SINGAPORE (Dec 20): Saudi Arabian Oil Co (Saudi Aramco), the kingdom’s national oil corporation (NOC) and world’s biggest oil producer, had a positive debut on the Tadawul exchange. Its shares have gone up 19% from its IPO price of SAR32, closing at SAR38 on Dec 16 and giving the company the US$2 trillion ($723.1 billion) valuation that Saudi Arabia was aiming for. However, the same optimism could not be seen in the broader and related sectors.

Ray Farris, chief investment officer at Credit Suisse in South Asia, says the bank is still “underweight” energy stocks. “From an asset allocation perspective, the sector still doesn’t [seem] to be particularly attractive,” he says at an outlook briefing on Dec 2. He did concede that there could be one or two individual gems within the sector.

The outlook for the sector is dim even though crude oil is trading at higher prices than at the start of the year. Year to date, the prices of West Texas Intermediate crude and Brent crude are up 32.6% and 21.5% respectively. “[Energy stocks] are the worst performing because nobody believes that these prices are sustainable,” says Suresh Tantia, senior investment strategist at Credit Suisse in Asia-Pacific, at the same briefing.

“Given the increase in [crude oil] supply, [environmental, social and governance] concerns and weakening demand, we think there are better alternatives compared with the energy sector [from an investment perspective],” he explains.

David Gaud, Asia chief investment officer at Pictet Wealth Management, is also bearish. He expects companies operating in the oil and related sectors to see more defaults on bond issuances as activity in the upstream and midstream segments continues to stay subdued. In particular, the oil contractors, subcontractors and service providers are most at risk. “Clearly, we are going to see [casualties] in the energy space across the [value] chain,” he says at a Dec 4 outlook briefing.

Perhaps the clearest indication of the pessimistic view is the reluctance to invest in Saudi Aramco. Neo Teng Hwee, chief investment officer at UOB Private Bank, says he would not advise his clients to buy shares in the NOC. “It doesn’t mean that we don’t like it, but we don’t have a positive view on it,” he says at a briefing on Dec 3.

Crude oil prices to remain low

The crux of the matter is that crude oil prices are still relatively low and could continue to be so, given the oversupply of black gold. This is despite a deeper-than-expected cut agreed to by the Organization of the Petroleum Exporting Countries and its allies — also known as OPEC+.

From Jan 1, 2020, OPEC+ will raise its total production cut to 1.7 million barrels a day. This will be achieved through the reduction of about 370,000 and 130,000 b/d by OPEC and non-OPEC members, respectively.

Notably, Saudi Arabia will bear the biggest cut of 167,000 b/d among OPEC members, while Russia will bear the biggest reduction of 70,000 b/d among non-OPEC members. This will exclude Russia’s production of condensates, however. In addition, Saudi Arabia will voluntarily reduce its production by a further 400,000 b/d. OPEC+ says it will reconvene in March 2020 to recalibrate production quotas.

Still, compliance among OPEC+ members with their respective production cut figures has been shabby. Only 57% of members have been dutifully producing less than their quotas so far this year, notes DBS Group Research.

The majority of the load was borne by Saudi Arabia, and aided by involuntary reductions among several other countries such as Angola, Azerbaijan and Mexico, it adds.

On the other hand, Iraq and Nigeria, two of the largest oil producers in the group, had expanded rather than throttled their production. Russia, the leader of non-OPEC nations, has also not been living up to its end of the deal, meeting its target only 30% of the time in the past 10 months. This is despite the fact that non-compliance can partly be attributed to its rising condensate production, which will now be exempted from its output figure.

That said, things could improve. DBS expects “firmer” conformity by Iraq and Nigeria as other member countries dial up the pressure on them. Already, the oil ministers of both countries have been more vocal on flagging demand in 2020 and have been demonstrating better commitment in recent months, it notes. In addition, Russia has expressed its willingness to ensure deeper supply cuts as well.

“Put together, we should see global oil supply shaved by another 300,000 to 400,000 b/d, assuming greater (still incomplete) compliance by Iraq, Nigeria and Russia. Improved discipline by other non-con formers like Malaysia and Gabon would further trim supply by around 100,000 b/d,” DBS analysts Ho Pei Hwa, Suvro Sarkar and Jason Sum write in a Dec 9 note.

