Brokers Report: Oil & Gas - Hangover in the rig market

SELL CALL on UMWOG and and CEASE COVERAGE for Perisai

Highlights

Oil & Gas - hangover in the rig market?

Malaysian rig count at all time low. 

Rig count in Malaysia dropped to as low as 4 in 2016 compared to 6-10 rigs range seen in 2015, a dismal environment to be operated in for local rig players. The rig count seems to lag the oil price trend based on our observations possibly due to rig demobilization lag and decision making lag by the oil producers.

Oil price volatility can’t be ignored. 

Our study has shown that oil price volatility is in fact a better gauge for predicting rig count levels. The trend is evident in 2009-2011 periods whereby oil prices were rising but with volatility but rig counts were still stalling. Rig count only improved in 2011-2014 time period where oil prices stabilized above USD100/bbl levels.

When is the recovery then? 

Despite improvement in oil prices in 2H16 from low of USD30/bbl earlier this year, we do not anticipate strong recovery in rig counts despite expectation of improvement in oil prices in 2017. We opine that a few overhangs need to be cleared: (i) OPEC’s decision in production freeze (ii) rising oil production in Russia, and (iii) shorter than average investment cycle of US shale oil drilling.

Low DCR here to stay. 

DCR for high-spec jack up rigs had plunged to USD70,000-90,000/day from USD130,000-150,000/day amid severe industry downturn. We do not anticipate the rates to recover to their previous highs at least for 2017 underpinned by 2 major arguments: (i) oil prices are not expected to recover to US$70/bbl level and beyond soon, making oil producers to keep their costs low despite recovery in industry activity, and (ii) supply overhang of 177 rigs still under various construction stages in the yards which needs to be absorbed.

Financing gap for rig players. 

Other than industry fundamental issues, the local rig market also faces critical financing issue. Two major rig players, namely PERISAI and UMWOG, have a total short term financing gap of close to circa RM1bn based on our calculations. Debt refinancing is always the 1st choice but we opine that it is difficult to obtain in this environment due to low bank appetite to provide credit to O&G companies.

Equity fund raising, the last resort. 

The companies may resort to equity fund raising as the last resort to bridge their financing gap. This would be dilutive for their shareholders with PERISAI to face larger dilutive impact as 3.9bn new shares need to be issued based on last traded price compared to 461.2m shares for UMWOG. This could send a negative signal to the market but the possibility of this solution to be employed is still there in our opinion.

Catalysts

Weaker than expected oil production growth.

Risks

Further slump in oil prices.

Significant supply overhang in jack up rig market

Rating

NEUTRAL

Positive: Lower CAPEX from oil producers reining in oil production.

Negative: Persistent oversupply in the market.

Stock Pick

UMWOG: Maintain SELL with TP of RM0.69 (based on 0.5x PBV).

Perisai: Cease coverage due to high liquidity risk amid difficult operating environment.

Source: Hong Leong Investment Bank Research - 26 September 2016