Offshore & Marine - UOB Kay Hian 2016-05-20: Global Bellwethers ~ On An Oil Price Recovery, It's Balance Sheet First

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Offshore & Marine – Singapore: Global Bellwethers: On An Oil Price Recovery, It’s Balance Sheet First

With the oil market moving towards equilibrium by end-16, we shift our focus to management comments from E&P companies, which are the first beneficiaries of higher oil prices.
Their comments carried a more upbeat outlook, with most expecting a recovery.
Unsurprisingly, their top priority is balance sheet repair and achieving cash flow neutrality before resuming capital spending.
A US$60/bbl level is eyed for resumption in capital spending despite having projects viable at US$50/bbl.
Maintain MARKET WEIGHT, with top BUY being SCI and top SELLs SMM and NCL.

We shift our focus to exploration & production (E&P) companies in our quarterly bellwether tracking as they will be the first beneficiaries of the higher oil prices.
A look into the business strategies of E&P companies will shed light on the direction of activities post oil price recovery.
Management comments proved to be slightly more upbeat this quarter, with most anticipating a recovery as soon as end-16. Key highlights below:

A key theme among oil majors is to repair their balance sheet and achieve cash flow neutrality post an oil price recovery.
Oil majors have not significantly reduced dividend payments entering the downturn as the use of cash remained a top priority. This had the effect of stretching their balance sheets as oil prices declined.
Continued high dividend payouts and production/maintenance capital spending also meant many oil majors were cash flow negative throughout 2015. Going into a recovery, oil majors are keen to reduce gearing and achieve cash flow neutrality before committing to higher capex.
Brent price for industry to be cash flow neutral is estimated by WoodMac at US$53/bbl.

A key concern among analysts has been a ramp-up in oil production by shale producers on higher oil prices.
Surprisingly, E&P companies are exercising capital discipline, withholding spending despite having portfolios that could be developed profitably at US$50/bbl and focusing on repairing their balance sheets.
Business sustainability is an oft repeated word among management, with most eyeing US$60/bbl as the level where they would increase new capex spending.

Another theme among oil majors is a shift towards shorter-cycle projects. Oil majors, caught wrong-footed with their long offshore development projects in the downturn, now want a greater mix of shorter-cycle projects to balance their portfolios.
In an extreme case, ConocoPhillips said it is exiting deepwater development, while Schlumberger expects conventional land and unconventionals to meet demand in the near term. This means that post recovery, a lower focus on offshore development will have an impact on offshore activity peak levels.

While oil price recovery is on track, spending remains tight and oil majors are committed to seeing their projects developed on- time and on-budget.
Remarks by Subsea 7 showed that clients were selecting contractors/operators based on their balance sheets, and seeing jobs going to tier-1 companies solely because of their balance sheets. While that alone does not guarantee a contract win, it does lend a significant advantage to contractors and operators.

While valuations appear attractive at current levels, stocks in this segment pose downside or non-performance risks due to earnings weakness in the coming quarters.
We do not expect an earnings pick-up until oil majors increase capital spending.
At the same time, the stocks provide significant tactical upside potential on a mere turn in oil prices. Thus, we recommend cautious accumulation of stocks in this sector, preferring candidates with strong balance sheets.
In the shipyard segment, Keppel Corporation (KEP SP/HOLD/Target: S$6.40) and Sembcorp Industries (SCI SP/BUY/Target: S$4.00) are potential candidates owing to their diversified earnings with exposure to O&M.
We prefer Keppel due to its balance sheet strength and higher risk-reward.
In the oilfield services space, we prefer Ezion (EZI SP/ HOLD/Target: S$0.60) due to its strong operating cash flow and balance sheet strength.

Nancy Wei UOB Kay Hian | Foo Zhiwei UOB Kay Hian | http://research.uobkayhian.com/ 2016-05-20

UOB Kay Hian Analyst Report HOLD Maintain HOLD 6.40 Same 6.40

BUY Maintain BUY 4.00 Same 4.00

SELL Maintain SELL 0.07 Same 0.07

SELL Maintain SELL 0.90 Same 0.90