations, reveals that most may still be producing poor scores on various metrics used to gauge their financial health. However, it must be noted that any one assessment metric cannot provide a complete picture of a company’s situation and must be read with other information. The calculations rely on historical data and do not necessarily indicate future performance.

One metric used is the current ratio, which essentially measures a company’s liquidity by comparing its short-term assets with its short-term liabilities — a ratio below 1.0 indicates potential trouble if the company’s debts come due immediately.

Overall, the O&G sector’s total gearing — calculated by using the total debt versus total equity of all companies surveyed — is at 68.1%. The 39 companies surveyed collectively have over RM50 billion in debt, although many have a healthy interest coverage ratio, meaning they can comfortably repay interest on outstanding debt.

It must be noted that the O&G support service sub-segment remains highly geared at 92.7%, a level that is just behind the shipbuilding segment’s 104%.

‘Worst is over’

However, analysts contacted by The Edge concur that the local sector is unlikely to see further casualties from the oil price downturn this year, following Perisai Petroleum Teknologi Bhd’s bond default last October.

“It is quite unlikely. I don’t see [further casualties] especially among listed players,” says Areca Capital’s Wong. “The worst is over, definitely, provided the prices remain stable — there is more breathing space now.”

One analyst comments that most listed O&G players on Bursa are sizeable enough to survive and some can look to strong major shareholders to lend support. Further stress may be more visible among privately held companies, the analyst adds.

Contract flow is expected to improve this year as the downturn had compelled state oil company Petroliam Nasional Bhd (Petronas) to postpone a number of critical maintenance works, says the analyst. “You cannot delay these things forever. With the slightly improving outlook now, it would be easier for Petronas to proceed with these works,” the analyst adds, cautioning however that this does not mean the floodgates will open. “There are more contracts coming but they would not benefit everyone, just a few players.”

Wong agrees, pointing to the growing trickle of small contracts awarded over the past six months. However, he notes that the fine print of these contracts vis-à-vis their value and margins remains unclear.

The awards in turn may boost the prospects for relevant companies in the support and service segment. For others, however, things have not improved amid drying order books, especially those that are reliant on oil exploration and production (E&P), such as rig charterers. Market observers say while oil prices have risen and stabilised, there will be a lag effect on the resumption of E&P works as producers need time to remobilise.

In addition, the sudden collapse in crude prices in 2014 that sparked the current downturn would give pause to many oil majors on ramping up production so soon, lest they get burnt again.

That said, after a dismal earnings reporting season last November, in which market observers say some 30% of O&G players missed estimates compared with the normal 10% to 15%, financial performance may improve slightly this year, according to Wong.

This is partly because heavy kitchen-sinking and debt write-offs will not be as heavily done this year. “I see better earnings this year as these [write-offs] are a one-off thing,” says Wong. “A lot of companies have also done a lot of cost restructuring and are in a better position now.”

The crucial earnings to watch will be for the first two quarters of this year, which will be reported in May and August, because these will signal what sort of recovery lies ahead, he adds. Better financial performance, helped by the low base effect from 2016, may “lead to confidence coming back”.

In addition, the move in January by UMW Oil and Gas to acquire two companies — listed Icon Offshore and privately held Orkim Sdn Bhd — in deals worth RM721.61 million may spark further consolidation in the sector, especially among those facing mounting pressure, according to the analyst. “We have got UMW Oil and Gas, a relatively large player, making the first move to consolidate. This may lead to other players reconsidering the mergers and acquisitions option,” the analyst says, although any guesses on potential timing would be speculative at best.

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