PP 7767/09/2010(025354)

19 July 2010

Malaysia Corporate Highlights

RHB Research
Institute Sdn Bhd
A member of the
RHB Banking Group
Company No: 233327 -M

Sector Upda te
19 July 2010
MARKET DATELINE

Recom : Neutral
Oil And Gas (Maintained)

Getting Better?

Table 1 : Oil And Gas Sector Valuations

Fair EPS EPS growth PER P/NTA P/CF GDY
FYE Price value (sen) (%) (x) (x) (x) (%) Rec
(RM/s) (RM/s) FY10 FY11 FY10 FY11 FY10 FY11 FY10 FY10 FY10
Dialog Jun 1.06 1.30 6.1 8.8 14.9 44.8 17.4 12.0 4.2 15.3 3.2 OP
EPIC Dec 1.85 2.72 26.9 27.2 7.9 1.1 6.9 6.8 0.9 4.8 5.1 OP
P Gas^ Mar 10.20 10.71 62.6 64.4 31.6 2.9 16.3 15.8 3.2 11.0 6.5 MP
Wah Seong Dec 2.39 2.38 16.1 18.3 23.1 14.0 14.9 13.0 3.0 5.1 2.6 MP
SapuraCrest^ Jan 2.26 2.46 16.9 18.9 26.5 12.0 13.4 12.0 2.2 8.0 3.1 MP
Kencana July 1.53 1.27 8.0 9.8 11.3 22.5 19.2 15.7 3.2 13.2 0.4 UP
Petra Perdana Dec 1.37 1.15 6.8 12.2 -31.1 79.9 20.2 11.2 0.8 1.5 1.5 UP
KNM Dec 0.51 0.36 2.8 3.6 -24.5 27.2 17.9 14.1 6.6 18.6 3.9 UP
Sector Avg 8.0 10.5 15.8 14.3
Sector Avg (excl Pet Gas) -6.0 22.4 15.0 12.3
^ FY10-11 valuations refer to those of FY11-12

♦ Positive news flow … We cannot deny that there has been a stream of Table 2. Basis For Fair Value Estimates
good news for the oil & gas sector that suggests that upstream activity is Company Valuation Basis
turning more positive. However, we believe that investors should view all Dialog Target PER of 15x FY06/11,
news flow in perspective given there are still underlying economic issues premium to the sector
benchmark due to good
that could pull sentiment down.
management and robust
balance sheet.
♦ … rising number of working rigs in Southeast Asia. Recently
EPIC Target FY12/11 PER at 10x to
announced June rig counts clearly show Southeast Asia offshore activity factor in flatter growth and
outshining the rest of the world with mom increase in the number and smaller market cap.
utilisation of working rigs. Utilisation rates are also up vs. six months ago. Kencana Target FY07/11 PER at 13x,
in line with the sector
♦ … contracts soon for UMW’s jackup rigs. We expect UMW to secure benchmark.
contracts for its Naga 2 and Naga 3 jackup rigs soon. We also note that KNM Target FY12/11 PER at 10x to
factor in higher earnings risk.
charter rates appear to be improving but are still below the peak in 2008.
Petra P’dana Target FY12/11 PER at 10x

♦ … BP’s Macondo well successfully capped, for now. Last Friday, BP

for marine, plus share of
Petra Energy’s FV at 9x, to
appeared to have successfully capped the leaking Macondo well in the factor in higher earnings risk.
Gulf of Mexico. Although pressure tests on the cap are still ongoing, PetGas DCF
stopping the leak is a significant leap forward and relieves pressure on the SapCrest Target FY01/12 PER at 13x,
US government to impose further drilling restrictions which in turn in line with the sector
benchmark.
reduces the risk of offshore assets moving to this region looking for jobs.
Wah Seong Target FY12/10 PER at 13x,

♦ … new listings. Other than the listing of MMHE and Petronas’

in line with the sector
benchmark.
petrochemicals division, we expect UMW to revisit its proposal to list its Source: RHBRI
oil & gas division in 2011. Potentially, this could also spur the revival of
other proposed listings in the sector that were postponed. Conditions are
also ripe for more corporate restructurings within the sector given
valuations have fallen back, but long-term outlook is positive.

♦ Risk. Stronger-than-expected recovery in economic conditions which will

in turn boost demand for petroleum products.

♦ 2011, more than 2H2010. While the news flow is supporting the
trading sentiment for oil & gas stocks, we believe they are pointing
Yap Huey Chiang
towards more robust conditions in 2011 rather than 2H10. Our Neutral
(603) 92802171
call stands as we believe the sector needs to ride out the “normalisation” yap.huey.chiang@rhb.com.my
of economic growth. Meantime, Dialog (OP, FV = RM1.30) is our top
pick given its 70% recurrent earnings and robust balance sheet.

Please read important disclosures at the end of this report.

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The Good News

♦ Positive news flow … We cannot deny that there has been a stream of good news for the oil & gas sector that
suggests the underlying upstream activity is turning more positive. However, we believe that investors should
view all these news flow in perspective given there are still underlying economic issues that could pull sentiment
down.

