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.

 
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.

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by Affin Hwang Capital