Not Going Anywhere Yet

Not Going Anywhere Yet By Sean Lim Ooi Leong l sean.lim@kenanga.com.my NEUTRAL Volatile oil prices are expected to stay despite recent recovery from the bottom premised on slower supply-demand rebalancing and weaker demand. We also toned down our Brent crude forecast to average USD38/bbl and to end at USD47/bbl for 2016. A successful collaboration between OPEC and non-opec countries to address the oversupply imbalance could be a sector game changer. Tougher operating environment is expected, resulting from more opex and capex cut from oil majors. While the sector is currently trading at average to trough valuations, we believe such valuations have factored in the bleak earnings outlook. However, further missing the consensus forecasts materially will see further de-rating for affected players. YINSON remains our preferred pick within the upstream segment for its resilient earnings outlook while we like downstream players like PCHEM for its long-term growth story anchored by the RAPID project. Meanwhile, SKPETRO, in our view, remains the best proxy to trade the volatility in oil prices given its oil production profile, which will directly benefit from stronger oil prices despite weaker correlation observed in the past 30 days. Still a NEUTRAL call but slightly more bearish on the sector. Oil prices recouped losses. We saw Brent crude oil prices rallying to above USD42/bbl for the first time since December last year, recovering from an 11- year low of USD27.88/bbl in mid-january after OPEC and non-opec countries decided to meet in April for a potential production freeze discussion regardless of Iran s participation. Despite the optimism on better oil prices prospects and hopes for a production cut, the US Energy Information Administration (EIA) forecasted Brent crude to average at USD34/bbl and USD40/bbl, USD3/bbl and USD10/bbl lower in 2016 from its previous estimates, respectively, premised on slower than expected reduction in global oil production coupled with weaker-than-expected demand growth. Meanwhile, we also toned down our average 2016 Brent crude price assumption to USD38/bbl from USD47/bbl on similar reasons. We still anticipate a better 2H16 with oil prices exceeding USD45/bbl at year-end but reiterate that price recovery is capped beyond that by the potential revival of shale oil production from the drilled but unfracked wells in US. Tougher operating environment. Even though the oil market sentiment has improved in the past two months, we did not observe much improvement within the upstream space, especially when local industry leader Petronas decided to cut CAPEX and OPEX up to RM20b this year. This will translate into further project deferrals and slower contract awards. Besides, based on our channel check, Petronas had initiated another round of service rate renegotiation with services providers on existing contracts beginning of this year and we believe some service players are under pressure to succumb in order to preserve client relationship. At the same time, asset players are facing challenges to maintain the vessel utilisation given more intense competition in job bidding as limited projects are available in the market. In view of oversupply of jack-up rigs and OSVs, local players have to tender for jobs overseas such as the Middle East. Default and insolvent risk still manageable. In our last strategy report, we highlighted that players are facing stretched cashflows but insolvency risk is not apparent. Our view is largely reaffirmed as banks are supportive enough to reshuffle/refinance short-term debt so that these companies can sail better through the harsh times. Net gearing increased to 0.61x from 0.42x in 2014 due to more loan drawdowns upon asset deliveries coupled with impairment hurting equity value. However, moving forward the credit outlook continues to be put on test in this slow environment resulting in weaker cashflows from operations and cashflow management is the top priority at this juncture. Trading at trough valuation. Most stocks under our coverage (except for Petronas-related companies) are trading at an average of 0.6x Fwd PBV, ranging from average to trough valuations. We believe the huge discount towards book value is justifiable since most companies have taken impairment hit last year, albeit at different quantums. Questions were raised whether book value is reflective of the intrinsic value given that many of these assets were acquired or committed during good times. In our view, such trough valuation has factored in bleak and poor earnings outlook unless these companies miss the consensus forecasts materially in the coming quarters. We reckon such deep discount will only be narrowed when impairment risk has largely subsided coupled with stronger cash generating ability on these assets. Still a NEUTRAL call but slightly more bearish on the sector premised on slower supply-demand rebalancing and weaker demand. Investors should stay at the sideline on the sector given prolonged oil price recovery and sluggish outlook while awaiting for re-rating catalysts. YINSON (OP, TP: RM3.92) remains our preferred pick within the upstream segment on its resilient earnings outlook while we like downstream players, like PCHEM (OP, TP: RM7.50), for its long-term growth story anchored by the RAPID project. Meanwhile, SKPETRO (MP, TP: RM1.93), in our view, remains the best proxy to trade volatility in oil prices as its oil production profile, which will directly benefit from stronger oil prices despite weaker correlation observed in the past 30 days. PP7004/02/2013(031762) Page 1 of 9