♦ More positive sentiment? The positive news flow comes after 18 months of uncertainty in the sector following
the plunge in crude oil prices amidst the global economic downturn at the end of 2008. We believe these
activities are driven by a number of factors, including:

o Competition for Petronas’ capex plans which will be focused on domestic supply. As it stands, headline oil &
gas capex numbers for Malaysia may appear compelling – for example, we highlighted in our recent Oil &
Gas Sector Update (2 Jul), four potential new onshore projects which together with Petronas’ planned capex
of RM12bn for FY11, suggest figures in the RM20-30bn range;

o FY11 valuations for some oil & gas stocks have fallen back to relatively attractive levels compared to the
2011 market PER of 13.7x, and to our target FY11 PER for the sector of 13x. The drop in valuations has
affected mainly the asset plays such as Petra Perdana, Tanjung Offshore and SapuraCrest, although we
highlight that earnings for FY10-11 may remain fluid until there is more visibility on new offshore work
programmes; and

o Exploration and production (E&P) activity in Southeast Asia has reportedly remained strong in June
compared to other major drilling regions especially in North America, South America, Middle East and West
Africa. We also note that Southeast Asia, Black Sea and North Sea rig counts in May had already shown an
uptick compared to Dec 2009 and Jun 2009 (see Table 3), a trend which is evident in other major drilling
regions. Again, this suggests that the underlying conditions in Southeast Asia remain relatively robust. This
would also appear to be supported by expectations that UMW will secure contracts for its Naga 2 and Naga 3
jackup rigs soon. Although charter rates appear to be improving, we expect the new lease contracts to be
significantly lower than the 3-year US$170m PCPP contract for Naga 2 (or US$155k per day) that was
awarded in Aug 2008 and cancelled in Jul 2009.

Table 3. Rig Utilisation Rates In Major Offshore Drilling Regions

Region Jun 2010 (%) May 2010 (%) Dec 2009 (%) Jun 2009 (%)
Southeast Asia 81.5 76.2 69.9 72.6
Black Sea 66.7 66.7 50.0 66.7
Europe – North Sea 90.1 88.7 80.3 88.7
N. America - Mexico 81.8 90.6 91.4 88.6
N. America – Gulf of Mexico 70.6 77.4 71.6 55.7
S. America - Brazil 82.0 80.0 88.5 84.8
Middle East – Persian Gulf 75.3 72.4 73.7 73.3
Africa – West 81.5 83.3 81.1 67.3
Source: Rigzone

♦ BP’s Macondo well successfully capped, for now. Last Friday, BP appeared to have successfully capped the
leaking Macondo well in the Gulf of Mexico. Although pressure tests on the cap are still ongoing, stopping the
leak is a significant leap forward and relieves pressure on the US government to impose further drilling
restrictions which in turn reduces the risk of offshore assets moving to this region looking for jobs.

♦ New listings ahead for the sector. The market is already anticipating the listings of MMHE in the 2H2010, and
Petronas’ petrochemicals division in early 2011. Both companies are relatively sizeable and depending on their
estimated free float, the stocks will likely be included in either the FTSE Bursa Malaysia Top 100 (FBM100) index
or the FBM KLCI (top 30).

♦ UMW. Other than the two proposed Petronas-related listings, we anticipate the revival of UMW’s proposal to list
its oil & gas division in 2011. UMW’s management told us that they expect to submit the new listing proposal to
the Securities Commission (SC) by the end of this year, given market conditions appear to have stabilised, and
on the expectation that oil & gas activities will begin to pick up in 2011. The listing of UMW’s oil & gas division is
driven by: 1) corporate restructuring to turn each of the operating units (excluding Wuxi Seamless Oil Pipe, the
listed associate) into wholly-owned subsidiaries, and transfer the minorities up to the holding company level –

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 19 July 2010

although this will require negotiations with each of the parties involved; 2) funding purposes as the division has
grown significantly.

♦ Others. Potentially, this could also spur the revival of other proposed new listings in the sector that were
postponed earlier this year, including Bumi Armada.

Table 2. Potential New Oil & Gas Listings

Company Business Major Shareholder
MMHE Major Fabricator MISC
Petrochemicals division Petrochemicals Petronas
UMW Oil & Gas Pipe manufacturing and coating, jackup rigs, semisubmersible, land rigs UMW Holdings
Bumi Armada Offshore support vessels, FPSO Usaha Tegas
Source: Company, RHBRI, Media

♦ Restructurings and strategic tie-ups. Conditions are also ripe for more corporate restructurings within the
sector given valuations have fallen back despite positive long-term outlook. In our view, SapuraCrest’s strategic
tie up with Seadrill and Acergy, and Dialog’s strategic partnerships with MISC, Trafigura, Vopak, Johnson
Matthey and Shell MDS in its various business units provide the templates for other Malaysian oil & gas
companies. As it stands, we have recently seen new major/strategic shareholders emerge in three oil & gas
companies (i.e. Singapore’s Ezra Holdings’ 19% stake in Perisai Petroleum, Ekuinas’ 20% stake in Tanjung
Offshore, and Nam Cheong’s 10% stake in Petra Perdana), plus one proposal for a full takeover (Titan Chemicals
by South Korea’s Honam Petrochemical). Potentially, we see more strategic tie-ups (among the foreign and local
fabricators, asset companies, equipment suppliers and engineering companies) that would strengthen these
players’ bids for new contracts in a highly-competitive market, especially given Petronas’ focus on keeping costs
under control.

