Navigating Singapore ~ Offshore and Marine - Neutral, oil circular reference
Upgrade from Underweight to Neutral
- We upgrade the sector from Underweight to Neutral on the following grounds:
- anticipated gradual uptrend in crude oil prices in 2017F;
- lower impairment risks because the higher crude oil price scenario means that owners do not have to adjust their books as much;
- largely-diminished sector default risks for 2017-2018F as companies have already extended their loan tenures; and
- the Singapore government schemes (SPRING and IFS) that could alleviate some of the working cap and capex needs of small players so that they can focus on servicing interest costs in the current downturn.
Oil circular reference
- The uncertainties posed by the new Trumponomics vow that the US will become energy independent could have accelerated the decisions by Organization of the Petroleum Exporting Countries (OPEC) and non-OPEC (including Russia) to cut production, in our view. Saudi Arabia (and most energy-producing nations) have been severely hurt by two years of extremely low oil prices. The earlier reluctance to enforce a production cut could have been intentional, as OPEC and Russia sought to curb the threat from US shale oil companies. However, shale output has been resilient, with only c.11% drop in production since its peak in 2015. In our view, there is no better time than now for OPEC and non-OPEC to join forces in view of the political uncertainties ahead.
- Assuming global demand growth is intact, the production cut would result in a deficit, keeping oil prices high, in our opinion. High oil prices would spur shale producers to turn on their taps and tempt other oil-producing countries to increase production and reap higher profits. The US producers are ever-ready to turn on the taps to capitalise on the higher crude oil environment, given their wide range of breakeven prices (US$28-68/bbl). According to WoodMackenzie, tight oil drilling accounts for 60% of the production that is commercial at US$60/bbl.
- Higher production and supply, amid lacklustre global demand growth (Europe and Brexit uncertainty, China’s economy rebalancing) would put a cap on the deficit quantum and oil price, in our view.
- As such, we believe that oil prices will stay in the range of US$45-60/bbl in 2017F, high enough to improve the fiscal deficit of oil-producing nations but not too high that they would spur a surge in shale and other crude oil production.
Shallow-water asset owners to benefit before yard players
- In our view, the primary beneficiaries of the price rally would be the E&P players, given the higher prices for their products. Thereafter, we view shallowwater OSV players as likely first-tier beneficiaries, as production and maintenance activities are accorded priority over exploration work in the early part of sector recovery.
- Yards (for both rigs and vessels) however, may face a protracted winter, given that there are still an estimated 179 rigs, 432 AHTS/AHT and supply fleet global order book to be drawn down
Cheap valuations and under-owned sector
- Large-cap stocks are trading at 0.95x forward P/BV, a 32% discount to 1 s.d. below the 16-year historical mean of 1.4x.
- Small-cap stocks are trading at an at a new trough of 0.4x forward P/BV. The sector valuations are now lower than the trough levels during the global financial crisis (GFC).
- Valuations of large caps are close to the levels seen in 2001-2002 post-dotcom bubble.
- We have not turned Overweight on the sector as there are still significant uncertainties in 2017, namely:
- OPEC members and Russia adhering to production limits;
- Trump’s policies on US production;
- anaemic global world GDP; and
- existing asset glut, which could keep earnings flattish for the next 1½ years.
- Our Neutral call is premised on OPEC and Russia’s commitment to curbing output in 2017 and the assumption that there will not be any large sector blowups moving forward.
- Downsides risks are:
- both OPEC and Russia abandoning the cause at any time during the year; and reverting to over-production to gain market share (similar to the scenario in 2015);
- higher-than-expected US production, which would undermine the market’s rebalancing efforts; and
- another sector blowup in 2017 involving any of the companies.
- Upside risks are:
- swifter-than-expected recovery in crude oil prices;
- instability in any of the OPEC member-countries (reduces OPEC production); and
- higher-than-expected global GDP growth, which would lift demand.