By Dimitra Defotis | 24 January 2009
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Now, with crude more than $100 below that level, shares of the integrated oil giants— those that do everything from exploring to producing to refining and distributing— remain in a slump. Some now look tempting for long-term investors, but there's no need to rush. Big oil stocks could get even more tempting in coming weeks as the companies report earnings, issue subdued guidance for 2009 results and reduce the value of their reserves to reflect the latest realities of crude pricing.
The U.S. Energy Information Administration expects oil to average about $43 a barrel in 2009, while some Wall Street energy bulls consider $60 more likely. If either forecast is right, petro stocks will benefit later this year. If on the other hand, crude slides below its current level, as some Street bears expect, the shares could stumble further. Of course, few oil-price prognosticators have covered themselves in glory over the past year, and there's no reason to assume that their forecasting skills have improved. Especially since just where the price will go has much to do with another great unknown: how long the global recession lasts and how strong the subsequent recovery will be.
Short-term price forecasts vary greatly, but long term, the thrust is upward. But a recovery will come eventually, and higher oil prices almost surely will follow. The most enthusiastic bulls even see them returning to $100 within a few years. That's why, over the next few months, patient investors would do well to buy the stocks of the best-positioned companies with the strongest finances and best long-term outlooks. Among them: ExxonMobil, Total and BP. Also worth considering, although more speculative: Petrobras.
Of the top three, ExxonMobil (ticker: XOM) looks the priciest, but its mighty cash position makes it the No. 1 candidate for a dividend increase. The company, the world's largest non-government-owned energy outfit, is also a low-cost petroleum producer, as are France's Total (TOT) and the U.K.'s BP (BP), each of which also has impressive natural-gas holdings. Brazil's Petroleo Brasileiro, known as Petrobras (PBR), a smaller, production-heavy player, has made some intriguing energy discoveries, but some can't be exploited profitably at current petroleum prices.
The story is less positive for the other big players, whose shares are cheap for good reasons. Although it has a decent cash position and dividend, Royal Dutch Shell (RDSA) trades at a discount to its peers, in part because of its miserable history of writing down the size of its reserves. ConocoPhillips (COP) has a weaker balance sheet than most of its rivals, leaving it at a disadvantage in bidding for assets to replace its maturing reserves. And Chevron (CVX) looks downright expensive, especially in light of its high reserve-replacement costs.
The challenge for the publicly traded global giants is replacing their oil and natural-gas fields on a massive scale. National oil companies, chasing profits, now control about 80% of the world's oil. As energy prices rose, ExxonMobil and ConocoPhillips were among the companies booted from nationalized projects— most notably in Venezuela.
The political realities have forced the majors to do much of their exploration in difficult terrain, where finding-costs are high. The good news is that oil-rich countries seeking to fill growing budget holes are likely to offer more attractive terms to the majors, says Daniel Yergin, an energy expert and the author of The Prize, an oil-industry history. The inducements: the majors' access to capital and ability to execute projects and to marshal technology.
The major, independent energy companies still can thrive with oil prices down because they are "so big and diverse, they benefit in the chemical and refining areas from a drop in prices...," says Sean Bogda, a money manager at Global Currents, a unit of Legg Mason. One big bull on the sector is Tim Guinness, who runs the Guinness Atkinson Global Energy Fund (GAGEX). He contends that all the integrated oil stocks are a "screaming buy" with more than 50% upside, if you believe, as he does, that petroleum prices will average $60 in 2010 and $70 in 2011. The money manager's argument: The Organization of Petroleum Exporting Countries (OPEC) wants $70 oil and ultimately will take the actions necessary to obtain it, even if its members have an interest in "giving the world an economic break" with lower prices for now.
See FULL Table:
Big Break for Energy Investors
With the drop in oil prices, shares of some of the largest integrated oil companies, particularly ExxonMobil, Total and BP, look relatively inexpensive. They offer nice dividends, too.
