UBS Energy Teams' take on upstream companies - June 29

[dan_s]

Comments below are from a UBS report dated June 29, 2020. As expected they are warning their clients that Q2 results will be bad, but outlook for 2H 2020 has improved.

2Q Focus? "Bottom of Cycle" Corroboration, 2H Theme
It's no surprise that 2Q numbers will be poor. With that said, investors are interested in
(1) Corroborating 1Q commentary around "bottom of cycle" breakevens, implied
decline rates, and go forward capital efficiency. Given the number of requests for
scenario analyses, finding data to confirm "normalized" FCF potential will continue to
be the guiding metric. (2) The above though is complicated by shut-ins and restarts, so
updates on cadence there will also be under the microscope. Details around peak
"turn-downs" and production trajectories, including plans for DUCs and frac spreads
will be questioned. (3) With that said, we don't expect much in terms of 2H20 capex or
exit rate production guidance as commodity price volatility is likely to remain high over
the intermediate term, and reversing guidance especially painful for management
teams. (4) Finally, given the equity bounce, investors are searching for the next
differentiating themes. Since UBS' conference the election has been used; We can
already see it in the relative spreads. Questions have not just been on US shale
exposure, but also offshore permitting, ESG, Iran policy, and tax change. We're back to
favouring Tier 1 assets, lower decline, better balance sheet with commodity volatility
expected to be high. Favorites into 2Q earnings are CNQ, CXO, PE, PXD and COP. < Nice to see three of our Sweet 16 on their "Favorites" list.

Revised Numbers, PTs Following Changes to UBS Deck, Numbers, Spreads
UBS updated its commodity deck forecasts in mid-June, tied to positive signs and with
OPEC+ willingness to extend cuts and congestion data indicating increasing demand
(click for Jon Rigby's update here). Some E&Ps have started to reverse shut-ins (like PE,
COP, FANG, CXO, MUR), and even sell barrels from storage. A virtually flat 12-month
WTI curve provides limited incentive to store add'l barrels. With that said, many of the
larger public E&Ps, though, are not rushing to increase FY20 or 2021 capital. We've
adjusted numbers for differentials, spreads, State production data and cost indications.
Revised estimates, price targets, and risk premiums are shown in Figures 8-11.

US supply projection down ~11.5% exit19-to-exit20
In conjunction with UBS' revised commodity estimates, we updated our basin-by-basin
US supply production model. Despite shut-in production coming back, we still see the
biggest impact of reduced activity in '20 with production down ~1.5 mmbpd or 11.5%
exit '20 (vs ’19 exit - Fig 1). Our forecast includes a large percentage of curtailed
volumes back online in early 3Q20. As the year progresses, we also expect the rig count
to tick back up; expecting it to be down 50% since Jan-20 as compared to down
~70% today. DUC drawdowns will help mitigate some of the declines in latter '20. In
'21 we expect exit-to-exit production to be down ~6% vs ’20. As activity stabilizes and
legacy declines shallow allowing for production levels to bottom out and start to see
some growth through '22. Moreover, we model incremental activity to be at a
measured rise going forward with corporates opting for lower growth rates in
exchange for FCF growth.

Valuation Methodology
Given the focus on cap structure for highly leveraged names and those where debt
payments are a concern (where rated HY by credit rating agencies) we used EV /
EBITDA as EBITDA is a better representation of cash available to both equity and
debt holders whereas Price to cash flow generally focuses on cash available to
equity holders. This is particularly relevant for HY as debt holders will get paid first
in the event of a liquidation. Accordingly, we have applied an EV/EBITDA multiple
valuation methodology for companies that are HY or near HY in some instances
and applied a P/CF methodology for companies that are IG. In many cases our
detailed Net Asset Values (NAV) and DCF serves as an important basis / check,
especially for less mature companies where multiple histories are not reliable. After
selecting the appropriate multiple, we use the 5-yr avg on 2022 estimates as the
avg covers the latest full cycle including the 2016 trough. We use 3-yr avg in
instances where the company has recently optimized its portfolio. Our 2022
estimates assume a normalized scenario at $50/bbl and $2.50HH.
Our base case assumes 2022E avg WTI of $50 and ~$2.50HH, whereas upside case
assumes ~$60 WTI and ~$2.90HH and downside scenario is based on ~$40 WTI
and ~$2.00 HH (Fig 9-10).
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MY TAKE: I don't expect much of an increase in the active rig count until WTI is over $50/bbl. Bring back shut-ins and Q4 completions of DUC wells could cause a rise in U.S. production into year-end, but base decline rate will continue to wipe out most of the production increases.

[dan_s]

UBS updated price targets for the Sweet 16 companies that they follow:

XEC = $45
CXO = $99
CLR = $16 < UBS is only using a 3.5 X cash flow valuation for CLR, which the lowest multiple of all the companies on their list. Justified by the fact that CLR has no oil hedged.
FANG = $86
OVV = $17 < A month ago their valuation was $10
EOG = $78
PE = $22
PXD = $173
RRC = $6 < A month ago their valuation was $2.30