Market Strategists. SG & US Equity Analysts. By Phillip Securities Research. 21 st July 14, 8.15am/11.15am Morning Call/Webinar

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1 21 st July 14, 8.15am/11.15am Morning Call/Webinar Market Strategists Joshua Tan, Head of Research Kenneth Koh, Market & Equity Analyst Soh Lin Sin, Macro Economist Osama Bakhteyar, Research Assistant SG & US Equity Analysts Lucas Tan, Real Estate Wong Yong Kai, US Equities Colin Tan, Telcos Caroline Tay, Real Estate Ben Ong, Financials Richard Leow, Transport By Phillip Securities Research Mr. Chan Wai Chee, CEO Jermaine Tock, Operations Exec 1

2 Disclaimer This presentation is provided to you for general information only and does not constitute a recommendation, an offer or solicitation to subscribe for, purchase or sell the investment products mentioned herein. It does not have any regard to your specific investment objectives, financial situation and any of your particular needs. Accordingly, no warranty whatsoever is given and no liability whatsoever is accepted for any loss arising whether directly or indirectly as a result of you acting based on this information. Investments are subject to investment risks including the possible loss of the principal amount invested. The value of the units in any fund and the income from them may fall as well as rise. Access to services and your account may be affected by market conditions, system performance and other reasons. The information contained in this presentation has been obtained from public sources which PSPL has no reason to believe are unreliable and any analysis, forecasts, projections, expectations and opinions (collectively the Research ) contained in this presentation are based on such information and are expressions of belief only. PSPL has not verified this information and no representation or warranty, express or implied, is made that such information or Research is accurate, complete or verified or should be relied upon as such. Any such information or Research contained in this presentation is subject to change, and PSPL shall not have any responsibility to maintain the information or Research made available or to supply any corrections, updates or releases in connection therewith. In no event will PSPL be liable for any special, indirect, incidental or consequential damages which may be incurred from the use of the information or Research made available, even if it has been advised of the possibility of such damages. You may wish to seek advice from a qualified financial adviser, pursuant to a separate engagement, before making a commitment to purchase any of the investment products mentioned. In the event that you choose not to seek advice from a qualified financial adviser, you should consider whether the investment product is suitable for you before proceeding to invest and we do not offer advice in this regard unless mandated to do so by way of a separate engagement. You are advised to read the Conditions governing Phillip Securities Trading Accounts and the Risk Disclosure Statement carefully before investing in this product. 2

3 Indonesia (Upgrade UW to OW) Call for structural reforms 2.0 Open policy way to sustainable economy Risks to monitor stubborn twin deficits, government transition and policy change (reform agenda) upgrade to OW from UW on bet on a Jokowi victory leading to a cleaner and efficient administration; reform story remains in tact 3

4 Indonesia (Upgrade UW to OW) JCI has rallied 18.65% year-to-date, currently trading at 20.49x P/E, slightly above its 52- weeks trailing P/E, and valued at 16.35x estimated 12-month earnings with a consensus earnings forecast growth to grow at 50.86% y-y. Post-election near term volatility. Investors may book gains into potential market rally postelection, but reforms agenda and timeline may limit market upside. Mutual Funds that proxy Indonesia Aberdeen Indonesia Equity Fidelity Indonesia A USD ETFs that proxy Indonesia Lyxor Indonesia10US$x@ (P2Q) DBXT MSINDO 10US$x@ (KJ7) Ishares MSCI Indonesia ETF (EIDO) Market Vectors Indonesia Index ETF (IDX) 4

