PP 7767/09/2010(025354)

12 March 2010

Malaysia Corporate Highlights

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

Sector Upda te
12 March 2010
MARKET DATELINE

Recom : Overweight
Oil & Gas (Maintained)

Stronger Contract Flows In 2H 2010

Table 1 : Oil And Gas Sector Valuations

Fair EPS EPS growth PER P/NTA P/CF GDY
Price
FYE value (sen) (%) (x) (x) (x) (%) Rec
(RM/s) (RM/s) FY10 FY11 FY10 FY11 FY10 FY11 FY10 FY10 FY10
Wah Seong Dec 2.45 3.09 19.3 20.8 46.1 8.0 12.7 11.8 2.9 4.6 3.1 OP
Dialog Jun 1.03 1.29 6.4 9.3 -3.4 45.4 16.2 11.1 4.1 14.0 3.4 OP
EPIC Dec 1.59 2.69 26.9 27.2 7.9 1.1 5.9 5.8 0.8 4.1 5.9 OP
Kencana July 1.56 1.88 10.2 11.7 42.9 15.0 15.3 13.3 3.0 11.4 0.5 OP
SapuraCrest^ Jan 2.44 2.66 16.6 18.4 40.9 10.3 14.7 13.3 2.1 6.3 1.6 MP
KNM Dec 0.79 0.90 5.7 7.0 52.4 21.5 13.7 11.3 11.4 11.9 2.5 MP
Petra Perdana Dec 1.30 1.00 8.0 17.1 -18.5 +>100 16.2 7.6 0.7 1.4 1.5 UP
P Gas^ Mar 9.80 10.08 55.0 57.0 17.8 3.6 17.8 17.2 3.0 11.5 6.0 UP
Sector Avg 21.3 11.3 15.7 14.1
Sector Avg (excl Pet Gas) 31.7 19.7 13.5 11.3
^ FY10-11 valuations refer to those of FY11-12

♦ Spread between spot and futures to narrow. We note that crude oil Table 2. Basis For Fair Value Estimates
futures curve has flattened with the 9 March 2010 spread between spot Company Valuation Basis
delivery and one-month futures narrowed to its 18-month low of 40 cents Dialog Target PER of 16x CY10,
(vs. US$2.35 on 30 Dec 2009). The potential backwardation (i.e. spot price premium to the sector
rising above longer-dated futures) suggests that oil demand would likely benchmark due to good
management and robust
catch up with supply going forward, thus capping downside risk to crude oil
balance sheet.
price over the medium term. EPIC Target FY10 PER at 10x to
factor in flatter growth and
♦ Leading indicators pointing to better E&P spending ahead. According smaller market cap.
to industry sources, 2010 global E&P spending is likely to increase 10-15% Kencana Target CY10 PER at 16x,
yoy (vs. -15% yoy in 2009) driven mainly by recovery in US and Canada premium to the sector
spending (i.e. non-conventional projects such as oil sands and shale gas) as benchmark due to
improved earnings
well as resilient spending in Asia, Africa, Russia and Middle East. Leading
visibility and above-
indicators such as improving rigs activities and increase in oil sands industry earnings growth.
investment as well as uptick in FPSO leasing market further reinforce our KNM Target FY10 PER at 13x in
view that E&P spending would pick up momentum in 2H 2010. line with sector
benchmark.
♦ M&A activities set to rise in 2010. With global energy demand expected Petra Perdana Target FY10 PER at 13x for
to surge in the next 5-10 years and declining supply from conventional oil & marine, plus share of Petra
Energy’s fair value at
gas resources, we expect many of the larger players are looking to acquire
11.7x.
or enter into a j.v. with smaller companies, whose expertise and assets will Petronas Gas DCF
help them thrive in a more competitive environment going forward. SapuraCrest Target FY01/11 PER at
16x, premium to the
♦ Risks to our view. 1) Sharp pullback in crude oil prices due to weaker- sector benchmark due to
than-expected demand for crude oil; and 2) Strengthening of US$. improved earnings
visibility and above-
♦ Reiterate Overweight. Given stronger outlook of E&P spending as well as industry earnings growth.
still-low asset prices, we believe companies with strong balance sheet (i.e. Wah Seong Target FY10 PER at 16x,
premium to the sector
Dialog and Kencana) would be in a better position to acquire strategic
benchmark due to
assets over the medium term. We note that Wah Seong is already in improved earnings
acquisition mode. In addition, we believe investors should also focus on visibility and above-
companies with the assets and expertise related to E&P gas projects (Wah industry earnings growth.
Seong, Dialog and KNM). Hence we maintain our Overweight stance on Source: RHBRI
the sector. Our top picks are Wah Seong and Dialog.

