After coming out of the gate strong in 1Q19, E&P stock performance took a step back in 2Q and the selloff has continued in July driven by a growing number of fears including U.S-China trade, a late cycle economy, oil price uncertainty, natural gas and NGL price weakness, and of course, capex coming in above expectations. However, a lot of this now feels embedded in the sector, with the value gap to the S&P500 reaching 6.5x on NTM EV/EBITDA, the widest level since 2001. In our view, this is providing the E&Ps an opportunity to stem the decline with a good 2Q reporting season, which is what we see on tap. A repeat will be needed in 3Q to increase investor confidence in the 2020 FCF outlooks to come, but we see the E&Ps exiting this season higher than where they come in.
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Following the launch of MALESSA and the Crude Oil Predictor (COP) model, Wolfe’s QES Team continues its Energy focus by introducing DEPTH (Dynamic Exploration & Production Tactical Hedge), an E&P sector stock selection model. In combination with traditional quant factors and machine learning techniques, the model uses 150+ E&P specific factors to rank almost 70 U.S. and 60 International E&P stocks that’s designed to be crude oil and natural gas beta neutral. See full details of the QES Team’s DEPTH report here and within for our interpretation of the model.
Our E&P Index finished the week flat, underperforming the +0.8% move in the S&P500 and the big +4.7% jump in WTI. Part of the driver for the flat E&P week was a split decision amongst the sub-groups with the oil focused producers positive while the nat gas producers were down 2%, giving us a perfect intro for this weekend as we provide feedback from GasWeek and some apropos music inside.
It wasn’t a great week for the E&Ps, as underperformance returned with our Index -3.0% vs. the S&P500 +1.7%. The gap was mostly driven by WTI’s -1.6% move despite the U.S.-China truce at the G20 summit and the OPEC meeting coming and going as expected. Seems as if the extension of the cuts through 2020 was tough to outweigh global demand growth concerns and U.S. supply growth, continuing the thought trends from the past few weeks.
We think everyone is ready for a little vacation after the roller coaster month. Our E&P Index rose 5% in June, but the month was filled with wild swings, as sentiment and stock levels approached near trough levels in mid-June on crude oil demand and trade war concerns, before rallying as geopolitical risk spiked and storage drawdowns were higher-than-expected. YTD our E&P Index is nearly flat, an 11% underperformance vs. the S&P500 Energy Index, 16% underperformance vs. the S&P500, and a sharp 29% lag vs. the run up in WTI prices. Given this underperformance against the commodity, and the E&Ps trading at the widest valuation gap to the S&P500 on NTM EV/EBITDA since 2001, we see the E&Ps as attractive, but still very much in “show me” mode.
Another good performance this week for the E&Ps with our Index +1.7% vs. the S&P -0.3%, WTI +1.8%. Besting BYND (+4.2%) will need to come another time though. Sorry for the fascination with this stock, but I finally got around to trying the non-meat burger this past week. I have to say, it comes pretty close to tasting like beef and depending on how it’s dressed, you may not be able to tell the difference, but there is a subtle one.
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.
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.
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