BIMB Securities Research

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BIMB Securities Research

7 January, 2021 A Member of BIMB Holdings Group

PP16795/03/2013(031743) |1

Oil

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Gas

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Oil and Gas upstream outlook

Overweight▲

On recovery path

Possible lower-for-longer oil price scenario prompted Petronas to delay

marginal field development. Nonetheless, the outlook for mid-to-large sized

field development remains constructive as oil stabilizes above USD40/bbl, in

our view. We forecast Brent to trade at an average of USD45/bbl in 2021.

We are optimistic with recovery in offshore projects as we expect Petronas to

allocate more capital towards upstream segment following completion of its

downstream project.

We upgrade our sector recommendation on upstream to OVERWEIGHT (from

NEUTRAL) as we foresee a recovery in offshore development projects in near

future. At current price, we believe the upside potential outweighs the risk.

Resumption in new offshore development projects

Despite pessimism over Petronas’ capex cut, we believe the worst is over for

Malaysia’s upstream segment as we think under-investment in prior years will

ensure a steady number of projects maturing within next 3 years. In addition, we

believe Petronas’ effort in high-grading its development strategy to favour mid-to-

large sized fields will reduce the possibility of further delay in new field development

projects. Despite higher dividend payment to government, we think the completion

of Petronas’ downstream project (i.e. Pengerang Integrated Complex) which is worth

c.RM100bn will lead to higher allocation towards upstream projects.

Riding on recovery theme

Overall, there are 11 projects now under execution and 19 new projects already

approved to be sanctioned over the next 3 years. On top of that, there are also 25

projects that are at pre-FID stage currently. We believe this should continue to

support revenue visibility for fabricators in the medium term. Meanwhile, Petronas

projects that it would require 7-10 jack-up rig (JUR) annually over the next 3 years,

which is close to 5-year average (8.5 units), based on our estimate. This is higher

than typical downcycle demand level, as higher demand for development well

drilling is required currently (after the completion of HUC activity) before first oil/gas

to be produced. Furthermore, 8 out of 11 on-going projects are expected to be

completed this year which should also support jack-up rig utilisation. As such, we

think both fabricators (MMHE) and jack-up rig operator (Velesto) are on track to see

recovery in business activities and revenue for FY21 and FY22.

Change in earnings forecast

With expectation of stable demand for JUR, we raised Velesto’s FY21/22F utilisation

rate assumption to 70%/67% (from 60%/60%) which brings us to reduce our earlier

net loss forecast by 53%/60% respectively.

OVERWEIGHT on Upstream services

We upgrade our sector recommendation on upstream to OVERWEIGHT from

NEUTRAL. We upgrade Velesto to BUY (from HOLD) with higher TP of RM0.265 on

steady demand for jack-up rig in next 3 years. We also maintain our BUY call on

MMHE with higher TP to RM0.77 given the recovery path in offshore projects.

Azim Faris Ab Rahim, CFA

[email protected] (603) 2613 1734

BIMB Securities Research Sector Update: Oil and Gas

www.bisonline.com.my | Page 2

Petronas to favour mid-to-large sized field development

The plunge in oil price in 2020 has showed how fragile and dependent oil market is on a

unified OPEC+ cooperation in stabilising prices. As a precautionary measure, Petronas

reviewed its business strategy and thus preparing itself for possible lower-for-longer oil

price scenario. Moving forward, as implied by its Petronas Activity Outlook 2021-2023 (PAO)

report, we reckoned that Petronas will shift away from its original plan to monetise

marginal field development towards focusing on development of larger field. This makes

sense as these fields can be developed at lower breakeven cost due to economies of scale.

According to Tengku Taufik, the CEO of Petronas, Petronas will strives in ensuring that all

future development projects to be profitable at USD40/bbl.

The key changes transpired from 2021-2023 PAO include only 1 lightweight well head

platform (WHP) project left remaining to be sanctioned over 2021-2022 from initial 5-11

projects planned (refer Chart 1). This does not include 3 lightweight WHP projects planned

for 2020 whereby 2 of them were deferred to a later time while the other project was

simplified to only include infill drilling. Meanwhile, medium weight WHP projects are

gaining traction where the number of projects is to be increased to 6-8 projects (from 1-5

projects).