5 Update: M1 Limited (S$3.62, Accumulate, TP S$ under review, pending results) Share price at S$3.62, up 8.4% since 1Q14 results on 14 Apr 14 (1yr return: ~11%) 3M14 earnings at S$43m, representing 25.4% of our FY14F earnings (Fwd P/E: ~20x) 2Q14 results to be released on 21 Jul 14 after trading hours. Key Upsides: Growth in Mobile services from: 1) higher excess data charges at S$10.70/Gig, 2) more subscribers exceeding data bundle, 3) extra charges on 4G plans from Jan-2015 (new signups/re-contracts) Growth in Fixed services from: 1) Increase residential take-ups in fibre broadband 2) Demand from SMEs for ICT & hi-speed connectivity solutions Downside risks: Further price erosion for fibre broadband offerings due to strong competition Potential new competitor entry in mobile telecom space Fig: M1 share Price over last 6 months Source: Bloomberg 5

6 Update: Silverlake Axis Limited (SAL) (S$1.15, Accumulate, TP S$1.32) Share price rallied over 30% since 3Q results on 7 th May Bright growth prospects, supported by consolidation, regionalisation and digitisation initiatives from banks. Bank IT spending in Asia expected to grow at about 7% CAGR leading up to 2017 * Focus toward integrated software suite instead of standalone systems Approx. 300 banks in the region still using in-house developed software applications Key Upsides: Post-merger integration projects from possible CIMB-RHB-MBSB, OCBC-Wing Hang mergers Upgrades, enhancements from existing customers Downside risks: Above mergers, acquisitions fall through Fig: Evolution of Core Banking Systems Absence of new customer acquisitions Maintain Accumulate with revised TP of S$1.32 (~15% upside, 3.3% div yield) Source: Capgemini Analysis, 2013 Fig: Growing SAL s Core Revenue Source: Company 6

7 Pre-results update: SATS Ltd 1Q FY15 (FYE Mar) (Previous close: S$3.18, Neutral, TP S$3.05) 1Q FY15 financial results to be announced on Tuesday, 22 July. Announced the Changi operating data for 1Q FY15 on Friday, 18 July. Operating Statistics for Singapore Aviation Business 1Q15 1Q14 y-y (%) 4Q14 q-q (%) Comments Pa s s engers Ha ndled (mn) % % Fli ghts Ha ndl ed ('000) % % Uni t Services ('000) % % Ca rgo ('000 tonnes) % % Gross Meals Produced (mn) % % Growth in pa ssegers handled. Unit Meals Produced (mn) % % Growth in pa ssegers handled. Source: Compa ny, CAG, PSR All operating metrics saw modest y-y growth. Growth in Cargo throughput was slightly stronger. In line with our forecasts (made in last report) of y-y growth across the board. "Neutral" rating, with revised TP of S$3.05 7

8 Company update: Ezion Holdings Limited (S$2.10, Accumulate, TP S$ under review, pending change of analyst) Wins two service rig contracts 1. Secured new contract to support an east European based National Oil Major in the North Sea To provide a service rig over a 7 year period Contract value approx. USD million Bareboat charter to be deployed by 2Q 2015 Ezion will not own the rig 2. Received LOI to provide a new-build to be used by a Southeast Asian based national oil company To provide a liftboat over a 5 year period : Contract value approx. USD 146 million Time Charter to be deployed by 3Q 2016 Remain positive on Ezion with strong demand for liftboats as key growth driver Downside risks include competition and rising gearing 8

9 Initiation: Kim Heng Offshore & Marine (S$0.275, BUY TP S$0.33) Kim Heng Offshore & Marine is an established integrated offshore & marine value chain services provider. Their activities are classified into two 2 broad categories, namely (i) Offshore Rig Services and Supply Chain Management; and (ii) Vessel Sales and Newbuild. Asset light business with high returns and strong operating and free cash flow generation Gross profit margins and net profit margins high, resulting in superior returns on equity and invested capital, robust and positive Op CF and FCF since FY2010. Once capex cycle over, expect good potential for increasing shareholders returns High utilization rates and aging rig fleet a positive for Kim Heng Rig utilization across the global fleet of offshore drills high. High oil prices (>US$100/barrel) are also keeping offshore activity levels buoyant. Above 40% of global jackups and close to 30% of global floaters are above 30 years old. These factors would be demand drivers for Kim Heng s repair and maintenance services and solutions. Re-rating catalyst with expansionary plans and potential turnkey projects Enhancing yard facilities and looking to acquire subsea services. Catalyst for growth! Currently Kim Heng is trading at a ~10% to its peers, like Mencast and MTQ Corp, not warranted considering its high returns of invested capital and equity, undergoing expansionary phase now. INITIATE with BUY at TP$0.33, representing ~20% upside. 9

