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.
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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.
While 4Q18 results were mixed, the focus coming out of the quarter was clearly on the changing dynamics of the sector – forward outlooks that include lower spending, lower growth, and a goal to deliver free cash flow at lower crude oil prices. This is the path investors have been pushing E&P management teams to pursue, but it was only a year ago the same promise was on table, only to have budgets rise and stock prices suffer. This makes sticking to the current outlooks crucial for gaining investor confidence in free cash flow projections and is an important step in turning around multi-year sector underperformance.
Two things from us this weekend. First is the underperformance of the SMID caps vs. the Large Caps during the month long 4Q18 earnings season and second, we put four scenarios together for CDEV to see what the outlook through 2022 may look like following the strategy shift this week.
This note marks the first edition of our new recurring monthly “Energy Gauge”. We hope this provides an informative look back at the month that was in E&P stock performance, while providing some thoughts on what’s to come. We welcome any feedback and suggestions.
Ahead of E&P earnings, we’re providing quick snapshots and commentary on the following day’s reports. Daily earnings snapshot for companies reporting Wednesday PM (Feb 27) & Thursday AM (Feb 28) below:
Happy Sunday and good luck in your Oscar pools. Roma looks to be the favorite for Best Picture while Glenn Close has an edge for Best Actress and Rami Malek for Best Actor. I’m going to be curious how this “no host” event goes as well. Just seems strange to not have anyone MC the event and making awkward jokes with the A-listers at the beginning, but so be it. The E&Ps are changing their stripes so maybe Hollywood is too.
While 4Q18 realized pricing was weak, we view this as one of the negative hurdles to clear en route to one of the best 2020 set ups amongst E&Ps. The other 1H19 hurdle will be showing more field-level evidence of the EGN acquisition working as expected, but they’re already providing confidence by putting the synergies in guidance and given company history, we expect them to be delivered upon. With hurdles clearing in 1H19 we see an opportunity to own a once premium multiple FANG at a discount to peers on 2020 EV/EBITDAX multiple while holding top-tier growth and FCF/sh, supporting our Top Pick view. See pages 2/3 for FANG’s 2020 profile vs. peers at $55 WTI.
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