By Khairie Hisyam
As panic selling wipes billions off oil and gas counters’ market capitalisation, values are emerging, say analysts. But how does an investor find his way through the frenzy? KiniBiz takes a look.
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As crude oil prices continued tumbling, nearly RM2 trillion worth of future investments are suddenly not viable, scrapping planned projects of oil and gas players worldwide.
In a report released in August this year, environmental think tank Carbon Tracker Initiative (CTI) looked at the future projects of seven largest public-listed oil players and found that collectively, the companies have some US$548 billion (RM1.9 trillion) in potential capital to spend between 2014 and 2025.
However these projects require a market price of at least US$95 per barrel to be viable. Some, said CTI, require prices above US$150 per barrel.
In contrast crude oil prices dropped closer to US$60 per barrel yesterday as inventories in the United States rose while Saudi Arabia, an influential member of the Organisation of Petroleum Exporting Countries (Opec) which produces 40% of global crude oil supply, reiterated its firm stance of not cutting output.
Closer to home, state-owned Petroliam Nasional Bhd (Petronas) said in end-November that it plans to cut capital expenditure for 2015 by 15%-20% if global oil prices remain between US$70-US$75 per barrel next year.
This sent the benchmark FBM-KLCI index on its worst single-day drop in nearly two years, dropping 2.3%. Oil and gas companies lost further value on top of year-to-date loss in market capitalisation up to that point.
Lower capital expenditure would in turn hurt oil and gas companies who rely on jobs from the spending. Less spending means less jobs, which in turn means less income.
How the oil price affects companies
To navigate the turbulent waters of the oil and gas sectors, an important factor to keep in mind is that not all oil and gas-related companies are affected equally or simultaneously.
The immediate impact of falling oil prices is lower profitability, which in turn leads to exploration and production players such as Shell, BP and Petronas to cut down on capital expenditure as less profitable or downright non-viable projects are shelved.
When this happens companies in the exploration space will be hurt first – for instance companies in the jack-up drilling rigs segment, said UOB Kay Hian analyst Danny Chan to KiniBiz, adding that some businesses may see charter rates coming down as there are less jobs to go around.
If the low-price environment is prolonged then the effect would spread to players in the field development phase. “Fabricators will be the first to be hit in this space,” said UOB Kay Hian’s Chan. “Fabrication businesses would be the worst hit as fewer oil fields are being developed.”
As for other oil and gas players with long-term contracts, earnings may be stable for some time but only for those whose locked-in jobs are on a dedicated basis. Those whose contracts are on call-out basis would also be hurt by less utilitisation, said Chan.
In other words, some oil and gas players will bear the brunt of a prolonged low-price environment while others may see delayed effects.
However this is not so clear-cut for some counters as there are companies with multiple divisions operating at different parts of the supply chain. A prime example is SapuraKencana Petroleum, which is not only involved in field exploration but also do work at the development stages, offshore services as well as fabrication and more.
In panic, value emerges
So far 2014 had seen the oil and gas sector on Bursa Malaysia lose nearly 30% of their collective market capitalisation value according to KiniBiz calculations in the previous piece in this issue.
Taking away share price gains earlier in the year, however, the period of slightly over five months from July 1 to early December had seen a 41% regression for 17 oil and gas companies collectively in terms of market capitalisation, according to KiniBiz calculations.
Some companies had been hit harder. Perisai Petroleum Teknologi, for instance, had lost nearly 70% of its market capitalisation in this five-month period while TH Heavy Engineering’s share prices had dropped by 61% in the same timeframe. In comparison Yinson only saw its share price regress by roughly 7%.
What is causing the mass selldown is essentially uncertainty, say various analysts, as no bottom is yet in sight for falling prices. With prices now near five-year lows as Opec lowered demand expectations to the lowest since 2003 yesterday, many investors are naturally nervous.
“No one knows how oil prices will behave in the next three months,” said UOB Kay Hian analyst Danny Chan to KiniBiz. ”Because of this uncertainty, investors are saying why don’t I exit and revisit the sector when oil prices stabilises.”
However the selldown had seen value emerging on various counters, suggesting opportunities for investors to pick up good deals. In a report last week, Maybank opined that values are emerging despite fragile sector outlook.
“Share prices of some oil and gas stocks have fallen to below book value,” said Maybank. “However interest will not pick up until oil price stabilises and the market adjusts to the new oil price order.”
RHB Research agrees, noting in a report that current market valuation does not accurately reflect the fundamentals of the overall oil and gas sector. “Some stocks have a long-term cash flow visibility, proven track record and support from sizable firm orderbook.”
Picking value
In finding value picks within the current environment, analysts appear unanimous in advocating selectiveness for investors. Generally, analysts seem to agree on the importance of income stability.
The first step is to look past sentiment. Focus should be on quality and execution, not sentiment, said RHB Research.
“Stock differentiation has become even more crucial,” said UOB Kay Hian. “We continue to advocate a bottom-up strategy — we believe investors will return to stocks that deliver earnings growth amid lower oil prices.”
