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Energy products Deserve a closer look



The energy industry is trapped between slate stone and a difficult political place. The American shale oil tree has left the world in crude oil, although many governments and climate activists are pushing for a cleaner, greener future. Add geopolitics to the mix, including the sometimes unpredictable features of the organization of petroleum exporting countries and US sanctions against several OPEC members, and the result has been volatile oil price fluctuations and persistent pressures on energy company shares. Today, the energy sector represents only 5.4% of the S&P 500 index, and after a 1

4% share price this year.

Just as the savvy drillers can find hydrocarbons in unpromising terrain, the panelists on our 2019 energy route experience see real values ​​among the industry's dilapidated names. Partly due to the fact that US investigation, production and energy infrastructure companies have finally asked their spending habits to focus on capital discipline, balance strength and sustainable disbursement to holders. In the same way, some integrated oil and gas companies are ready to benefit, as the projects long in the planning finally come online. While our panelists do not see a huge surge in oil prices, $ 60 is not a hindrance to the success of the best-managed companies with the right business mix.

Our 2019 panel includes Helima Croft, global leader of commodity strategy at RBC Capital Markets; Chris Eades, portfolio manager at ClearBridge Investments and co-responsible for the company's midstream energy strategies, including three listed fund assets; David Heikkinen, founder and CEO of Heikkinen Energy Advisors, a Houston-based investment research firm; and Jonathan Waghorn, co-responsible for the Guinness Atkinson Global Energy Fund (ticker: GAGEX), who joined the group via London video conference. Helima, an expert on the Byzantine world of OPEC, also participated in the Barron's 2018 Energy Round Table.

This year's round table was held in late February. At that time, West Texas retrieved intermediates, the US benchmark, around $ 57 a barrel, and Brent, the global benchmark, traded for $ 65.55. On Friday, the WTI was priced around $ 58, and Brent, at $ 66.50.

Barron's : The energy stocks have been clarified over the past five years, and the industry's long-term views are questionable. Why should investors themselves care about this sector today?

Chris Eades: I am an investor in midstream companies, which transport, process and store energy products, mainly in the United States. What is important for these companies is not the price of oil or natural gas, but the volume of oil and gas. While the shares did not do well in 2018, the companies had a record cash flow, and will have a record cash flow in 2019. The corporate balance sheets will improve and the dividend or distribution coverage will increase. Nevertheless, valuations are quite low.

Midstream companies, including C companies and master companies, are interesting at today's level for income-oriented investors. The Group's average return is 6.5%, compared with about 2% for S&P 500, 3% for tools, and 4% for real estate investments, or REITs. Midstream companies are also better positioned from a valuation and dividend coverage perspective, and the balance is better than any tool and REITs. The activity class is out of favor for reasons that are probably not sustainable in the medium and longer term.

At what level will oil prices be a problem for midstream volumes?

Eades : If prices were to fall below $ 45 a barrel, it could be a significant contraction in US drilling. At some point it will affect the cash flow in the cash flow. In the mid-40s, we will also have a problem with feelings towards the shares.

Jonathan Waghorn: The size of the energy room in the market reflects the profitability of the companies. Return on capital for 24 companies we own went from a low of 5% in 1998 to a peak of 20% in the mid-2000s. As oil prices went up and down, the industry started on a massive cycle of spending and returns went down and down and down. Return on capital tied to 2% in 2016 and is now recovering, not due to changes in oil prices, but because companies are focusing on improving the return on capital employed. As these companies become more profitable, they should start trading at a book value premium. That's why investors should look to get back to the sector.

David Heikkinen: Growth investors should not care about this space today, but relative value and value investors should. Oil production grew so dramatically in the United States over the past four years, delivering high demand, and killing the $ 100-barrel boom. Then, when oil prices went down, the broad stock market took off. There is no investor's muscle memory around how to make money in energy anymore. With the sector shrinking to a fraction of the S&P 500, investors have not had much need to look beyond super-mares or other big cap names.

Helima Croft by RBC Capital Markets considers the developmental relationship between Saudi Arabia and Russia, and what it means for the energy market.

We see the possibility because, as the industry has slowed down, it has been easier to see a differentiation in property quality, capital efficiency and free cash flow among companies. At the same time, volume growth is in line with demand.

Helima Croft: I do not focus on some companies, but from a raw material perspective, the fourth quarter was incredibly difficult. [The price of WTI crude oil fell 38%.] Investors, and even oil minister, tell me that knowing who is trading oil is a big challenge. Systematic trading [computerized trading, based on quantitative strategies] is believed to cause some unusual traits. On December 26, oil prices even increased nearly 10% in the absence of any basic news to justify such a move.

This year, OPEC is trying to stabilize the market by imposing production cuts. They have been very effective. Saudi Arabia's willingness to balance this market from a supply perspective is serious. Sixty dollar oil is the new $ 100 for superb manufacturers. The problem is that many OPEC countries have not been able to get their financial houses in a way that allows them to adjust to a $ 60 price.

Is systematic trading a major part of the energy market?