US production showed signs of tapering While the expected non-opec production reduction is largely anticipated to come from US, it is crucial to understand how much more the US production can be reduced. Note that US oil production had already normalised to c.9.0m bbl/day level in end of March from its peak of c. 9.7m level in July 2015 while US oil rigs count also fell to the lowest level since 2010, recording only 372 as of 25 March 2016. Future production is bound to fall further with lesser drilling activities, particularly in horizontal wells drilled into tight formations, which have steep initial decline rate. but oil inventories are piling up On the other hand, US commercial crude oil and refined products continue to pile up, approaching record high level. EIA forecasted global oil inventories to increase by an average of 1.6m bbl/day in 2016 and another 0.6m bbl/day in 2017. We believe the larger-than-expected global oil inventories are major hurdles to rebalancing the oil market. US Crude Oil Production vs US Stocks of Crude Oil US Crude Oil Production vs US Rigcount Source: EIA, Kenanga Research Shale oil ready to come back soon? Gone are the days of shale oil companies bagging fat profits ever since oil price plunged in late 2014 and we saw massive investment cut back and significant drop in rig count. Shale producers rather shut down their wells and left them idle until oil prices move above production cost. As oil prices have rallied more than 40% in the past two months, we reckon the production from these wells will revive gradually across different fields depending on the specific lifting cost. Recent news in early March quoted that one of the dominant shale oil players, Continental Resources is prepared to increase spending if US crude goes back to the USD40/bbl level and boosts 2017 production by 10%. Its rival Whitting Petroleum Corp plans to stop fracking new wells but is considering completing some of the wells at similar oil price level. These statements do not conclude that shale oil production breakeven is at USD40/bbl level but certainly depicts costs have been rebased much lower than it used to be. Slower supply-demand rebalance leading to lower oil forecast. EIA toned down their oil prices forecast in March to USD34/bbl in 2016 based on weaker consumption growth of 1.1m bbl/day to 94.8m bbl/day in 2016 and 1.2m bbl/day in 2017 while maintaining the view that non-opec production will fall by 0.4m bbl/day in 2016. This has led to slower restoration of supply demand equilibrium within the oil market and the recovery could be further delayed if non-opec production continues to stay more resilient than expected. All in, our economist believes oil prices will stay volatile and reduce the average Brent crude price forecast to USD38/bbl from USD47/bbl in 2016. World Liquid Fuels Production and Consumption Balance Source: EIA PP7004/02/2013(031762) Page 2 of 9

Better oil prices not necessarily equal higher share prices. Despite crude oil prices improving 12% YTD, as at our report cutoff date, 25 March 2016, the oil and gas stocks under our coverage have recorded an average YTD 7% fall, underperforming the local equity barometer, FBMKLCI which posted 2% gain over the same period. Our recent analysis also shows that the correlation between our core coverage stocks and crude prices have derailed in the past three months, suggesting that better oil prices do not translate into higher share price performance. We carried out a correlation analysis on all the oil and gas stocks under our coverage and found out that most stocks except for PETDAG (UP, TP: 24.20) and PCHEM are positively correlated to oil prices in the past one year. However, if we were to take a shorter data set, i.e. 30 day-rolling correlation, our findings show that the correlation to oil prices has fallen to -0.17 as at end of March. This is true, to a certain extent, as Malaysian oil and gas companies are mainly services or asset players and earnings key drivers are capex and opex spending allocation from oil majors. The 40% improvement in oil prices to USD40/bbl level might not be sufficient to entice oil majors to increase spending. Hence, short-term trading premised on riding the volatile oil prices is less effective and investors must be more selective in trading. SKPETRO, in our view, remains the best proxy to trade the volatility in oil prices given its oil production profile, which will directly benefit from stronger oil prices despite weaker correlation observed. Share Prices Performance as at 25 th March 2016 Company Price as at 25th March 2016 (RM) 2016 YTD (%) Changes from 52 week high Changes from 52 week low ALAM 0.355-17% -51% 1% ARMADA 0.780-25% -40% 0% COASTAL 1.620-13% -49% 11% DAYANG 1.240-7% -55% 24% DIALOG 1.580 3% -6% 10% GASMSIA 2.430 3% -14% 26% MHB 1.050 5% -21% 17% PANTECH 0.585 1% -23% 22% PCHEM 6.710-7% -11% 25% PERISAI 0.260-7% -56% 13% PETDAG 24.200-3% -6% 26% PETGAS 21.780-4% -8% 5% SKPETRO 1.910-5% -33% 30% UZMA 1.720-9% -33% 9% WASEONG 0.770-21% -47% 7% YINSON 2.740-6% -16% 10% Simple Average -7% -29% 15% FBMKLCI 1724.75 2% -7% 13% Brent (USD) 41.590 12% -39% 49% Average O&G Coverage Stocks Correlation Coefficient against Brent Prices PP7004/02/2013(031762) Page 3 of 9