Chart 1: Changes to field development projects planned for 2021-2022

Before revision After revision

Base case

High case

Source: PAO, BIMB Securities

Overall, there are 11 projects that are under execution and 19 new projects already

approved to be sanctioned over the next 3 years. Eight out of 11 on-going projects are

expected to be completed this year. They are East Cendor Phase 1, Bergading Deep Phase 3,

Siakap North Petai Ph 2, Bakau NAG WHP, Pegaga CPP, Pemanis WHP, Integrated Bekok Oil

WHP and Ledang. Meanwhile, 3 other projects – Kasawari CPP, Gumusut Kakap Phase 3

and Bayan MOPU - will be completed in 2022-2023F.

In addition to 19 approved projects, there are also 25 projects that are at early engineering

design works (i.e. concept select and Front-End Engineering Design (FEED) phase) which

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2021 2022

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2021 2022

Light WHP Medium WHP



should be mature for development in the medium-term. This include large discovery fields

such as Shell’s Rosmari & Marjoram, ConocoPhillips’ Salam and Patawali and PTTEP’s Lang

Lebah field which may require CPP and FPSO for production (Table 1).

Table 1: Future large discovery development projects Projects Status Operator Potential development concept

Rosmari & Marjoram Pre-FEED Shell CPP, subsea facilities and onshore processing facility

Bestari Pre-FEED Petronas Tie-back to Limbayong FPSO

Kelidang cluster Pre-FEED Petronas Subsea facilities tieback to new floater

Salam & Patawali Concept Select ConocoPhillip Leased FPSO

Lang Lebah Appraisal PTTEP

Source Various, Upstream, BIMB Securities

Anticipated projects in 2021

After almost a 1-year long delay on new project award, we foresee Petronas to resume its

new offshore field development projects in 2021. Due to its sheer size, FPSO Limbayong

and Jerun CPP (a heavyweight fixed platform with weights more than 7,500 MT) are the

year’s top two most anticipated projects. Meanwhile, there are also 3 gas field

development projects which will require the construction of medium weight WHP (less

than 7,500 MT) as well as 1 oil field development which requires subsea structures (either

subsea production system or subsea umbilical risers facilities (SURF)).

For FPSO Limbayong project, we understood that the project design and specs have been

reduced amidst low oil price environment. We estimate the charter contract to be valued

at c.USD500-700m (based on capex USD400m and 7-year charter contract). This time, MISC

and Yinson are anticipated to tender for the charter contract independently rather than in

JV form. Meanwhile, we think MMHE remains as the frontrunner to secure the floater’s

topside fabrication and hulls conversion works, leveraging on its expertise as the sole local

company capable of completing FPSO conversion project. We understood that FPSO

Limbayong will have 90% local content requirement whereas the fabrication projects are

expected to start in 2022.

Jerun CPP fabrication project is another large project to be sanctioned in this year. To recap,

the CPP will be installed at Jerun field as part of the second phase development of SK408

production sharing contract (PSC) offshore Sarawak. The final investment decision (FID) is

expected to be made by 1H2021. We think Sapura Energy has an advantage over MMHE to

secure the project as the former was also the EPCC contractor for the SK408 first phase

development which entails the development of Gorek, Larak and Bakong fields via 3 WHPs

and the rejuvenation of Shell’s nearby F6 platform.

Table 2: Upcoming major project award in 2021 Projects Type Operator Potential winner

Limbayong FPSO Floating Petronas MISC / Yinson

Jerun CPP Fixed SapuraOMV Sapura Energy / MMHE / KKB

Source: Various, Upstream, BIMB Securities

Worst is over for fabricators and jack-up rig operators

With the resumption in new offshore development projects, we think fabricators will

benefit from demand for fixed platforms. The fabricators which have already signed frame

agreement with Petronas include MMHE, Sapura Energy and KKB Engineering. It is a 6-year

long term agreement to fabricate fixed offshore platform to Petronas and Petroleum

Arrangement Contractor (PACs – ExxonMobil, Hess, KPOC, Repsol O&G Malaysia Ltd and

Sarawak Shell/Sabah Shell Petroleum Company) up until 2024.