Croft : Yes. Banks come out of retail trade. Many commodity hedges have closed. Oil can be traded as part of a macroeconomic strategy, but there are fewer traders these days that were raised in the world of supply and demand. Systematic traders have stepped in.

Let's get your oil price warnings for 2019.

Croft: We have $ 60 a barrel for WTI and $ 68 for Brent crude. We have talked about prices more in scenario-based terms. What is the downside story? It would be a global recession. The upside story is unplanned outbreaks. We had expected production in Venezuela to fall by about 300,000 barrels a year, simply because PDVSA [Petróleos de Venezuela, the state-run oil company] did not pay employees or spent on maintenance and infrastructure. However, putting the PDVSA on the US Treasury's OFAC [Office of Foreign Assets Control] list allows for a number of sanctions that can be imposed. This makes it easier for the US to force other countries to cut Venezuelan imports.

Beyond sanctions, devastating outbreaks in Venezuela have a major impact on supply. And even though President Maduro leaves the office, Venezuela will recover hard. The extraction of the country's oil industry will take many years and demand billions of dollars in new investment.

Eades: I agree that $ 60 is a good starting point, but we believe that a $ 50 to $ 70 bond is an affordable way to look at the market, with volatility above and below this range on the cards term. I guess the average price for the next 10 years will be around $ 60.

Waghorn: Our forecast is also $ 60 a year – for Brent Oil. This would allow US production to grow at a reasonable amount and allow some OPEC production to return to the market. If the price goes much higher, we can see a sharp increase in production from US companies. If it goes much lower, we see a lack of investment.

Heikkinen: Our estimate is $ 50 to $ 52 for the next two years. OPEC has extra production capacity, and will at any time either need higher prices or higher volumes to generate revenue. We strengthen stocks from top to bottom and have found that better opportunities arise by having a negative bias and then being pleasantly surprised, as opposed to having a positive bias that does not play so well.

While the supply side supports a $ 50 per barrel floor, many generalist investors believe it is a terminal value for all oil and gas companies, as the demand side ends around 15 to 30 years from now. Up to this point, I haven't found a company that makes a lot of money in the alternative energy field. Solar and wind power are 50 to 100 year old technologies. You will not change the profile for future demand by using 100-year-old technologies. New technology can break through things like algae-based biofuels that sound interesting.
Exxon Mobil

[XOM] is involved in the work of using Crispr Cas-9 gene editing technology on algae, but it is far away.

Investors may be ambivalent with oil, but President Donald Trump is not. He has tweeted that OPEC should cut prices. Has this affected the market?

Croft: It has been hugely destabilizing. OPEC and the Allies reversed the course last summer on a long-term contract to cut production, and increased more than one million barrels of oil a day into the market pending the US's renewed economic sanctions against Iran in November. The group was led to believe that there would be no exceptions for importers of Iranian oil, so they were surprised to learn later that some countries were exempted. Led by Saudis, OPEC reversed courses again at the turn of the year, cutting production. When President Trump recently told OPEC to relax OPEC sent this message to voicemail.

I did not predict Suds U-turn last summer, but the steep decline in oil prices in the fourth quarter reminded them that there are consequences for persuading the market. I expect they will be reticent to make another mention soon. The agreement in December to cut production is likely to be a full-year agreement. Just look at Saudi budget numbers: This year's budget has an official spending increase of 7%. Unofficially it will probably be higher. Donald Trump may have an American first policy, but the Saudis have a Saudi first policy.

If OPEC reduces production, will it be a challenge for US companies to increase production in the coming years?

Eades: Yes. Ten years ago, energy production in the US was flat to fall. The United States now supplies 65% to 75% of the growing demand for oil in oil. Exports are a big part of America's energy series today. [Congress lifted a 40-year ban on U.S. oil exports in 2015.] Recently, the United States exported 2.7 million barrels a day. Exports are likely to increase over the next five years to seven million to eight million barrels a day. It will require a lot of incremental infrastructure on the pipeline and storage side. We export 1.1 million barrels a day with natural gas fluids, which are likely to rise to four million barrels over the next five years. Also in natural gas, the USA has switched to net exporter. Exports of liquefied natural gas went from zero in 2015 to 2.9 billion cubic meters a day, and probably led to 7.5 Bcf over the next three or four years. The path of growth is phenomenal, and it is not baked into stock prices at current levels.

Where are the best midstream values?

Eades: In 2010, when we launched our first Midstream Fund at ClearBridge, the best companies from an investment perspective were those who grew their dividends or dividends the fastest. Today, the winners are those who retain enough cash flow to finance their capital expenditures.

  2019 Energy Roundtable: Prospects for Oil Bearings


Photograph by Andrew White

Beyond appreciation, I look for eight things: no incentive rights [IDRs] paid by a master limited partnership to a general partner; high yield / distribution coverage ratio; self-financing (or close to it) Capitalized value less than 4.5 times debt until the end of 2019 Ebitda [earnings before interest, taxes, depreciation, and amortization]; exposure to Permian Basin and / or Marcellus formation [the Permian is a large shale-oil producing region in Texas and neighboring states; the Marcellus is in the Eastern U.S.]; exposure to increasing energy consumption in the United States; organic growth projects that generate visible cash flow growth; and fee-based cash flows with limited exposure to commodity prices.

