For an Energy analyst, the last 10 days have been a joy. We saw a bit of everything and for the first time in a while, our shrinking corner of the market got to be in the limelight. The E&Ps aren’t done shining though, as we believe the positives of the sector – consolidation, improving FCF generation, deep and visible resource potential, balance sheets <2x Net Debt/EBITDA, and 10% volume growth – are not being properly recognized in current valuations. The good thing is, we saw a broader investor base starting to look at the E&Ps and if they see what we do, the valuation disconnect can hopefully narrow.
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It was a busy week for the Wolfe Energy Team as Sam hosted XOM meetings in NYC (see takeaways note here), we met with COP management on Wednesday, had our 1Q19 E&P preview out on Thursday (see note here) and Blake was with NESR for two days. Then Friday came.
With forward spending and growth expectations reset lower alongside the 4Q18 updates, 1Q19 will be about how well E&Ps are adjusting to the new business models, in the face of rising crude oil prices. To that end, optics won’t look good this quarter as capex started the year elevated relative to 2Q-4Q, but we don’t see FY19 budgets moving higher, showing progress is being made towards generating higher FCF. “Show me” status remains, but we’re leaning positive and see the sector outlook significantly improved with crude oil over $60/bbl.
Happy Sunday and what a week to come. NCAA Basketball Championship games, UEFA Champions League matches Tuesday/Wednesday, and the soothing voice of Jim Nantz at Augusta Thursday-Sunday.
We’re also jamming at Wolfe this week with Sam Margolin hosting XOM meetings in NYC Monday-Wednesday and Blake Gendron hosting NESR Thursday in NYC and Boston on Friday. Additionally, the Wolfe Energy team will be hosting the quarterly lunch on Thursday, April 11 at Wolfe HQ in NYC, and we’re going to have two special guests join us. First, Sherif Foda, Chairman and CEO of NESR will be providing insights into the Middle East/North Africa (MENA) market and key OPEC trends. Both will be helpful as we’re heading into the June 25/26 OPEC meetings. Additionally, the Quant (QES) team will also be joining to help answer questions on the Energy stock selection model (MALESSA) and the crude oil prediction model. Sam, Blake, and myself will also be outlining our updated thoughts heading into 1Q19 results and commodity views. Email us for a spot at any or all of the events!
After a busy 2H18 with multiple corporate level transactions, 1Q19 M&A activity was virtually non-existent. However, with multiple public producers marketing non-core assets and a sector that’s ripe for consolidation up and down the market cap spectrum, we anticipate a pick up in activity to come. Within, we review the limited 1Q19 details, look at Permian acreage valuations, and update company by company M&A thoughts.
This week, our E&P Index was +2.7%, outperforming the +1.2% move for the S&P500 and the +0.4% move in WTI. A quarter into the year and it’s E&Ps +19.8%, S&P500 +13.1%, and WTI +32.4%. A couple items on the agenda this week.
With many of you off to New Orleans this week and 1Q earnings season around the corner, our slide deck provides a fresh list of questions for management across our coverage universe. The topics hit on key industry issues and concerns, including spending thoughts, decline rates, parent-child well implications, development style, scale, M&A, balance sheet leverage, hedging, and Colorado risk.
Nice bounce back for E&Ps this week with our index +6.8% vs. the +2.9% move for the S&P500 and wait for it....the +4.5% WTI move. With the 12-month strips at $59/$65 WTI/Brent, the E&Ps are now moving well into positive FCF territory and we believe that was the key driver of outperformance this week. Of course, that’s going to start up the “when are you going to increase activity” questions, and after a trip down to Houston this week to meet with 10 producers, we’ll have a better idea how the sector is reacting to crude oil’s strength. A few producers have previously outlined $50/bbl vs. $60/bbl spending plans, so we’ll see if there is already motion on this. We’ll share our takeaways next Friday at 10am on the weekly Wolfe Energy webcast.
Why Now? We continue to believe that the E&P sector is ripe for consolidation up and down the market cap spectrum. However, there must be driving forces to push the sector down this path, whether it’s poor returns or changing sector dynamics, which is what we address here – why will E&P consolidation happen now?
Never a dull moment in the Energy sector. Just when you thought it was going to be a quiet Friday, Norway shakes up the E&P sector and WTI is down 2.5% before we get into the office. Oil was able to bounce back some to finish down 1% on the day, but our E&P Index didn’t get the same memo, ending down 4% and bringing the weekly tallies to: WTI +0.5%, E&P’s -8.2%. This wasn’t just a one week divergence either, as WTI increased 6% in February while our E&P Index was -0.6%. The trend feels very reminiscent of the 2H17-1H18 period when the equities couldn’t catch up to crude oil’s move to $70/bbl.
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