Similarly, we also expect recovery for jack-up rig operator such as Velesto Energy in view of

higher development activities. Based on PAO, Petronas expects demand for JUR to be

stable at c.7-10 units per annum over next 3 years. Based on our estimate, this is close to



mid-cycle demand (5-year average JUR demand: 8.5). To put into perspective, local JUR

demand ranged between 5-14 units annually during previous 2016-2020 short cycle (see

Chart 2).

Chart 2: Malaysia JUR demand

Source: PAO, BIMB Securities

We reckon that the rise in developmental well drilling is the key driver of stronger JUR

demand in the near future as opposed to more weights for exploration well drilling during

2015-2016. As we mentioned above, there are 8 on-going development projects that are

expected to be completed this year. Upon completion of HUC activities, drilling of

development wells will be carried out before first oil/gas will be produced.

Changes in earnings forecast

We raised Velesto’s FY21/22F revenue forecast by 13/21% (see Table 3) as we increased

our utilisation rate assumption to 70%/67% (See Table 4) which is closer to average

utilisation rate during FY17-18 (Chart 2). This brings to our earlier net loss forecast being

reduced by 53%/60% respectively. Our forecast also had factored in a strengthening in RM,

which we have pegged at RM3.80/USD.

Table 3: Change in Velesto earnings forecast

FYE Dec (RM bn) Previous After Change (%)

2021F 2022F 2021F 2022F 2021F 2022F

Revenue 507.2 474.0 574.0 573.3 13.2% 20.9%

EBITDA 241.6 224.3 283.0 280.5 17.1% 25.0%

EBIT 1.6 (15.7) 43.0 40.5 >100% >100%

Core PBT (69.9) (87.3) (29.5) (31.3) 57.7% 64.2%

Tax expense (6.3) (6.3) (6.3) (6.3) 0.0% 0.0%

Core PATAMI (76.2) (93.6) (35.8) (37.5) 53.0% 59.9%

Source: Company, BIMB Securities

Table 4: Change in Velesto’s key assumption

FYE Dec (RM bn) Previous After

Comments 2021F 2022F 2021F 2022F

Utilisation rate (%) 60 60 70 67 Stable demand will support utilisation rate

Daily charter rate (USD ‘000/day) 70 65 72 75 Stable demand will sustain DCR recovery

USDMYR 4.00 4.00 3.80 3.80 Weaker dollar


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2016 2017 2018 2019 2020 2021F 2022F 2023F

units

Malaysia JUR demand Velesto JUR working



Upgrade Upstream to “Overweight”

We upgrade our sector recommendation on upstream to OVERWEIGHT (from NEUTRAL) as

we foresee a constructive outlook for offshore development projects in the near future.

This should provide a stream of positive news flow from the industry and potentially

providing a re-rating catalyst on the sector. At current prices, both Velesto and MMHE are

trading at below -1SD which suggests that the market has largely factored in near-term

earnings risk (Chart 3 & 4). As such, we believe the upside potential at the moment for

share prices outweighs the risk.

Chart 3: Velesto historical P/B Chart 4: MMHE historical P/B


We upgrade Velesto to BUY (from HOLD) with higher TP of RM0.265 (from RM0.14) on

steady demand for jack-up rig in the next 3 years. Our TP implies 0.8x P/B FY21F which is its

5-year average, reflecting mid-cycle valuation. With an improving demand outlook, we

think there is limited risk for further asset impairment moving forward. We also observed

that there is a tendency for Petronas to award call-up orders for JUR instead of committing

for long-term contracts as showcased by Velesto’s steady utilisation rate during 3Q20.

