May 19, 2015

Oil-price rally may fizzle and pressure share prices

We believe the current oil-price rally may soon fizzle as supply demand fundamentals are still negative. Some short-term kickers may have run their course while others may soon reverse. In view of a possible near-term correction in oil prices, unfavourable valuation and possible weak earnings, we downgrade heavyweights SAKP and Pchem to SELL (from HOLD), and the sector to UNDERWEIGHT.

malaysia oil & gas stocks performance 
Oil price has rallied on a confluence of positive factors…
Ytd 2015, the Brent and WTI crude-oil prices have risen by 17% and 12%, respectively. Notably, oil prices staged a strong rally of 37% (WTI) and 25% (Brent) from their recent lows in March, driven by a confluence of positive factors, including geopolitical tensions in the Middle East, slower US output growth, the unwinding of short positions by hedge funds, weaker US$ and an upgrade in EIA’s global oil demand forecast.

… that said, the rally may soon fizzle
We opine that the oil-price rally may fizzle as the supply-demand fundamentals are still negative – global production (especially OPEC and Saudi Arabia) is still growing and the US oil inventory is near record highs. Besides, some short-term kickers (ie. short squeeze) may have run their course while others (weakening of US$, slower production growth, lower inventory) may soon reverse.

Oil-price correction may spillover to O&G stocks
Malaysian listed oil & gas stock prices have seen a strong correlation to crude-oil prices since the start of the oil-price downturn in 4Q14 (0.8-0.9x, excluding Pchem and DLG). As a result, the oil-price correction, if it materialises, could spillover to the domestic O&G stocks.

A tactical downgrade to UNDERWEIGHT
After the recent share-price rally, the oil & gas sector now trades at 16x forward PE, above its historical mean of 15x. Taking into consideration the unfavourable risk reward trade-off at 16x forward PE, a possible short-term correction in oil prices and likely earnings disappointment in the upcoming results announcements, we recommend a tactical downgrade on the sector to UNDERWEIGHT (from NEUTRAL). We maintain the earnings forecasts and TPs of all O&G stocks under our coverage but downgrade SAKP and Pchem to SELL (from HOLD) following strong price gains.

Key risks
Key risks to our sector downgrade would be a sharp, sustained recovery in oil prices, stronger-than-expected new contract awards, and better-thanexpected quarterly earnings.

Peer Comparison
oil gas share peer comparison

by Affin Hwang Capital