While it may not feel this way given YTD stock performance, the investor push for E&Ps to focus on generating higher FCF and corporate returns is working. Looking at ROCE, the E&Ps improved 600bps in 2018 vs. 2017, and the impact of slower growth strategies in 2019 is estimated to result in another 400bps of improvement in 2020. This is a good thing and the sector should eventually be rewarded based on this outlook, but we wanted to put E&P ROCEs into context and outline some of the challenges in its use.
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This was a much needed bounce back week, and it happened during a conference, a rare combination to witness in the Energy sector. We even heard there were three generalists moving amongst the crowd. That’s a trifecta, so maybe there is some bottom fishing going on considering the market cap of Beyond Meat (BYND – not covered) is roughly the same as WPX and PE combined. For the week, our E&P Index was +6.8% vs. the S&P500 +2.2% and WTI +9.7%.
Last week our E&P Index was -4..4% vs. the S&P500 +0.5% and WTI -2.7%. YTD, our E&P Index is now -5% and has underperformed the S&P500 by 20%, all of which has occurred over the last month. There hasn’t been anywhere to hide either, but there has been a huge dispersion between the Large Caps (+2.8%) and SMID Caps (-14.2%) YTD.
Another week, another round of underperformance for the E&Ps. Our Index was -0.5% this week, underperforming the +4.4% S&P500 move and WTI +0.9%. Group performance was split though, with Large Caps +1% while the Smid Caps were -2.1%, mostly due to the natural gas producers moving 2.5% lower on back of the declining NYMEX and NGL pricing.
Inside this week, we provide our takeaways from the OXY-APC S4 filing that just came out on Friday. Because of how public this was, there’s no Company A or B…just OXY and CVX. Always interesting to see how these deals come together and how boards assess risk/reward around the transactions. Additionally, we’re showing our June quant based model and portfolio read throughs from MALESSA following the +2.6% market-cap weighted return in May vs. the 11% decline in our E&P Index.
Though summer doesn’t officially start for another two weeks, producers are already feeling the heat with <$50/bbl WTI pricing potentially back in play. Our view remains for WTI to move back towards $60/bbl over 2H19, but inside we show updated hedge positions and balance sheet leverage for our coverage as these factors become increasingly important below $50/bbl. Additionally, we’ve updated our good vs. bad balance sheet basket trade, as this tends to follow crude oil price direction.
Our E&P Index fell 15% in May, paced by a corresponding 16% drop in WTI over the last two weeks of the month. Pain was widespread, with no E&Ps in positive territory and it was the second largest monthly drop for the S&P500 Energy Index since mid-2011, with only Dec 2018 worse. The fall was enough to move the YTD gain for our benchmark E&P Index back to only +1.6%, placing the group far below the S&P 500 YTD. After what had been a strong start to 2019, the sell off created an attractive entry point, as we see crude oil recovering to $60/bbl, management teams adhering to budgets, and the sector offering 2x the market growth rates, and similar “return of cash yields,” while trading at half the S&P500 multiple.
Another week and more volatility for the E&Ps. While we didn’t get as harsh a sell off as last week, our E&P Index was down another 5.3% this week and underperformed the S&P500 by 2.7%. The sell off was driven by an 8.7% decline in WTI, with a large portion of this coming Friday afternoon. We’ll take it as a good sign that the E&Ps were able to relatively shake off the Friday decline, but this market still feels like it’s in a risk off mode and that’s going to hurt the sector investment case.
Given the two-week 16% WTI decline, it was also a good time to see a few management teams, which we did in Texas with PE, FANG, and CXO, followed by EOG in NYC Friday morning. We provide our takeaways from EOG’s sell-side breakfast inside and show two charts - Energy making fresh lows as a % of the S&P500 and the CFTC Natural Gas Net Long Positions doing something not seen in 18 months.
The extra day this weekend is needed after the Energy market reminded us how quickly things can swing. For the week, our E&P Index was -8.3% vs.
Over the last two days, the Energy sector has been hit hard by a combination of market headwinds and WTI moving below $60/bbl. While volatility may remain elevated, we see crude oil higher by YE19 and believe the pullback has provided an opportunity to buy high conviction stocks. Additionally, sector performance has looked somewhat rational in this risk-off environment (Integrateds significantly outperforming beta E&P), but there may be some buying opportunities for stocks that have moved out of character. Below we highlight stock thoughts for each subsector.
We reviewed the proxy materials for all 31 E&Ps under coverage (we’re down four y-o-y due to M&A) to see how management teams were compensated.
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