Among others this strategy would favour resilient companies positioned in regional shallow and mid-water depths or a cabotage market that has high barriers to entry, said UOB Kay Hian, as well as those with sufficiently good margins to weather industry downturn.
“They also need to have a less heavily geared balance sheet, so that if indeed jobs are not coming in, they are not as worried about serving bank loans,” said UOB Kay Hian analyst Chan on what companies need to survive.
In addition companies whose earnings are less sensitive to oil price movements and capital expenditure cuts due to long-term contracts may be good tactical buys, said Maybank. This would mean less uncertainty in terms of future earnings.
With less jobs to fight for, proven track record, staying power and management quality is also important to look at in a counter.
“Companies with strong orderbooks and long burn rates would be more resilient against violent fluctuations in industry sentiments, crude oil prices and during quiet periods of new contracts scarcity,” said MIDF Research, adding that diversified sources of income is also a plus.
It is worth remembering that while Petronas has stated it will cut capital expenditure, the state-owned oil corporation had also reiterated that maintenance spending as well as ongoing projects would continue. In other words there are still jobs to go around for players in these segments.
“There are still pockets of opportunities in the sector as the Petronas would still invest in operations and maintenance (O&M) and E&P to sustain domestic O&G production,” said UOB Kay Hian.
Notably some major shareholders of oil and gas companies had apparently taken the opportunity to beef up their shareholdings as prices dip.
Mokhzani Mahathir
Among others SapuraKencana shareholder Mokhzani Mahathir added two million shares to his stake while Bumi Armada’s Ahmad Fuad Md Ali and Abdul Farish Abdul Rashid added more than two million shares to their collective equity.
Uzma director Che Nazahatuhisamudin Che Haron, Wah Seong major shareholder Tan Chin Nam Sdn Bhd of the Tan family, and Deleum director Abdul Ghani Abdul Aziz are also examples of shareholders who have upped their stake recently.
These movements appear to be a signal of confidence in the respective companies’ long-term prospects.
Timing and fortitude
However timing is also something to consider for investors looking to capitalise on the current selldown.
“At least for the next three months, it is definitely going to be a period of volatility for oil prices,” said UOB Kay Hian analyst Chan. “If you really want to invest, you may need to go through a period of volatility…share prices could come down further.”
Chan adds that while the current selldown is a good opportunity for long-term value investors, the market would only have a clearer idea on demand by January and volatility would continue till then.
In other words, investors going in now need to have staying power and fortitude against further share price dips.
This is especially so for several counters, according to UOB Kay Hian’s trough analysis last week. If conditions get worse, companies such as Dialog, Malaysia Marine and Heavy Engineering (MMHE) and Yinson may see their share prices tumble further to the tune of 45-55%.
On the other hand some companies are already scraping the bottom such as Barakah Offshore Petroleum, Bumi Armada and Perisai, said UOB Kay Hian.
Looking ahead, while the bottom for global oil prices are yet within sight analysts expect some consolidation in the oil and gas services sector.
“We could expect to see some small service providers merging among themselves or with the larger ones in order (i) to offer more holistic services and product offerings, (ii) to better compete with regional service providers, as well as (iii) to protect their profitability margins,” said MIDF Research.
In addition acquisitions of oil and gas assets may increase on the back of lower valuations, said MIDF Research. “For example, when SapuraKencana recently announced its intention to acquire stakes in a few Vietnamese oilfields from Petronas, the long term average price forecast used in the valuation was sub-US$90pb, as opposed to previous examples of acquisitions which were valued at long-term prices in excess of US$90pb.”
Other smaller players are moving as well. For instance earlier this month Uzma announced a RM25.3 million purchase for 18.98% equity in Setegap Ventures Petroleum Sdn Bhd, which provide well pumping, coil tubing units (CTU) and cementing services.
Looking forward, the current low-price environment looks like it will be the new normal for some time, unless either side in the current price war across the Atlantic gives in.
Earlier this month the US Energy Information Administration cut its forecasts for crude oil prices next year to an average of US$62.75 per barrel for West Texas Intermediate while lowering expectations for Brent crude to US$68.08 per barrel on average. The figures are about US$15 per barrel lower than earlier projections.
However it is not difficult to see prices climbing back to US$100 levels in the long term, given that supply and demand is in a constant state of flux. More recently, the recent crash in 2008 to below US$50 per barrel comes to mind, with prices recovering subsequently to stay above US$100 for years.
For brave investors with healthy amounts of sense and caution, the current climate may represent a window of opportunity to pick up good stocks for the long-term, those that can weather the current turbulence till the next upcycle. As legendary investor Warren Buffet once said:
“You want to be greedy when others are fearful. You want to be fearful when others are greedy.”
That said such investors would also need to be certain that they have sufficient fortitude to weather the darkness before first light comes – as things stand, long-term can be anyone’s definition.
Yesterday: In five months, crude oil fall wipes RM33 bil in value
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