10 Oil & Gas Industry: Exploration & Production Wong Yong Kai Investment Analyst Phillip Securities Research 21 July 2014

11 Different Types of Oil/Gas Natural Gas gaseous mixture of hydrocarbon compounds, primarily methane. Crude Oil mixture of hydrocarbons that exists in liquid phase in natural underground reservoirs and remains liquid at atmospheric pressure. West Texas Intermediate (WTI) and Brent two grades of crude oil used as benchmarks for oil pricing. WTI currently trading at ~$8/bbl discount to Brent. WTI => US & Canada interior Brent => Europe, Africa, Middle East Natural Gas Liquids (NGLs) non-crude oil liquids naturally found together with natural gas, and made up of lighter hydrocarbons (ethane and propane > 50%). Shale Gas/Tight Oil refers to hydrocarbons produced from shale formation. NOT to be confused with shale oil, even though media uses the term loosely. Shale Oil = kerogen (non-crude oil) produced from sedimentary rocks. 11

12 Different Types of Oil/Gas 12% 5% 2% 9% 41% Finished Motor Gasoline Diesel & Fuel Oils Kerosene-Type Jet Fuel Petrochem Feedstock Petroleum Coke Other Products 31% Source: EIA Refinery Yield Crude oil and natural gas are commonly grouped together as Energy, BUT: => Crude oil mostly refined into products such as gasoline (cars), diesel (trucks), kerosene (jet fuel), and naptha (plastics). 81% used for transportation. => Natural gas used in power plants (electricity generation), chemical feedstock (fertilizers, plastics), and also residential heating. Price spikes in winter. 12

13 Resources vs Reserves PROSPECTIVE RESOURCES potentially recoverable + undiscovered accumulations. CONTINGENT RESOURCES potentially but not currently commercially recoverable + known accumulations PROVED RESERVES (1P) commercially recoverable + known accumulations + 90% probability quantity > estimates PROBABLE RESERVES (2P) similar to 1P, but only 50% probability quantity > estimates 13

14 Exploration Process Crude oil often discovered near known producing areas; similar environment (heat, pressure) encourages formation, geology enables the entrapment. Eagle Ford and Bakken plays each makes up 10% of US proved oil reserves. Conventional reservoirs require sufficient depth for heat and pressure to turn hydrocarbons into crude oil, porous reservoir rocks for crude oil to accumulate over millenniums, and lastly impermeable layer of rocks on top of the porous formations to trap the oil and prevent it from escaping to the surface. Low 10-15% chance of discovering oil in a location where oil has never been found, vs 50% or higher success rate where there is precedence. Step 1: Bidding for concessions that grants rights to explore and produce. Step 2: Seismic study to reveal underground layers and map out oil reservoir. Step 3: Drilling to confirm presence of hydrocarbon, and estimate quantity. 14

15 Production Rate No. of barrels of oil (bbl) or barrels of oil equivalent (boe) extracted per day. 1 bbl oil = 42 US gallons = 159 litres. After initial optimization and ramp-up, oil production will decline over time due to the gradual drop in pressure unless various recovery techniques are utilized to sustain or increase production. 1 boe = Amount of energy released by burning 1 bbl oil = 5.8 x 106 BTU, and roughly equivalent to 6,000 cubic feet of natural gas (6 mcf). However, 1 bbl oil doesn t sell for anywhere near the same price as 1 boe. As of 25 June 2014, WTI Crude Oil trades at $106.44/bbl, while NYMEX Natural Gas trades at $4.53/mcf (ie. $27.18/boe). Therefore, 1 bbl 4 boe in price. 15

