Downstream oil and gas companies

OCBC on 6 June 2012

DOWNSTREAM oil and gas companies reported weak results for the first three months of calendar year 2012 (Q1 2012) that were below expectations. Rotary Engineering disappointed with lower gross margins and a steep $4.6 million foreign exchange loss.

PEC Limited barely broke even with net profit of just $1.3 million against revenue of $106.7 million. Outside our coverage, Hiap Seng Engineering and Mun Siong Engineering reported quarterly net losses of $2.2 million and $0.1 million, respectively.

Rotary, PEC, Hiap Seng, and Mun Siong are mainly involved in engineering and maintenance services for the downstream oil and gas sector. They are highly dependent on the pricing and volume of work it secures.
As we have discussed in earlier reports, the recent shortage of project and maintenance work has resulted in severe pricing pressure. With the dismal results, we now fear that some downstream companies are operating at near or below break-even rates.

We are not expecting a quick recovery for the downstream oil and gas sub-sector. First, uncertainty over the eurozone situation may continue to discourage investments by oil companies. Second, the downstream companies lack the scale and bargaining power (against oil companies) to push prices upwards.

In addition to that, Rotary and PEC will require time to fine-tune their overseas operations. To date, Rotary has encountered unexpected delays on its Fujairah project and PEC has unresolved claims on its Rotterdam joint venture. As long as the companies continue to pursue overseas projects, such risks cannot be ruled out.
Meanwhile, the share prices of Rotary ("hold", fair value: $0.50) and PEC ("hold", FV: $0.64) have fallen to near historical lows.

While we have an "overweight" rating on the broad oil and gas sector, we think that investors should wait for clearer signs of a recovery before buying into downstream counters such as Rotary or PEC.
Rotary Engineering - HOLD
PEC Limited - HOLD