• Take a more defensive stance
• Stick to focused stock-picking
• Go for quality names

The FTSE Oil and Gas index lost ~20% of its value since Sep

We had been relatively sanguine at the start of this year with an overweight rating on the broader oil and gas sector. The FTSE Oil and Gas index saw some volatility in Jan, but recovered in the subsequent months such that the index traded pretty much rangebound in the first eight months of the year. We downgraded the sector to NEUTRAL on 2 Sep 2014, and the FTSE Oil and Gas index has lost about 20% of its value ever since. At current levels, valuations are not demanding, but we do not see strong re-rating catalysts in the near term. Meantime, we do not see a significant oil price recovery till perhaps 2H15, which is when we see the impact of production cuts.

Risks tilted more to the downside

Looking ahead, we see that risks are actually tilted more to the downside. For one, oil price volatility would affect the rate at which projects are being awarded, compounded by the renewed focus by international oil companies on shorter term shareholders’ returns. There is also the possibility of a credit crunch should the short term outlook deteriorate. There are several highly indebted companies in the industry, and it is imperative that they have a favourable debt maturity profile in view of rising interest rates and a likely subdued oil price environment. Those that are operating in segments of the industry with relatively high breakeven costs are more at risk, and we would monitor them closely.

Take a more defensive stance

We believe that the offshore sector has strong long-term fundamentals as countries have an interest in fulfilling as much domestic demand as possible in order to boost energy security. But equity investors are generally a jittery lot, and stepping into 2015, we would favour companies with strong balance sheets to weather any downturns. Those with exposure to higher quality clientele (e.g. direct dealings with end users such as national oil companies, and established operators instead of speculators) and a significant outstanding order book should also be more resilient. As such, resilient. As such, investors keen to have an exposure to this sector may want to consider Keppel Corporation [BUY, FV: S$9.89], and Ezion Holdings [BUY, FV: S$2.04]. Maintain NEUTRAL.

Source: OCBC Research - 1 Dec 2014