RJ says investors should focus on 3 things in Q1 reports
Posted: Mon Apr 25, 2022 7:04 pm
From Raymond James 4-25-2022 E&P Energy Sector Update
Theme #1: Return of Capital – Remains the #1 Priority
In an incredible twist of fate over the past few years, E&Ps have now firmly planted themselves in the world of… equity income? It wasn’t long
ago that the idea of an oil and gas company returning any substantial amount of free cash flow to shareholders was ludicrous, much less the 75%
targets we’ve seen from some in our coverage. Oil and gas companies now account for the highest dividend yields in the S&P 500.
DVN was an early mover bringing the structured shareholder return policy to the E&P space and was rewarded handsomely for its efforts as the top
performing company in the S&P 500 index last year. Whether using dividends and/or share-buybacks, companies continue to adopt shareholderfriendly return policies at an increasing rate. The strategies may vary from company to company but the end result is similar: return an increasing
amount of cash to shareholders. Some companies such as OXY have seen strong stock price performance as the timeline to returning cash to
shareholders has compressed dramatically as the unhedged company has been a huge beneficiary of the commodity move. Other companies, such
as AR, are poised to further enhance their previous shareholder return framework. In today’s environment, the implementation of shareholder
return plans or adjustments to existing plans is a key differentiator of stock performance.
Theme #2: Cost inflation – An Increasing Concern Among Investors
Inflation continues to be a hot topic in 2022 and for good reason. Steel and other commodities have soared, and the CPI the last two months
has exceeded 8%. Despite the majority of our coverage universe’s plans for maintenance capex budgets, steel, fuel, labor, and sand are pushing
budgets higher.
That being said, most E&Ps feel comfortable with their current guidance, having baked ~10-15% cost inflation into initial budgets. During 1H22,
the combination of previously secured items (rigs, drill pipe, sand, etc.) and efficiency gains are helping to keep costs under control. However,
our view is that most companies will begin to experience much higher cost inflation in 2H22 than was initially assumed in forecasts due to certain
oilservice items rolling off current contracts. Therefore, we see an upward bias to FY22 budgets, but the more meaningful pressure will be felt in
FY23. We also believe that supply chain bottlenecks (many of which HAL emphasized on its recent conference call) will persist.
Theme #3: New Year, New Hedge Books
To quote the venerable Forrest Gump, “life is like a box of chocolates — you never know what you’re going to get.” That statement could definitely
apply to oil and gas hedges. In the span of roughly two years, hedges evolved from a source of financial strength (2020) to a financial anchor in
today’s commodity environment. The good news for our E&Ps is hedges are down considerably Y/Y; compared to FY21, our coverage (on average)
reduced oil hedges by ~50%, while gas hedges dropped ~30%.
Lower hedges (and rising commodity prices) of course, results in added free cash flow. In fact, at current strip, our coverage averages an FCF/EV
yield of roughly 17%, by far the highest of any Russell 3000 sector! Looking at the charts below, nearly half of our coverage is hedged below 10% on
both oil and gas. Names with full exposure to the oil and gas strip include the following unhedged names: OXY, APA, COP, PXD, and MNRL, while CLR
and AR possess no liquids hedges. Additionally, HES paid $325M in 1Q22 to remove its call options that had previously capped its oil price upside.
--------------------------
I highly recommend MNRL.
Theme #1: Return of Capital – Remains the #1 Priority
In an incredible twist of fate over the past few years, E&Ps have now firmly planted themselves in the world of… equity income? It wasn’t long
ago that the idea of an oil and gas company returning any substantial amount of free cash flow to shareholders was ludicrous, much less the 75%
targets we’ve seen from some in our coverage. Oil and gas companies now account for the highest dividend yields in the S&P 500.
DVN was an early mover bringing the structured shareholder return policy to the E&P space and was rewarded handsomely for its efforts as the top
performing company in the S&P 500 index last year. Whether using dividends and/or share-buybacks, companies continue to adopt shareholderfriendly return policies at an increasing rate. The strategies may vary from company to company but the end result is similar: return an increasing
amount of cash to shareholders. Some companies such as OXY have seen strong stock price performance as the timeline to returning cash to
shareholders has compressed dramatically as the unhedged company has been a huge beneficiary of the commodity move. Other companies, such
as AR, are poised to further enhance their previous shareholder return framework. In today’s environment, the implementation of shareholder
return plans or adjustments to existing plans is a key differentiator of stock performance.
Theme #2: Cost inflation – An Increasing Concern Among Investors
Inflation continues to be a hot topic in 2022 and for good reason. Steel and other commodities have soared, and the CPI the last two months
has exceeded 8%. Despite the majority of our coverage universe’s plans for maintenance capex budgets, steel, fuel, labor, and sand are pushing
budgets higher.
That being said, most E&Ps feel comfortable with their current guidance, having baked ~10-15% cost inflation into initial budgets. During 1H22,
the combination of previously secured items (rigs, drill pipe, sand, etc.) and efficiency gains are helping to keep costs under control. However,
our view is that most companies will begin to experience much higher cost inflation in 2H22 than was initially assumed in forecasts due to certain
oilservice items rolling off current contracts. Therefore, we see an upward bias to FY22 budgets, but the more meaningful pressure will be felt in
FY23. We also believe that supply chain bottlenecks (many of which HAL emphasized on its recent conference call) will persist.
Theme #3: New Year, New Hedge Books
To quote the venerable Forrest Gump, “life is like a box of chocolates — you never know what you’re going to get.” That statement could definitely
apply to oil and gas hedges. In the span of roughly two years, hedges evolved from a source of financial strength (2020) to a financial anchor in
today’s commodity environment. The good news for our E&Ps is hedges are down considerably Y/Y; compared to FY21, our coverage (on average)
reduced oil hedges by ~50%, while gas hedges dropped ~30%.
Lower hedges (and rising commodity prices) of course, results in added free cash flow. In fact, at current strip, our coverage averages an FCF/EV
yield of roughly 17%, by far the highest of any Russell 3000 sector! Looking at the charts below, nearly half of our coverage is hedged below 10% on
both oil and gas. Names with full exposure to the oil and gas strip include the following unhedged names: OXY, APA, COP, PXD, and MNRL, while CLR
and AR possess no liquids hedges. Additionally, HES paid $325M in 1Q22 to remove its call options that had previously capped its oil price upside.
--------------------------
I highly recommend MNRL.