The Bad News

♦ Direction of crude oil prices remains unconvincing. Despite the recent upsurge in the Euro, crude oil prices
have barely moved out of its trading range (see Chart 1), and in our view, this suggests that the underlying
crude oil price catalysts currently do not include US$ and Euro fluctuations although we note that this has been
the case since 4Q09.

Chart 1. WTI Crude Oil Price Vs. EUR/US$

WTI Crude
Oil Price

EUR/US$

Source: Bloomberg

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 19 July 2010

♦ Demand and supply as the key price catalyst. The US-based International Energy Agency (IEA) recently
forecast global oil demand to increase at a slower pace of 1.6% to 87.8m barrels/day (bpd) in 2011 vs. an
estimate of +2.1% to 86.5m bpd for 2010. However, OECD oil inventories continued to rise, adding 35m barrels
in May to a total of 2.8bn barrels, equivalent to 61 days of consumption (of 45.5m bpd), which is near the top
over the last five years. We are also concerned that fears of a sharper-than-expected global economic slowdown,
and especially China, could have a similar impact on global oil demand. This suggests that there is little pressure
for crude oil prices to move up.

Risks And Mitigating Factors

♦ Risks. We believe the oil & gas industry still faces near-term uncertainty given the lack of convincing catalysts
for crude oil prices, sharper-than-expected global slowdown especially China.

♦ Mitigating factors. However we expect demand to bounce back in the longer term as the global economic
conditions move into a new growth cycle. As we highlighted above, oil & gas spending to expand supply
infrastructure will have to play catch up after a long period of delays.

Conclusion - Differentiate between news flow and fundamentals.

♦ The broader equity market’s volatile conditions are driven by sentiment trading, which in turn is driven by news
flow. For the oil & gas sector as highlighted above, we see big headline figures being quoted in media reports,
and this could create some spikes in related share prices.

♦ Our Neutral call stands as we believe the sector needs to ride out the “normalisation” of economic growth
before the longer-term recovery in demand for petroleum products once again places pressure on the supply
infrastructure. There appears to be no rush for oil & gas companies to begin spending aggressively as the near-
term uncertainty in crude oil prices will continue to be a key risk factor for now. Moreover, we highlight that
major projects are typically executed over 2-4 years which implies minimal benefit to FY10-11 earnings. In the
meantime, fundamental earnings for the likes of KNM and Petra Perdana may continue to disappoint over the
next 2-3 quarters.Therefore Dialog (OP, FV = RM1.30) remains our top pick for the sector given its 70%
recurrent earnings, robust balance sheet and conservative management.

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Chart 2: Dialog Technical View Point

♦ After trending above the Uptrend Line (UTL) since
Oct 2008, the share price of Dialog drifted away
from the UTL in May 2010.

♦ However, the stock still traded at above the key

support level of RM1.06 thus far, as it closed on the
dot of the level on last Friday, still lacking an
important confirmation signal of the derailment of
the UTL.

♦ Technically, as it holds near the RM1.06 level in

recent trading, the 10-day and 40-day SMAs were
also trending sideways, doubling its support at the
level near RM1.06, in our view.

♦ As such, though the stock registered a negative

candle on the chart, and the short-term indicators
were both pointing south, indicating a negative
immediate outlook this week, we remain optimistic
that the stock should hold near RM1.06 in the near
term.

♦ Until and unless it loses the level convincingly, we

will expect the stock to trade sideways with a fair
chance to rebound towards the RM1.15 resistance
level, near the extended UTL at the RM1.17 –
RM1.20 region.

♦ A lower support level is only seen at RM0.96 should

it ever lose the tough RM1.06 support level.

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IMPORTANT DISCLOSURES

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The recommendation framework for stocks and sectors are as follows : -

Stock Ratings

Outperform = The stock return is expected to exceed the FBM KLCI benchmark by greater than five percentage points over the next 6-12 months.

Trading Buy = Short-term positive development on the stock that could lead to a re-rating in the share price and translate into an absolute return of 15% or
more over a period of three months, but fundamentals are not strong enough to warrant an Outperform call. It is generally for investors who are willing to take
on higher risks.

Market Perform = The stock return is expected to be in line with the FBM KLCI benchmark (+/- five percentage points) over the next 6-12 months.

Underperform = The stock return is expected to underperform the FBM KLCI benchmark by more than five percentage points over the next 6-12 months.

Industry/Sector Ratings

Overweight = Industry expected to outperform the FBM KLCI benchmark, weighted by market capitalisation, over the next 6-12 months.

Neutral = Industry expected to perform in line with the FBM KLCI benchmark, weighted by market capitalisation, over the next 6-12 months.

Underweight = Industry expected to underperform the FBM KLCI benchmark, weighted by market capitalisation, over the next 6-12 months.

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