Monday, 14 April 2014

Oil and Gas Sector

OCBC on 10 Apr 2014

YTD, the FTSE ST Oil & Gas Index has slipped 3.3%, versus the STI’s 1.3% gain. We believe investors should take opportunity of the share price correction in the sector to accumulate quality stocks, as the softness in the exploratory drilling market is largely seen as a ‘momentary pause’. The long-term fundamentals of the oil and gas sector remain favourable. Maintain OVERWEIGHT on the sector, with Ezion Holdings [BUY, FV: S$2.57], Keppel Corp [BUY, FV: S$12.25], Nam Cheong [BUY, FV: S$0.42] and Sembcorp Marine [BUY, FV: S$5.26] as our preferred sector picks.

Lacklustre share price performance YTD
YTD, the FTSE ST Oil & Gas Index has slipped 3.3%, versus the STI’s 1.3% gain. We believe this has been driven by increasing concerns over a slowdown in offshore activities, as major international oil companies such as ExxonMobil, Chevron and Royal Dutch Shell have earmarked lower capex plans this year in a bid to reduce costs. Recent comments by offshore drillers suggest there may be some softness in the offshore drilling market, but this is largely seen as a ‘momentary pause’ and also more prominent within the ultra-deepwater (UDW) space. Singapore rig-builders Keppel Corp (KEP) and Sembcorp Marine (SMM) are well-versed in the design and construction of high-specification jack-up rigs which is still seeing robust demand, in our view. 

Demand and supply dynamics for OSV segment still positive
Despite concerns over a slowdown in offshore exploration and production (E&P) activities, we believe the demand and supply dynamics for the offshore support vessels (OSV) segment remains positive. Previous years of successful exploratory drilling have resulted in more fields reaching the development and production phase, which requires more support from OSVs. The OSV/rig ratio has stabilised at 4.34 in Mar 2014 (Feb 2014: 4.36), while the ratio of OSVs under construction to rigs under construction has been gradually declining from 2.28 in Aug 2012 to 1.96 in Mar 2014 due to stronger growth in rig orders, thus alleviating concerns over oversupply issues. We also expect the replacement cycle of older OSVs to pick up pace going forward, as 25% of the global OSV fleet is more than 25 years old.

Stick with quality
We believe investors should take opportunity of the share price correction in the sector to accumulate quality stocks which we believe will outperform once the industry gets over this cyclical short-term patch. The long-term fundamentals of the oil and gas sector remain favourable. We like KEP [BUY, FV: S$12.25] and SMM [BUY, FV: S$5.26] for their strong order books and market leadership positions. We likeEzion Holdings [BUY, FV: S$2.57] for its stellar earnings growth potential and its dominant position within the service rigs market, especially in Asia. Although Nam Cheong’s [BUY, FV: S$0.42] share price has already appreciated 11.1% YTD, we still recommend it as one of our preferred picks given its compelling valuations (FY14F PER of 7.8x, a steep 39% discount to its closest peer Coastal Contract’s FY14F consensus PER of 12.9x). Maintain OVERWEIGHT on the broader sector.

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