| Rec ent | 12-Mo | Rev | Reser —ves | Repl —ace | Cash | Div | P/E | EPS | EPS | ||
| Company/ Ticker | Price | Chg | '08E (bil) | '07 (bil)* | Cost '07** | (bil) *** | Yld | '09 | '09E | '08E | Comments |
| Exxon Mobil / XOM | $78.23 | -6% | $457 | $22.5 | $8.00 | $36.7 | 2.0% | 14.2 | $5.51 | $8.46 | Massive cash stash. |
| Royal Dutch Shell / RDSA | 47.01 | -33 | 453 | 11.7 | 17.65 | 7.8 | 6.6 | 6.9 | 6.82 | 9.56 | Expanding LNG assets. |
| BP / BP | 41.44 | -33 | 399 | 17.6 | 9.50 | 6.1 | 8.0 | 7.8 | 5.28 | 8.85 | Healthy payout ratio. |
| Chevron / CVX | 69.95 | -14 | 264 | 10.8 | 28.41 | 10.6 | 3.7 | 11.7 | 5.97 | 11.10 | High reserve replacement costs. |
| ConocoPhillips / COP | 48.09 | -33 | 223 | 10.8 | 11.52 | 1.1 | 3.9 | 9.3 | 5.17 | 10.78 | Cash position weak vs peers. |
| Total / TOT | 46.75 | -34 | 206 | 10.1 | 18.64 | 16.9 | 6.6 | 7.2 | 6.51 | 8.07 | Decent cash position. |
| Petrobras/ PBR | 24.29 | -51 | 66 | 13.9 | 11.75 | 5.6 | 3.7 | 18.4 | 1.33 | 1.58 | Offshore discoveries bode well. |
*At year end, in barrels of oil equivalent; PBR figure is current.
**Worldwide reserve replacement cost, in barrels of oil equivalent.
***At end of third quarter.
E=Estimate.
Sources: Thomson Reuters, Boomberg; IHS Herold; company reports
Big Break For Energy Investors
One threat overhanging all of the oil companies is the possibility that the Democrat-controlled Congress will revive the windfall-profits tax of the 1980s. But just how deeply such a levy would bite into earnings and whether it really would be imposed are both unknowns at this point. Bears also fear that dividends will fall unless crude and natural-gas prices heat up. But, says Jeff Parsons, an energy analyst at Eaton Vance Management: "Integrated oil companies, even if they have a downturn in cash flows, rarely cut the dividend-they try to maintain or grow it. What they can do is reduce their capital expenditures." In fact, capex budgets are shrinking already, in line with oil prices.
Herewith, a look at the most attractive players, and some of their rivals:
ExxonMobil
This company is in a league of its own, not just for its girth and $37 billion cash stash, but for its low reserve-replacement costs— born of many accessible energy fields and superior technology— project-financing capability and a shrewd but conservative management team. Headed by CEO Rex Tillerson, Exxon's management gets consistent praise on Wall Street. This is why Exxon investors have long paid a premium multiple, which today stands near 14 times estimated 2009 earnings of $5.51. That's a roughly 10% premium to the integrated oil sector, but well below the 30% the stock boasted last year.
Exxon shares have been the most stable among those of the big energy firms, down only 6% over the past 12 months. In contrast, its 2% yield is the lowest among the integrated giants. But, given the company's powerful financial position, bulls argue that it's likely to boost its payout, after having emphasized repurchases in recent years.
Exxon spent $26.9 billion in 2008's first nine months, shaving its total of outstanding shares by 5.5%, to roughly five billion. The company has repurchased more than 2 billion shares over the past decade. If the buybacks were to continue apace, Deutsche Bank analyst Paul Sankey has quipped, ExxonMobil could be a private company by 2020.
ExxonMobil didn't respond to a request for comment. It noted in third-quarter filings, however, that dividends rose 13% per share in 2008's first nine months— largely the result of fewer outstanding shares. Recently, speculation has grown about whether ExxonMobil will make an acquisition. Among the rumored targets are Britain's BG Group (BG.U.K.) for its natural-gas assets. There has even been talk of a bid for all or part of Royal Dutch Shell, a deal that would face regulatory hurdles.
Total
This big French energy company's outlook is being brightened by the appeal of liquefied natural gas, especially outside the U.S. Standard & Poors expects the company's natural-gas reserves to be significantly bolstered by a recent agreement with Russia's Gazprom. Under it, Total obtained a 25% interest for 25 years in a Barents Sea gas field that the two will exploit together. Unexpected shutdowns in Africa and the North Sea cut production last year, but European refining margins were up 88% in the third quarter alone. With low-cost production in Africa (the source of 42% of Total's earnings before interest and taxes, according to S&P), and rapid expansion in the Middle East, Total should thrive if oil prices stay at current levels or rise. The French major had $17 billion in cash at the end of the third quarter. S&P has a 12-month target of $92 on the stock, double the current price.