As a result, DBS expects crude oil to continue trading sideways on neutral supply-demand dynamics. “While we are now slightly more positive on crude oil prices, we still maintain our 2020 and 2021 average Brent crude oil price forecast of US$60 to US$65 per barrel, near the current level, as global crude oil supply and demand growth in 2020 will be largely balanced,” say Ho, Sarkar and Sum.

This is because lower OPEC+ supply will be offset by considerable supply growth from other sources such as the US, Norway and Brazil, according to DBS. While a more promising macroeconomic outlook is expected to underpin a pickup in growth to one million b/d in 2020, it will be “barely adequate” to absorb the increase in supply, it adds. “Upside in oil prices from here on will be limited unless there is better-than-expected OPEC+ compliance, faster rollback of US-China tariffs or an escalation of geopolitical tension in the Middle East,” the DBS analysts note.

Stock picking

So, should investors stay away from locally listed companies that service the oil sector? Or are there stocks that continue to shine? According to CGS-CIMB Research, the moves by Temasek on the three companies it controls — Keppel Corp, Sembcorp Industries and Sembcorp Marine (SembMarine) — will be what the market is watching out for.

Temasek is already trying to increase its stake in Keppel. Assuming it clears the regulatory hurdles and other pre-conditions, the sovereign fund’s tighter control could unlock value at both Keppel and Sembcorp. In particular, Keppel’s balance sheet could be freed up for more synergy creation options, says CGS-CIMB. This includes an asset swap between Keppel’s infrastructure business and Sembcorp’s urban development business to realise the hidden gem: the Vietnamese industrial parks.

CGS-CIMB adds that Keppel could buy and/or recycle property-related assets to achieve its mid-term return on equity (ROE) target of 15%, while benefiting from the redevelopment of the Greater Southern Waterfront. “We do not rule out the divestment of M1 (which Keppel owns partially) to StarHub to help the ailing telco segment and create a cleaner structure for Temasek-linked companies,” Lim Siew Khee, CGS-CIMB head of research, writes in a Dec 9 note.

CGS-CIMB also expects Keppel’s offshore and marine (O&M) margin to remain “strong” over the next few quarters. This is underpinned by its year-to-date order wins of $1.9 billion, bringing total order book to $5.1 billion. The research house expects the company to end the year with $2.2 billion of new order wins and secure $3 billion of new contracts next year. “We project the final settlement of Sete Brasil rigs to take place by 1Q2020, which could add US$166 million to US$316 million of new orders,” says Lim, referring to the bribery scandal in Brazil that has dogged Keppel and Sembmarine for the past few years.

Besides Keppel, CGS-CIMB is “excited” over CSE Global’s earnings prospects, especially given its “padded” order backlog. The company, which provides technology solutions to the oil and gas sector, had an order intake of $348.9 million in 9MFY2019 ended Sept 30, up from $236.1 million in the same period last year. In October, the company announced that it had secured contracts worth $103 million, which will bring 10MFY2019 order intake to $452.5 million.

This compares with FY2018’s order intake of about $381 million. “We think CSE could end FY2019 with an order backlog of at least $300 million, the highest order backlog in the past five years,” says CGS-CIMB analyst Cezzane Lee.

DBS says it favours Sembcorp, as the company offers a unique value proposition as a proxy to ride a potential cyclical O&M upturn, supported by a defensive utilities business. Assuming a fair value of $1.40 for SembMarine, Sembcorp’s utilities segment is way undervalued at 0.55 times book value and 5.6 times earnings, against an ROE of 6%, it says. At group level, Sembcorp is trading below its historical trough of 0.6 times book in 2016. “We believe continuous improvements in India will rerate Sembcorp’s utilities business and [lead to the] recovery of marine orders and earnings,” say Ho, Sarkar and Sum.

CGS-CIMB has maintained its “add” call for both Keppel and CSE, with price targets of $8.36 and 73 cents respectively. DBS has a “buy” rating for Sembcorp, with a price target of $2.90.