Very quiet quarter. Total number of contract awards for upstream related projects announced in 1Q16 jumped 22% QoQ to RM2.9b. However, if we take a closer look, only six companies have announced contract awards (vs. 15 companies in 4Q15) and unevenly boosted by SKPETRO s 10-year maintenance contract. This indicates that the upstream space is still relatively sluggish and name likes ALAM (UP, TP: RM0.29), DAYANG (MP, TP: RM1.43), MHB (MP, TP: RM1.00), WASEONG (UP; RM0.73) and COASTAL (MP, TP: RM1.76) will have to depend on their existing orderbook to generate earnings. On the other hand, we did not hear much from the downstream segment with only one sub-contract civil work and underground piping job worth RM57.8m awarded to JV company between HOHUP and KNM (vs. RM7.1b in 4Q15). Going forward, we believe more jobs from RAPID as the government has announced to allocate RM18b to develop RAPID in the Budget 2016. Contract trend Petronas Capex QoQ Comparison Petronas Capex YoY Comparison Source: Petronas, Kenanga Research More earnings disappointment? After two quarters of massive earnings adjustment, we believe earnings disappointment risk has moderated coupled with stabilisation of oil prices. Our FY16/17E earnings forecast is 12.7% below consensus but still projects an average 6.6% YoY growth in FY16. This is in line with our in view of gradual improvement in crude oil prices and better activities and work orders in 2H16. However, we do not discount that the pace of recovery could be worse than our expectations leading to further earnings cut. For instance, within our universe, we have assumed 75%/65%/55% utilisation (vs. actual utilisation of 75%/63%/56% in FY15) for DAYANG, ALAM and ARMADA (UP; TP: RM0.80) s respective OSV segment in FY16. These numbers may not materialise if they fail to replenish their depleting orderbook. PP7004/02/2013(031762) Page 4 of 9

Valuation & Recommendation: Trading at trough valuation. Most stocks under our coverage (except for Petronas-related companies) are trading at an average 0.6x Fwd PBV, ranging from average to trough valuation. We believe the huge discount towards book value is justifiable since most companies have taken the impairment hit last year, albeit at different quantums. Questions were raised whether book values are reflective of the intrinsic value given that many of these assets were acquired or committed during good times. In our view, such trough valuation has factored in the bleak and poor earnings outlook unless these companies miss the consensus forecasts materially in the coming quarters. We reckon such deep discount will only be narrowed when impairment risk has largely subsided coupled with stronger cash generating ability on these assets. YINSON, preferred pick within upstream. The FPSO segment so far is still deemed as one of the most resilient sub-segment within the upstream space despite a few FPSO terminations by clients. We like YINSON for its: (i) efficient execution, (ii) strong and firm contract with good termination clauses embedded, (ii) financially sound counterparties, and (iv) FPSO operating in oil fields with decent production and reserves. The stock is currently trading at 13.2x CY17 PER, relatively expensive to its global peers average of 10.0x. However, we believe it is justified given that premium is generally ascribed to Malaysian oil and gas sector as well as its ability to secure more large-size FPSO projects in the future. Our SoP-driven TP is RM3.92, implying 17.2x CY17 PER and +0.5SD valuation. The underlying risk to our call is delay in maiden contribution from Yinson Genesis, which is slated for August next year. PCHEM still have legs to go. Anchored by long-term growth prospect from RAPID and SAMUR project, PCHEM was one of the top performers within the sector with 33.3% surge in share price last year. YTD, the stock is taking a breather and currently trades at undemanding 15.5x CY16 PER. On the other hand, RAPID project serves as the other earnings catalyst to transform it into a more competitive regional player over the longer horizon. Our price target of RM7.50 is based on 17.3x CY16 PER, -0.5 SD to its 3-year mean. We gather that the new SAMUR facility has just started in 1Q16 in stages and is expected to commence full stream in 2H16. Note that any delays in the abovementioned projects and unexpected lower PU rate are the major risks to our call. Appendix: Fwd PER Levels Company Fwd PER as at 25 th March 2016 Current PER Std Dev* Fwd PER Peak Fwd PER Average Fwd PER Trough Std Dev Peak* Std Dev Trough* ALAM N/M N/M N/M N/M N/M N/M N/M ARMADA 13.19-2 42.73 31.43 13.19 1.5-2 COASTAL 5.85-0.5 13.80 7.06 3.74 2-1 DAYANG 5.45-2 20.73 13.19 4.96 2-2 DIALOG 25.23-1.5 40.53 30.79 25.23 2-1.5 GASMSIA 21.40-1 34.78 25.42 19.01 2-1.5 MHB 20.34-1.5 68.12 39.66 17.73 2-1.5 PANTECH 9.55 0.5 17.01 9.51 4.25 2-1.5 PCHEM 14.95-1.5 20.34 17.41 14.37 1.5-1.5 PERISAI 27.74-0.5 210.32 61.37 5.69 2-1 PETDAG 28.52-0.5 62.27 35.04 6.20 2-2 PETGAS 23.55 0.5 27.20 20.66 13.47 1.5-1.5 SKPETRO 11.58-1.5 28.60 17.98 10.31 2-1.5 UZMA 7.90-0.5 25.25 12.27 5.80 2-1 WASEONG 22.76-0.5 47.56 28.77 10.20 2-1.5 YINSON 17.18 0.5 22.69 13.23 3.11 1.5-2 Simple Average 17.01-0.80 45.46 24.25 10.48 1.87-1.53 *Std Devs rounded to nearest multiple of 0.5 PP7004/02/2013(031762) Page 5 of 9