16 Enhanced Oil Recovery Primary Oil Recovery Natural pressure of the reservoir or gravity drives oil into the wellbore. This pressure, combined with artificial lift techniques such as pumps, transports oil to the surface. 10% of the original oil in place is recovered this way. Secondary Oil Recovery As the pressure is relieved, less oil flows out by itself. Injection of water or gas displaces the heavier oil and drives it to a production wellbore where it is brought to surface % of the original oil in place is recovered this way. Enhanced Oil Recovery (EOR) By the time secondary techniques fail to induce more oil production, up to 70% of original oil is still underground. EOR (thermal steam or gas injection aims to lower viscosity and improve flow rate) has the potential to ultimately extract 30-60% of the original oil, but more costly than primary and secondary techniques and thus requires higher oil prices to achieve a reasonable ROI. 16

17 Identifying Top Picks 17

18 Identifying Top Picks $50.00 Adj. EV/1P ($/boe) $45.00 $40.00 $35.00 $30.00 $25.00 $20.00 $15.00 $10.00 $5.00 $0.00 BP PLC Hess Corp Chesapeake Energy Range Resources Southwestern PetroChina EQT Corporation ConocoPhillips Marathon Oil Exxon Mobil Total SA Devon Energy Cabot Oil & Gas Royal Dutch Shell Occidental Murphy Oil Chevron Corp Noble Energy Anadarko Petroleum Apache Corp Cimarex Energy EOG Resources Pioneer Natural EV/1P = Enterprise Value (EV) per barrel oil equivalent (boe) of proved reserves. The lower this metric is, the less the investor is paying for reserves. Doesn t reflect composition. $20 EV/1P might look cheap since 1 bbl oil sells for $100, but expensive if 1P is mostly natural gas (6 mcf sells for $27.18). 18

19 Identifying Top Picks $80.00 Adj. EV/1P Weighted By Price ($/boe) $70.00 $60.00 $50.00 $40.00 $30.00 $20.00 $10.00 $0.00 BP PLC Marathon Oil ConocoPhillips PetroChina Hess Corp Exxon Mobil Total SA Murphy Oil Occidental Royal Dutch Shell Chevron Corp Chesapeake Energy Devon Energy Apache Corp EQT Corporation Range Resources Noble Energy Anadarko Petroleum Southwestern EOG Resources Cabot Oil & Gas Cimarex Energy Pioneer Natural If EV/1P weighted based on their selling price, BP PLC, Marathon Oil, ConocoPhillips, PetroChina and Hess Corp are Top 5 with lowest adj. EV/1P. Pay less than $25/bbl for reserves that sell for equivalent of > $100/boe when produced. Also a function of production cost and geo-political risk. 19

20 Identifying Top Picks Source: US National Average Natural Gas Price Start-up of LNG export plants in the US might possibly reduce the glut of shale gas supply, with the effect of increasing selling price. It is currently hovering near historical lows, even as Asia LNG price rose to ~$14/mcf. $3/mcf for liquefaction into LNG, $3/mcf for shipping => money on table. 20

21 Identifying Top Picks 100% % Reserves Mix 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% NGL Crude Oil Natural Gas Southwestern Cabot Oil & Gas EQT Corporation Chesapeake Energy Noble Energy Range Resources Hess Corp Anadarko Petroleum Total SA Royal Dutch Shell Devon Energy Cimarex Energy PetroChina Exxon Mobil BP PLC Chevron Corp Apache Corp EOG Resources Pioneer Natural ConocoPhillips Murphy Oil Occidental Marathon Oil Investors betting on convergence (higher natural gas price) can look at Southwestern, Cabot Oil & Gas, EQT Corp, Chesapeake Energy, Noble Energy. Conversely, those who are bullish on crude oil fundamentals can consider Marathon Oil, Murphy Oil, Occidental, Chevron Corp and BP PLC. 21

