DOWNSTREAM oil and gas companies under our coverage (Rotary Engineering and PEC) will report their Q2 calendar year 2012 results next month and we expect a relatively weak financial performance from both companies. The industry has been experiencing severe pricing competition amidst a shortage of local large-scale petrochemical project works. In our view, a quick turnaround is unlikely.
Recent comments from the Economic Development Board (EDB) - the lead government agency responsible for attracting energy investments - have also been telling.
When asked for an update on a refinery plan, EDB's deputy director of energy and chemicals said, "EDB does not have a specific aim of attracting a green-field refinery investment at the moment ... the focus is on upgrading the complexity of these refineries."
We believe the sector's profitability will continue to remain depressed. In the last quarter, operating margins for Rotary and PEC were 0.83 per cent and 1.82 per cent, respectively. Outside our coverage, Hiap Seng Engineering and Mun Siong Engineering reported Q1 calendar year 2012 operating losses of $1.2 million and $180,000, respectively. Although margins may recover over the medium-term horizon, we have yet to see any meaningful catalyst. For now, the companies still lack the scale and bargaining power (against oil companies) to push prices upwards.
Investors should also watch out for any unexpected delay in Rotary's Fujairah project and PEC's unresolved claim on its Rotterdam joint venture. To-date, PEC has taken $11.2 million of provisions against $18.3 million of outstanding claims. Depending on the outcome of its negotiations with Verwater (its joint-venture partner), PEC may need to write off further losses. As we feel that there are more downside risks than upside risks, we keep our "underweight" rating for the sector. We also maintain our "hold" ratings for Rotary (fair value: $0.64) and PEC (fair value: $0.50).
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