Wong Chin Wai

Please read important disclosures at the end of this report. (603) 92802158
wong.chin.wai@rhb.com.my

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 12 March 2010

Crude oil price outlook

♦ Spread between spot and futures to narrow. We note that crude oil futures curve has flattened with the 9
March 2010 spread between spot delivery and one-month futures narrowed to its 18 months low of 40 cents (vs.
US$2.35 on 30 Dec 2009). The potential backwardation (i.e. spot price to rise above longer-dated futures)
suggests that oil demand would likely catch up with supply going forward, thus capping downside risk to crude
oil price over the medium term. With crude oil price hovering around US$70-85/barrel for the past 20 weeks
since 18 Oct 2009, we believe the gradual uptrend in 2010 would be driven by expectations of an economic
recovery and higher oil consumption in the future despite still-weak demand and high inventories currently.
Hence, we reiterate our 2010-11 crude oil projections of US$80-100 and US$100-120 respectively for now.

Sector Outlook

♦ Leading indicators pointing to better E&P spending ahead. According to industry sources, 2010 global E&P
spending is likely to increase 10-15% yoy (vs. -15% yoy in 2009) driven mainly by recovery in US and Canada
spending (i.e. non-conventional projects such as oil sands and shale gas) as well as resilient spending in Asia,
Africa, Russia and Middle East. In addition, we highlight that the following positive trends further point towards a
stronger recovery in E&P spending in 2H 2010:

1) Improving rigs activities. According to Seadrill and Transocean, demand for all segments (i.e. jack-up to
drillship) has improved since early 2010, with the most significant gain in the high-specification jack-ups and
tender rigs. We understand that both companies are in talks with E&P players for rigs capacity up to 2011.
For deepwater rigs, Seadrill remains optimistic that rising deepwater projects (i.e. 4,500-7,500 feet) will
likely absorb the extra capacity over the next 18 months and in turn push up the day rates to US$500k (vs.
US$350-450k currently).

2) Pick-up in oil-sands investment. We believe the sudden influx of project announcements for Canada’s oil
sands sector suggests that oil majors are moving forward with their respective plans for new or expanded
projects to take advantage of still-low costs as well as under-utilised labour market. Recall that
ConocoPhillips-Total and Suncor Energy Inc are expected to start work on phase 2 of Surmont project and
Phase 3 Firebag oil sands project respectively in Canada. Note that Canadian Association of Petroleum
Producers (CAPP) forecasts 2010 capital spending in the oil sands to increase 20% yoy (vs. -50% in 2009).

3) Uptick in FPSO leasing market. For the floating, production, storage and offloading (FPSO) market, we
understand that the number of formal inquiries is up in most segments except for small-mid FPSO vessels in
Africa. According to Fred Olsen (a Norwegian floater specialist), the FPSO vessel leasing market has picked
up significantly beginning 4Q 2009 with FPSO demand to remain strong in 2010 driven by E&P activities in
Asia and South America. Note that the company secured six new lease contracts in 4Q 2009, which was the
highest level of awarded contracts for a single quarter since 2006.

♦ Final decision on developments to pick up in 2H 2010. While delays in final investment decisions on major
projects would persist in 1H 2010, we believe E&P spending would pick up momentum in 2H 2010 given the
gradual increase in crude oil price as well as stabilisation of project costs. We highlight that projects cannot be
postponed indefinitely as declining production at more mature oilfields will have to be offset by resources that
are increasingly located in frontier areas (i.e. deepwater and oil sands) as well as through enhanced oil recovery
(EOR) activities for the current brownfield blocks i.e. to boost current output level. We believe Petronas and
other national oil companies would need to restart greenfield upstream projects in a more substantial way in 2H
2010 to sustain longer-term production targets. Already, Nigeria plans to increase its 2010 capex spending by
32% yoy to develop its Niger Delta (i.e. to boost its current oil output of 2m bpd). In addition, Petrobras
(Brazilian state oil company) plans to invest around US$42bn (+12% yoy) in 2010, with more than 50% to be
spent on exploration and production.

♦ M&A activities set to rise in 2010. With global energy demand expected to surge in the next 5-10 years and
declining supply from conventional oil & gas resources, we believe many of the larger players are looking to
acquire or enter into a j.v. with smaller companies, whose expertise and assets will help them thrive in a more
competitive environment going forward. A joint bid of US$3bn by Shell and PetroChina for Australian coal-seam
gas producer Arrow Energy became the latest takeover deal following the spate of M&As (see Table 3). Hence,
given still-low asset prices and more favourable financing environment as well as growing E&P spending, we
believe local service providers would likely acquire strategic assets to increase their chances of securing sizeable
contracts.