22 Identifying Top Picks 4,500 4,000 3,500 3,000 2,500 2,000 1,500 1, Cabot Oil & Gas EQT Corporation Total ('000 boe/day) % y-o-y change Production Rate Range Resources EOG Resources Noble Energy Cimarex Energy Chesapeake Energy Pioneer Natural PetroChina Anadarko Petroleum Murphy Oil Devon Energy Southwestern ConocoPhillips Chevron Corp Occidental Marathon Oil Exxon Mobil Total SA BP PLC Royal Dutch Shell Apache Corp Hess Corp Increasing production rates generally translate into higher revenue growth and better economies of scale. However, production declines need not be alarming as they could be due to asset divestures. Companies with highest growth are Cabot Oil & Gas, EQT Corp, Range Resources, EOG Resources, Noble Energy. 60% 50% 40% 30% 20% 10% 0% -10% -20% -30% 22

23 Identifying Top Picks 5.00% Dividend Yields 4.50% 4.00% 3.50% 3.00% 2.50% 2.00% 1.50% 1.00% 0.50% 0.00% BP PLC Total SA Royal Dutch Shell PetroChina ConocoPhillips Chevron Corp Occidental Exxon Mobil Murphy Oil Marathon Oil Chesapeake Energy Devon Energy Apache Corp Noble Energy Hess Corp Anadarko Petroleum EOG Resources Cimarex Energy Range Resources Cabot Oil & Gas EQT Corporation Pioneer Natural Southwestern Buy-and-hold investors concerned with income stream, would be interested at dividend yield plays (which tend to be more predictable and rarely cut), such as BP PLC, Total SA, Royal Dutch Shell, PetroChina, and ConocoPhillips. Once again, US dividend income is subject to 30% withholding tax rate. 23

24 Ending Remarks 24

25 Ending Remarks Oil & Gas Royalty Trusts excluded because marginal production cost will rise. Investors might be seduced by high yields without realizing the dangers. Traditional metrics such as P/E and P/B are less relevant to E&P producers, as their value lie in their reserves (not revenue generating), and the carrying value for the oil & gas reserves (historical) has nothing to do with its worth. Lowest Adj. EV/1P Weighted By Price Highest % Reserves Mix (Crude Oil) Highest % Reserves Mix (Natural Gas) 1. BP PLC (NYSE: BP) 1. Marathon Oil (NYSE: MRO) 1. Southwestern (NYSE: SWN) 2. Marathon Oil (NYSE: MRO) 2. Murphy Oil (NYSE: MUR) 2. Cabot Oil & Gas (NYSE: COG) 3. ConocoPhillips (NYSE: COP) 3. Occidental (NYSE: OXY) 3. EQT Corporation (NYSE: EQT) 4. PetroChina (NYSE: PTR) 4. Chevron Corp (NYSE: CVX) 4. Chesapeake Energy (NYSE: CHK) 5. Hess Corp (NYSE: HES) 5. BP PLC (NYSE: BP) 5. Noble Energy (NYSE: NBL) Highest Production Growth Rate Highest Dividend Yields 1. Cabot Oil & Gas (NYSE: COG) 1. BP PLC (NYSE: BP) 2. EQT Corporation (NYSE: EQT) 2. Total SA (NYSE: TOT) 3. Range Resources (NYSE: RRC) 3. Royal Dutch Shell (NYSE: RDS-A) 4. EOG Resources (NYSE: EOG) 4. PetroChina (NYSE: PTR) 5. Noble Energy (NYSE: NBL) 5. ConocoPhillips (NYSE: COP) 25

26 Ask Questions! Market Strategists Joshua Tan, Head of Research Kenneth Koh, Market & Equity Analyst Soh Lin Sin, Macro Economist Osama Bakhteyar, Research Assistant SG & US Equity Analysts Lucas Tan, Real Estate Wong Yong Kai, US Equities Colin Tan, Telcos Caroline Tay, Real Estate Ben Ong, Financials Richard Leow, Transport By Phillip Securities Research Mr. Chan Wai Chee, CEO Jermaine Tock, Operations Exec 26