Offshore & Marine - UOB Kay Hian Research 2015-10-01: IEA Now Expects Oil Supply-Demand Balance To Take Place Sooner, In 3Q16

Offshore & Marine - UOB Kay Hian Research 2015-10-01: IEA Now Expects Oil Supply-Demand Balance To Take Place Sooner, In 3Q16 Offshore & Marine SEMBCORP INDUSTRIES LTD U96.SI  EZION HOLDINGS LIMITED 5ME.SI  TRIYARDS HOLDINGS LIMITED RC5.SI 

Offshore & Marine – Singapore IEA Now Expects Oil Supply-Demand Balance To Take Place Sooner, In 3Q16 

  • We lower our Brent oil price estimates for 2015 and 2016 further to US$56/bbl and US$63/bbl respectively. 
  • IEA now expects oil demand-supply to be in balance by 3Q16 (4Q16 previously). 
  • In spite of this, oil prices remain weak, alongside weak demand in the jack-up and oil service space. A recent survey implies that cost savings from service providers have mostly been realised, providing a possible floor to dayrates. 
  • Our Singapore top stock picks remain SCI, Ezion Holdings and Triyards. 
  • Maintain MARKET WEIGHT. 


WHATS NEW 


 Revising 2015/16 Brent estimates. 

  • September saw our list of 38 agencies revising their Brent forecasts downwards by 2-40%. The change in the average consensus Brent estimates exceeded our 5% threshold. As such, we revise our Brent estimates for 2015 and 2016 to US$56/bbl and US$63/bbl respectively. 
  • However, our stock valuations - based on FY16 P/B - have already assumed a lower benchmark of US$60/bbl. Thus there is no revision to our stock target prices. 

 Implied oil supply surplus fell to 1.3 mbd; Brent remains range bound. 

  • According to the International Energy Agency’s (IEA) September Oil Market Report, stronger-thanexpected demand growth in 3Q15 raised its demand estimate by 0.4 mbd to 95.0 mbd. Declining production - led by lower US light tight oil (LTO) production - saw global supply decline by 0.6 mbd to 96.3 mbd. This suggests an improvement in the supply surplus situation, from 2.7 mbd in 1H15 to 1.3 mbd in 3Q15. 
  • Despite this, Brent price remained stubbornly low, trading at US$46-51/bbl in September. The market remains cautious as high gasoline inventories and China’s economic slowdown weigh on oil prices. 

 A potential silver lining - Supply-demand to be in balance by 3Q16, sooner than expected. 

  • Based on IEA’s latest estimates, oil demand and supply are expected to be on an even keel by 3Q16, earlier than its previous expectation of 4Q16. This revision stems from an upward revision of demand and a downward revision of supply estimates. The former is due to a stronger-than-expected demand for cheap gasoline from the US and Europe, from 24.5 mbd to 24.7 mbd and 13.5 mbd to 13.6 mbd respectively. Their growth assumptions however hinge heavily on higher global economic growth in 2016. 
  • IEA’s lower supply estimate is due to a decline in US oil production. This arises from a switch in EIA’s measurement method from relying on state data to direct polling of oil producers. The new data shows that the US oil production decline was actually faster than earlier expectations, thus leading to the IEA’s revision of supply from the Americas in 2016 from 20.0 mbd to 19.5 mbd. 

 Oil service downturn continues with drilling jack-up overcapacity expected throughout 2016. 

  • Despite a more optimistic oil scenario by the IEA, the outlook for the exploration phase remains bleak. Drilling jack-up demand remains muted. According to IHS-Petrodata’s latest report, marketed jack-up supply is expected to grow 9.8% to 569 units by Dec 16, outweighing demand growth of 2.2% in 2016. Marketed utilisation is projected to fall from 70% in Dec 15 to 65% in Dec 16. As such, we expect the oversupply situation to keep newbuild demand soft through 2016, and strain the financials of existing drillers. 
  • We expect rig delivery delays to be commonplace, with cancellation risks rising as the downturn persists. 

 Service sector cuts can only yield part of oil companies’ targeted 20-30% cost reductions. 

  • Based on a study by Wood Mackenzie in Sep 15, the consultancy finds that squeezing of the service sector will likely yield an average of 10-15% cost reductions. Oil majors seeking an average of 20-30% cost reduction on their projects have to focus on project optimisation and better ways of working with the service sector to realise this. 
  • While further dayrates may continue to slide, we opine that the downward pressure should start to ease. This is evidenced by the general slowdown and, in some cases, pickup in rates for offshore vessels. 


ACTION 


 Maintain MARKET WEIGHT. 


  • We retain our stock recommendations and maintain MARKET WEIGHT on the sector. 
  • Whilst the global O&G industry continues to face poor earnings visibility, this is more likely to be due to the slowdown in activities than another round of steep cuts. With further rate squeeze on service providers is unlikely to yield more savings to operators, we expect dayrates and activity to stabilise. 
  • Earnings are therefore expected to bounce along the bottom for service providers. The situation is different for yards, as a lack of demand and further delivery delays will dampen earnings. 
  • Additionally, they face rising cancellation risks as the downturn persists. The exception is for yards with diversified capabilities producing niche production assets and strong orderbook visibility. These are expected to remain fairly resilient in this downturn. 

 Stocks trading at cyclical troughs of 0.5x, accumulate for returns in the long term. 

  • Stock prices of small- and mid-cap oil service stocks are trading at close to cyclical trough valuations of 0.5x, and thus represent an opportunity to accumulate quality names. We expect outperformance in the long run, when the downturn has run its course. Prefer names with strong balance sheets and with dominance in niche assets. Our top stock picks in the Singapore offshore & marine (O&M) sector remain Sembcorp Industries (SCI), Ezion and Triyards. 


ASSUMPTION CHANGES / CATALYSTS / RISKS 


 Two key risks in the sector are: 

  1. another fall in oil prices and, 
  2. protracted low oil prices. 
  • Both would weigh on future capex spending, which needs to rise to return activity to the pre-crash level.


PEER COMPARISON 


Offshore & Marine - UOB Kay Hian Research 2015-10-01 Peer Comparison
Nancy Wei UOB Kay Hian | Foo Zhiwei UOB Kay Hian | http://research.uobkayhian.com/ 2015-10-01
UOB Kay Hian Analyst Report BUY Maintain BUY 4.69 Same 4.69
BUY Maintain BUY 1.05 Same 1.05
BUY Maintain BUY 0.81 Same 0.81


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