Fwd PBV Levels Company Fwd PBV as at 25 th March 2016 Current PBV Std Dev* Fwd PBV Peak Fwd PBV Average Fwd PBV Trough Std Dev Peak* Std Dev Trough* ALAM 0.38-1.5 3.57 1.45 0.38 3-1.5 ARMADA 0.59-1.5 4.05 2.09 0.59 2-1.5 COASTAL 0.51-1.5 1.79 1.10 0.51 2-1.5 DAYANG 0.75-1.5 3.50 1.74 0.69 2.5-1.5 DIALOG 3.51-1.5 5.12 4.15 3.51 2.5-1.5 GASMSIA 2.87-1.5 5.22 3.80 2.52 2-1.5 MHB 0.60-1.5 5.24 2.35 0.53 2.5-1.5 PANTECH 0.84-0.5 1.40 0.95 0.56 2-1.5 PCHEM 2.04-0.5 2.52 2.14 1.64 1.5-2 PERISAI 0.31-1.5 1.55 0.98 0.25 1.5-1.5 PETDAG 4.56 0 12.66 4.85 1.49 4.5-2 PETGAS 3.55 2 4.63 2.98 1.83 3-0.5 SKPETRO 0.86-1.5 2.47 1.61 0.78 1.5-1.5 UZMA 1.07-1.5 3.29 1.98 1.07 2-1.5 WASEONG 0.53-2 1.92 1.26 0.53 2-2 YINSON 1.17 0 1.76 1.18 0.49 2-2.5 Simple Average 1.51-1.00 3.79 2.16 1.09 2.28-1.59 *Std Devs rounded to nearest multiple of 0.5 Net Gearing as at Latest Period PP7004/02/2013(031762) Page 6 of 9

YoY Change in Operating Cash Flows YoY Changes in Days of Receivables as at Latest Period *Days of receivables calculated using periods less than 12m YoY 5-year Beta Comparison PP7004/02/2013(031762) Page 7 of 9