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Table 3. M&A On The Rising Trend

Acquirer Target/JV partners Timing Rational

Kencana Global Industries May 2009 Allows the company to perform higher-margin offshore
construction jobs to extend the life of brownfield facilities
as well as full-range of marine activities in Malaysia

Baker Hughes BJ Services Aug 2009 Access to specialised pressure-pumping capabilities, used
to break up rock and reach hard-to-access natural gas
supplies

Wah Seong Socotherm’s 32.5% Aug 2009 To increase earnings contribution from deepwater pipe-
stake in PPSCIH coating business

Alam Maritim Swiber Engineering Sep 2009 Allows the company to address execution risk by
leveraging on Swiber’s expertise as well as jointly share
the huge capital outlay of the barge to effectively manage
its gearing level

ExxonMobil XTO Energy Dec 2009 To step up on its exposure to the natural-gas market given
that XTO Energy is the largest US natural gas producer

Schlumberger Smith International Feb 2010 To transform itself into a larger, more diverse service
provider capable of accommodating E&P companies that
are faced with the task of accessing more challenging and
complex reserves

Shell & PetroChina Arrow Energy Mar 2010 To gain access to unconventional natural gas (i.e. coal-bed
methane) in Australia

Source: RHBRI

♦ Gas vs. oil? With declining production from conventional oil fields and still-high cost for deepwater E&P projects,
we believe E&P players are looking into gas resources to meet the energy demand going forward. The latest M&A
spurts, which include the acquisition of XTO Energy and Arrow Energy by ExxonMobil and Shell-PetroChina
respectively, suggest that oil majors are looking beyond the medium-term supply glut (which continues to weigh
down on natural gas prices) to the long-term demand growth driven by growing residential and industrial gas
demand as well as industry trend of moving towards cleaner burning fuels (i.e. a potential bridge to a carbon-
free economy). Thus we believe companies that have technologies and expertise for gas E&P or looking to
acquire the expertise, are the key beneficiaries to growing E&P spending for gas projects, i.e. Wah Seong for its
gas compression business and Dialog’s specialist products and services (used for the gas treatment activities) as
well as KNM’s higher-margin gas processing equipment.

Valuations and Recommendation

♦ Stock picking. While crude oil price is expected to remain volatile in 2010, we believe the oil and gas sector
would remain supported by the positive news flow from E&P projects to be announced in 2H 2010. Meanwhile,
given stronger outlook of E&P spending as well as still-low asset prices, we believe companies with strong
balance sheet (i.e. Dialog and Kencana) would be in a better position to acquire strategic assets over the
medium term. We note that Wah Seong is already in the midst of acquiring earnings-accretive assets. In
addition, we believe investors should also focus on companies with the assets and expertise related to E&P gas
projects (Wah Seong, Dialog and KNM). We also favour companies with strong recurrent earnings and
conservative management (i.e. Dialog) and improving cost management (i.e. SapuraCrest and Kencana).

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 12 March 2010

♦ Reiterate Overweight. While sizeable contract flows appeared to be minimal in 1Q 2010, we believe contracts
will likely flow more substantially in 2H 2010 given the gradual pick up in energy demand as well as increased
reserve replenishment activities by national oil companies and major E&P players. In the longer term, we
reiterate our view that the continued shortage of offshore E&P assets (exacerbated by delays in E&P spending)
will underpin the growth for the support services companies. Hence, we maintain our Overweight stance on the
sector. Our top picks for the sector are Wah Seong and Dialog.

Table 4: Oil And Gas Fair Value Calculations

Share Price Fair Value Basis Of Valuation Rec
(RM/share) (RM/share)
Dialog 1.01 1.29 16x CY10 PER plus DCF for Kertih Terminals and TLP tank terminals OP
at WACC of 16.8%
EPIC 1.56 2.69 10x FY10 PER OP
Kencana 1.47 1.88 16x CY10 PER OP
Wah Seong 2.43 3.09 16x FY10 PER OP
SapuraCrest 2.35 2.66 16x FY01/11 PER MP
Petra Perdana 1.29 1.00 13x FY10 PER for operating earnings plus share of Petra Energy fair UP
value at 11.7x
KNM 0.80 0.90 13x FY10 PER MP
Petronas Gas 9.75 10.08 DCF with WACC of 9.6% UP
Source: RHBRI estimates

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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
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Industry/Sector Ratings

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

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