It was another volatile week for the E&Ps this week as sector performance got off to a good start, faded towards the middle, and then rallied back on Friday to finish +6.9% for the week vs. the S&P500 +1.0% and WTI -2.8%. Performance between the sub groups continues to be split, with the rally in gas names continuing for a second week.
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While the E&Ps have strongly bounced back over the past two weeks, in part due to the market shift towards Value over Growth and Momentum, the sector is still -34% YTD vs. the S&P500 and increasingly has the feeling of being left for dead. Whether due to fear over oil prices heading below $50/bbl on weakening demand/plentiful supply, the rise of renewables, Energy shrinking to <5% of the S&P500 pie, or historical sector value destruction, we see the market’s perception of the E&Ps more about concern than opportunity. There’s still plenty for the E&Ps to prove, but with the sector pricing in $45/bbl WTI and trading at the widest margin (6.5x) to the S&P500 on NTM EV/EBITDA going back to 2001, we see good value in the E&Ps and believe this short rally could wake up the market to an improving outlook.
Inside this week we have two features, the first is we look at the S&P 500 Energy Index vs. the ISM Index as it broke 50 this week. FYI, Energy was the best performing sector this week. Second, we sat down with HES this week for a catch up, with notes inside.
It’s back to the grind this week and in preparation for the upcoming conference season, inside this weekend we provide a list of sector and company level questions across our coverage universe. We touch on the key issues around growth rates, return of capital, M&A, and asset specific questions/catalysts that can drive sector and stock performance through the rest of the year.
This morning (8/26/19), PDCE announced the acquisition of SRCI in a stock for stock deal valued at $1.7Bn. The transaction is one we can get behind, as it brings two DJ Basin focused producers together that can use increased scale and a lower cost structure to improve the forward FCF outlook at a time when many SMID cap peers are struggling to do so. Colorado regulatory/legislative and midstream risks remain, but we see a stronger pro-forma financial outlook with a local and bigger producer potentially providing a better solution to both issues. Maintaining $40 PT and upgrading to Peer Perform.
Thanks to all the companies and clients that participated in our Denver E&P Summit. We hope to have more to smile about next year, as the sector swoons continued this past week with our E&P Index -3% vs. the S&P500 -1% and WTI +1. Inside this week, we provide some additional takeaways from Denver and discuss the mystery chart below, as it’s very telling of what investors think of the Energy sector.
We’re providing quick snapshots and commentary as we update estimates post 2Q results across our coverage group.
We’re glad to be on the backside of earnings. Lots to discuss with our E&P Index -6.1% after this brutal week vs. the S&P500 -0.5% and WTI -2.4%. Over the three-week 2Q earnings period, our E&P Index fell 20%...not quite the outlook we were expecting heading into these updates. Additionally, this weekend we’re also highlighting the August DEPTH model, with the quant dashboard now up and running. It’s very user friendly and it shows you how a stock’s quant ranking has changed over the past two years and what factors are most important going into the current ranking. Last, with Premier League action starting up this weekend, we show the odds for each team, with Man City and Liverpool the clear favorites.
PDCE bounced back from a slow start to 2019 and is making further operational improvements in both the DJ and Delaware Basins. However, the lingering DJ Basin line pressure issues continue to challenge growth plans and will limit oil volumes, while lower natural gas/NGL pricing will result in declining 2H19//2020 activity. The adjustments PDCE is making are prudent in order to generate positive FCF next year, but the issues are unlikely to subside near-term, challenging the forward outlook. Underperform.
As reported by Bloomberg, PDCE (UP) and SRCI (NC) are in possible discussions to merge with the combination leading to a DJ Basin focused producer with >150k net acres in Colorado plus 42k net acres in the Delaware Basin. With both stocks at 52-week lows and the sector under pressure to reduce cost structures and generate increasing amounts of FCF, the idea of the combination makes sense on paper and was a potential idea proposed by Kimmeridge as part of the proxy campaign earlier this year. Further, this combination would make them the second largest DJ Basin producer (>160mboepd) with the increased production base providing more scale to drive a long-term solution to the midstream constraints that have long plagued the smaller producers. This last point has been a key reason behind our Underperform view on PDCE. We do not anticipate PDCE to comment on this during the 2Q call tomorrow, but we wouldn’t be surprised if it happens either.
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