Oil and Gas Sector Comparisons NAME Price @ 25 Mar 16 Mkt Cap PER (x) Est. Div. Yld. Hist. ROE P/BV Net Profit (RM m) CY15 NP Growth CY16 NP Growth (RM) (RM m) CY14 CY15 CY16 (%) (%) (x) CY14 CY15 CY16 (%) (%) (RM) Target Price Rating ALAM 0.36 332.8 5.8-12.2 60.8 0.0 6.9 0.4 57.3 (27.3) 5.5-147.7-120.0 0.29 UNDERPERFORM ARMADA 0.78 4,546.4 12.4 16.6 16.3 0.1 5.5 0.7 367.7 273.2 278.6-25.7 2.0 0.80 UNDERPERFORM COASTAL 1.62 864.8 4.5 4.4 6.5 2.4 13.3 0.6 190.8 198.8 198.8 2.2-32.2 1.76 MARKETPERFORM DAYANG 1.24 1,078.5 6.0 9.2 8.6 0.0 18.5 1.1 178.6 116.7 125.2-34.7 7.2 1.43 MARKETPERFORM DIALOG 1.58 8,354.1 41.2 29.7 28.1 1.4 11.5 4.7 202.9 281.6 296.9 38.8 5.4 1.65 MARKETPERFORM GASMSIA 2.43 3,068.8 17.8 24.0 20.5 3.0 16.5 3.0 167.6 124.1 145.6-26.0 17.3 2.68 OUTPERFORM MHB 1.05 1,664.0 17.0 20.0 19.9 0.0 3.7 0.6 97.6 83.1 83.8-14.9 0.8 1.00 MARKETPERFORM PANTECH 0.59 357.8 7.8 8.2 7.8 5.3 9.8 0.8 55.8 43.7 43.4-5.0 5.4 0.53 MARKETPERFORM PCHEM 6.71 53,600.0 19.7 19.3 15.5 3.2 12.0 2.4 2,726.0 2,782.0 3,468.0 2.1 24.7 7.50 OUTPERFORM PERISAI 0.26 311.7 31.1 39.5 26.6 0.0 0.8 0.2 10.0 7.9 11.7-21.0 48.1 0.29 MARKETPERFORM PETDAG 24.20 23,942.2 47.7 30.3 27.9 2.7 10.6 5.0 502.0 790.0 859.0 57.4 8.7 24.20 UNDERPERFORM PETGAS 21.78 43,571.7 23.6 24.5 23.9 2.9 17.1 4.0 1,709.0 1,780.0 1,825.0-3.4 2.5 21.99 UNDERPERFORM SKPETRO 1.91 11,025.6 9.1 14.6 14.4 0.8 10.2 0.9 1,160.5 1,217.1 714.5-37.6 1.2 1.93 MARKETPERFORM UZMA 1.72 517.9 12.8 13.2 9.2 0.0 16.0 2.0 40.5 39.2 56.4-3.2 43.9 1.71 MARKETPERFORM WASEONG 0.77 571.9 4.6 25.0 27.0 2.7 11.7 0.5 125.6 22.9 21.2-81.8-7.2 0.73 UNDERPERFORM YINSON 2.74 3,005.0 22.4 18.4 19.8 0.0 9.8 2.2 60.8 140.6 165.1 21.7-6.9 3.92 OUTPERFORM Simple Average 17.7 17.8 20.8 Weighted Average 25.2 23.4 24.9 Source: Bloomberg, Kenanga Research PP7004/02/2013(031762) Page 8 of 9

Stock Ratings are defined as follows: Stock Recommendations OUTPERFORM : A particular stock s Expected Total Return is MORE than 10% (an approximation to the 5-year annualised Total Return of FBMKLCI of 10.2%). MARKET PERFORM : A particular stock s Expected Total Return is WITHIN the range of 3% to 10%. UNDERPERFORM : A particular stock s Expected Total Return is LESS than 3% (an approximation to the 12-month Fixed Deposit Rate of 3.15% as a proxy to Risk-Free Rate). Sector Recommendations*** OVERWEIGHT : A particular sector s Expected Total Return is MORE than 10% (an approximation to the 5-year annualised Total Return of FBMKLCI of 10.2%). NEUTRAL : A particular sector s Expected Total Return is WITHIN the range of 3% to 10%. UNDERWEIGHT : A particular sector s Expected Total Return is LESS than 3% (an approximation to the 12-month Fixed Deposit Rate of 3.15% as a proxy to Risk-Free Rate). ***Sector recommendations are defined based on market capitalisation weighted average expected total return for stocks under our coverage. This document has been prepared for general circulation based on information obtained from sources believed to be reliable but we do not make any representations as to its accuracy or completeness. Any recommendation contained in this document does not have regard to the specific investment objectives, financial situation and the particular needs of any specific person who may read this document. This document is for the information of addressees only and is not to be taken in substitution for the exercise of judgement by addressees. Kenanga Investment Bank Berhad accepts no liability whatsoever for any direct or consequential loss arising from any use of this document or any solicitations of an offer to buy or sell any securities. Kenanga Investment Bank Berhad and its associates, their directors, and/or employees may have positions in, and may effect transactions in securities mentioned herein from time to time in the open market or otherwise, and may receive brokerage fees or act as principal or agent in dealings with respect to these companies. Published and printed by: KENANGA INVESTMENT BANK BERHAD (15678-H) 8th Floor, Kenanga International, Jalan Sultan Ismail, 50250 Kuala Lumpur, Malaysia Telephone: (603) 2166 6822 Facsimile: (603) 2166 6823 Website: www.kenanga.com.my Chan Ken Yew Head of Research PP7004/02/2013(031762) Page 9 of 9