What Even Works For Oil E&P Stocks These Days?
(Bloomberg Opinion) -- What works for investors in exploration and production stocks these days? The short answer is “nothing.” The longer answer is, well, a bit longer but only marginally more satisfying.
Carrizo Oil & Gas Inc. is the latest E&P company to get with the proverbial program in shale. Late on Wednesday, it took an ax to capital expenditure, with a 2019 budget more than a third below last year’s spending. Production growth suffers a bit of course, but is still expected to be double-digits percentage-wise. The requisite references to positive free cash flow and a “mid-$50s” oil-price assumption were also in there. No matter. The stock – not exactly a stunner anyway – fell another 4 percent Thursday morning.
Apathy toward oil and gas stocks abounds, with energy’s weighting in the S&P 500 about 5.5 percent lower than in early 2016, at the bottom of the oil crash, and back to 2003 levels. Anadarko Petroleum Corp., which exemplifies an E&P company shifting strategy from growth to returns, missed earnings forecasts badly this week and has dropped 10 percent since. On Wednesday’s call, CEO Al Walker talked gamely about the company’s free cash flow, pointing out the potential to beat the S&P 500 in terms of yield at higher oil prices. The market was unmoved.
Another striking rebuff concerns Concho Resources Inc. It hasn’t done anything this week; rather, it has been almost a year since Concho announced a deal to buy RSP Permian Inc. for $7.7 billion plus assumed debt. Back then, Concho’s market cap was $23.4 billion. Today, with the deal having closed in July and the share count having risen roughly a third as a result, Concho’s market cap is … $22.9 billion. Valued at 11.4 times forward Ebitdax (the “x” is exploration expense) when the deal was announced, Concho’s multiple has slumped to 7.5 times.
Diamondback Energy Inc. has faced similar, if less harsh, treatment since its own deal for Energen Corp. As for Encana Corp.’s move on Newfield Exploration Co., the less said about that one, the better. Concho’s and Diamondback’s reception is particularly surprising, as consolidation within the fragmented Permian shale basin is, if done right, a no-brainer. The opportunity to cut overheads and drill longer, more efficient wells on joined-up parcels of land addresses the biggest concern with shale; namely, getting costs down to free up more cash.
Sentiment-wise, the industry’s pushing on a string at this point. The sudden slump in oil prices that closed out 2018 didn’t help. The bigger problem is that a history of chasing growth at the expense of returns – often encouraged by skewed executive pay packages – has left investors wary or simply led them to write off the sector entirely.
Anadarko exemplifies this. Finding religion on returns, including pay reforms and share buybacks, sparked a re-rating in the fall of 2017, given added oomph by OPEC’s production cuts announced soon after. But that proved fleeting, even as Anadarko has stuck with the mantra.
Dan Pickering, who heads asset management at Tudor, Pickering, Holt & Co., says the market has essentially taken Anadarko’s message on board, but that isn’t enough to attract incremental investors in this environment:
Value guys already own it. The hedge fund says ‘there’s no catalyst here.’ And everyone else isn’t paying attention.
The implication is that Anadarko’s approach, as well as those of others like Carrizo that have reined in spending, acts more like defense rather than offense. In other words, imagine where these stocks would trade if the companies hadn’t switched things up.
A few months ago, I wrote about a shift in the metrics investors use to value E&P stocks, moving away from growth-oriented things like net asset value to cash-based measures. On that basis, and taking forecasts with the appropriate grain or two of salt, Anadarko should be garnering at least a glance from generalist investors. Others, however, continue to lag the market.
Further strength in oil prices as 2019 unfolds may yet rekindle interest in the sector. But potential catalysts on that front, such as Venezuela and Iran, are obvious and yet haven’t lifted sentiment for oil prices. Sticking with the focus on returns and showing the value of consolidation should ultimately be rewarded. But getting back into investors’ good books – or just onto the page – will be a long, hard slog.
Update: An earlier version of this story included a version of the “When 1+1=<1” chart that had a typo.
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Liam Denning is a Bloomberg Opinion columnist covering energy, mining and commodities. He previously was editor of the Wall Street Journal's Heard on the Street column and wrote for the Financial Times' Lex column. He was also an investment banker.
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