BP
In recent years, BP has blitzed consumers with clean-energy ads and expanded its natural-gas operations, especially in the U.S., where last fall it agreed to pay $3.7 billion for some of Chesapeake Energy's shale assets. But oil still looms large in the company's fortunes, and its earnings are likely to be hurt in the near term by low crude prices in Russia, where a joint venture accounts for about a quarter of production. In addition, profits could be squeezed by the restructuring of BP's considerable refining operations, including its Texas City, Texas, operation, the third largest in the U.S. Chief Financial Officer Byron Grote has said that BP's $3.36-a-year dividend isn't endangered, assuming oil stays in the 40s. Investors obviously are skeptical, however; the company's shares are off about 11% this month.
Petrobras
This Brazilian energy concern's shares have fallen about 50% in the past 12 months. While considerably smaller and less diverse than some of the other integrated outfits, Petrobras has crashed the Big Oil party because of a huge discovery under salt deposits deep off the coast of Brazil. The costly project will take years to come to fruition, and some analysts contend that it might be viable only if oil fetches $60 a barrel; the company says the real figure is closer to $40.
The uncertainty over this important discovery makes Petrobras more of a gamble than ExxonMobil, Total or BP, especially since it sells at a higher valuation than any of them. In addition, the Brazilian government, which controls about a third of Petrobras shares, has encouraged the company to return more profits as dividends. Petrobras now yields 3.7%— a number that's likely to rise slightly this year. One possible drag: higher taxes on oil profits by the Brazilian government. As for Petrobras stock, Deutsche Bank cut its target to 35 in December. But that's still well above the recent 24.29.
Royal Dutch Shell
Natural gas has become a more attractive fuel because it burns relatively cleanly and can be transported easily in liquefied form. Royal Dutch plans to double its liquefied natural-gas capacity by 2010, according to S&P. That includes a large Russian LNG project to be completed this year. Offsetting this is that, if oil prices don't rise from current levels, profits will fall at Royal Dutch's high-cost Canadian oil sands operations. In January 2004, before Royal Dutch Petroleum and Shell were unified under one U.K. parent company (resulting in a confusing batch of tickers), Shell was forced to remove billions of barrels of "proven" reserves from its books, resulting in huge financial restatements.
Criminal investigations yielded nothing, and the whole mess is history, but its legacy endures in investors' skepticism about Royal Dutch's management. That might change a bit after the company's well-regarded chief financial officer, Peter Voser, takes over as CEO this year. Royal Dutch Shell's A shares, which underlie its most active American depositary receipts, carry the lowest multiple among the big oil stocks, even though the company has more than $8 billion in cash and offers a nearly 7% dividend yield.
Conocophillips
This company, whose stock could rally as its low multiple attracts investors, has the highest exposure among the super-majors to the North American natural-gas market. It also has one of the most capital-intensive portfolios among the U.S. integrated energy outfits. Unless natural-gas prices this year exceed $7.50 per million British thermal units, well above the current $4.70 or so, the stock has only modest potential upside this year, writes JPMorgan analyst Michael LaMotte, who has a 12-month price target of $53. The shares now are in the high 40s.
Chevron
Shares of this company, which acquired Unocal in 2005, held up relatively well in 2008; they're down 14% over the past 12 months. LaMotte upgraded the stock earlier this month to Overweight, saying that with a higher percentage of crude production, compared to Exxon or ConocoPhillips, Chevron "can move more than the peer group on crude-price movements." While it has far-flung exploration and production projects, from those on land in Saudi Arabia to deepwater Nigeria, it also is searching for oil in deep areas of the Gulf of Mexico, where hurricanes hurt production last year. LaMotte has a target price of $95 on the stock, for an upside of 36%.
Not everyone is a fan of this stock, however. After Chevron released an interim fourth-quarter report showing that refining margins were down, Credit Suisse lowered its earnings estimates, reiterated its Neutral rating and maintained its $68 price target. The shares were around 70 at midday Friday.
In sum, the long-term picture for Big Oil is generally bright. But, given the differences in the companies' strengths and prospects, investors will have to be picky to find the biggest winners. And winners there will be, because despite the hopes of environmentalists and foes of Big Oil, it will be years before conservation and alternative-energy sources can slake much of the world's thirst for petroleum.
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Normxxx
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