We also maintain our BUY call on MMHE and upgrade our TP to RM0.77 (from RM0.42) as

we pegged higher P/B ratio of 0.6x FY21F (from 0.3x). We believe this is fair given the

recovery path of offshore projects. We think MMHE is well-positioned to secure Limbayong

FPSO’s topside fabrication and hulls conversion works due to the project’s high local

content requirement. Besides that, the company currently pursues modular fabrication

projects from Saudi Aramco and Taiwan’s offshore windfarm projects to improve its East

yard utilisation rate which is still idle.

Table 5: Changes in stock recommendation

Company TP (RM) Recommendation

Comments Old New Chg Old New Chg

Velesto 0.14 0.265 ▲ HOLD BUY ▲ Based on higher P/B ratio of 0.8x FY21F (from 0.5x)

MMHE 0.42 0.77 ▲ BUY BUY ◄► Based on higher P/B ratio of 0.6x FY21F (from 0.3x)

Source: Companies, BIMB Securities

Table 6: Peer comparisons for Oil and Gas upstream sector

Company Rec. RM Mkt Cap PER (x) PB (x) ROE (%) ROE-PB (x) EBITDA mar. (%)

TP Price^ % (RM m) 2019F 2020F 2019F 2020F 2019F 2020F 2019F 2020F 2019F 2020F

Velesto BUY 0.265 0.14 89.2 1,150 (15.1) (12.2) 0.4 0.4 (2.2) (2.8) (5.2) (6.5) 47.7 47.3

MMHE BUY 0.77 0.44 75.0 688 52.9 19.1 0.3 0.3 0.4 0.6 1.4 2.1 5.1 5.2

Note: ^Closing price as at 6th Jan 2021

Source: Bloomberg, Companies, BIMB Securities

Mean, 0.8

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DEFINITION OF RATINGS

BIMB Securities uses the following rating system:

STOCK RECOMMENDATION

BUY Total return (price appreciation plus dividend yield) is expected to exceed 10% in the next 12 months.

TRADING BUY Share price may exceed 15% over the next 3 months, however longer-term outlook remains uncertain.

HOLD Share price may fall within the range of +/- 10% over the next 12 months

TAKE PROFIT Target price has been attained. Fundamentals remain intact. Look to accumulate at lower levels.

TRADING SELL Share price may fall by more than 15% in the next 3 months.

SELL Share price may fall by more than 10% over the next 12 months.

NOT RATED Stock is not within regular research coverage.

SECTOR RECOMMENDATION

OVERWEIGHT The Industry as defined by the analyst’s coverage universe, is expected to outperform the relevant primary market index

over the next 12 months

NEUTRAL The Industry as defined by the analyst’s coverage universe, is expected to perform in line with the relevant primary

market index over the next 12 months

UNDERWEIGHT The Industry as defined by the analyst’s coverage universe, is expected to underperform the relevant primary market

index over the next 12 months

Applicability of ratings

The respective analyst maintains a coverage universe of stocks, the list of which may be adjusted according to needs. Investment ratings are

only applicable to the stocks which form part of the coverage universe. Reports on companies which are not part of the coverage do not

carry investment ratings as we do not actively follow developments in these companies.

Disclaimer

This report has been prepared for information and educational purposes only and are not recommendation or endorsement to sell or

solicitation to buy any securities, subscription of financial products or otherwise to be taken as investment advice of any form or kind and

neither should be relied upon as such. The information herein was obtained or derived from publicly available information, internally

developed data and other sources believed to be reliable. Whilst all reasonable care has been taken to ensure that all information and data

are accurate and the opinions are fair and reasonable, we do not represent or warrant their accuracy, timeliness, completeness and

currentness or applicability of such information for any particular purpose. The investments advice or idea discussed or recommended in this

report may not be suitable for all investors. Any recommendation presented in this report is general in nature and does not have regard to

the specific investment objectives, financial situation and the particular needs of any specific person who may read this report. The investors

are advised to conduct own research and seek independent professional advice prior to taking any investment or investment related

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damages arising from any use of this report.

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No. 8 Jalan Munshi Abdullah,

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