I have five recommendations.
energy transfer

[ET] a pipeline and storage company, has Permian, Marcellus, and export exposure. The share gives 7.9%; The company pays no IDR and equity capital expenditures. Distribution coverage is 1.8 times distributable cash flow. Balance delay will be 4.3 times Ebitda at the turn of the year. Capital expenditures will peak in 2019, when several large projects come into operation. With lower investment costs in 2020 and increasing cash flows from new projects, Energy Transfer will probably increase its distribution and / or implement a buy-back program. The shares are trading for $ 15 and I see the real value of $ 20.

Enterprise Products Partners

[EPD] has crude oil, natural gas and NGL infrastructure resources with exposure to the permian and growing US exports. The share is 6.2%. The company has no IDRs and is close to self-financing capital expenditures. It has one of the best balance in the sector, with a debt to Ebitda ratio of 3.5 times likely at the turn of the year. A $ 6 billion dollar project in Permian will drive cash flow growth over the next few years. A potential offshore terminal for export and another PDH [propane dehydrogenation] factory could further drive the growth. The stock is trading at $ 28 and I see the real value of $ 32.

What's going on?

Eades:
Kinder Morgan

[KMI] is natural gas focused, with exposure to both Permian and export. With an expected increase in the dividend for the quarter to 25 cents per share, it gives 5.2%. The company has no IDRs, 2.2 times dividend coverage and balance sheet utilization that should decline to 4.3 times at the turn of the year. An important part of the growth will be two large natural gas pipelines that go from Permian to the Gulf Coast of Texas. The stock trades for $ 19 and can trade up to $ 24.

Plains All American Pipeline

[PAA] is crude oil, with exposure to Permian. It provides 5.1% and does not need to issue equity to finance its demand. It has a distribution coverage of 1.9 times and no IDRs. Debt will hit 3.7 times Ebitda within the end of the year. The growth over the next few years comes from three major crude oil pipelines from Permian to the Texas Gulf Coast, and from continued expansion of the Plains & # 39; crude oil collection system in Permian. Distribution growth is likely to continue in 2019. The stock is trading at $ 23. Fair value is close to $ 28.

Williams Cos.

[WMB] is natural gas focused, with exposure to Marcellus. It gives 5%. Williams has no IDRs and is close to self-financing capital expenditures. It has a dividend coverage of 1.7 times, and should have 4.4 times debt to Ebitda by the end of the year. Williams' largest acquisition is the Transco pipeline, where the expansion projects will push through from 15 bcf a day a year ago to an expected 19.5 bcf a day in 2021. The stock is trading at $ 27 and can have up to $ 32 in the next. 12 months.

This stock basket generated a total return of 10% over the past 12 months, compared to 4% for the Alerian Midstream Energy Index. I expect the shares to continue to run.

Jonathan, give us the view from Europe.

Waghorn: Investors have lost interest in recent years due to surpluses of US supplies and OPEC's production strategy in 2014. [The organization couldn’t agree to cut output and oil prices plummeted.] There have also been concerns about demand history. It is a real interest for Europe in vehicle electrification. In Norway, 45% of new car sales are electric; Government grants have made it happen. Sustainability and decarbonisation are also major problems in Europe. Asset distributors say they are pressured by investors who want to assess green portfolios.

In addition, this industry must add more money to work each year to compensate for the production declines from existing projects. Companies operating in non-OPEC countries (except the US onshore) invested heavily until 2014-15, and projects related to the expenditure are now only starting production. Then there are prospects for reducing the growth of new projects. The same applies to OPEC. It will also become increasingly difficult for US shale producers to deliver growth.

Which stocks look most attractive to you?

Waghorn: It is difficult to find opportunities in gas. US supply is plentiful and prices are low. [Natural gas futures settled on Friday at $2.80 per million British thermal units.] Globally, there are not many good pure plays in liquid natural gas, and the valuations become rich. So our bias is against oil. We like companies with good financial returns, either through high cash flows or growth plus returns. We own four of the five super mares
Royal Dutch Shell

[RDS.A],
BP

[BP],
Total

[TOT] and
Chevron

[CVX] – and some major integrated companies. We have an equilibrium portfolio of 30 shares.

Shell's US receipts are for around $ 64, or just under six times business value by 2019 Ebitda. The five-year average is seven times. The share gives 6%. The company has a better return on capital employed and an increasing share of production from natural gas. Canada
Suncor Energy

[SU] An oil sands producer, is a bit more risky. It also operates in six times 2019 EV / Ebitda. The company got its house in good order as the oil price fell, and now delivers a dividend of 3.5% and a 10% free cash flow dividend. We see about 5% peak production growth and a well-supported balance sheet. At a final $ 34, Suncor is pricing in a long-term oil price forecast of around $ 54 a barrel of Brent.

PetroChina

[PTR] An arm of state-owned China National Petroleum, is an integrated oil company with natural gas focus. China's economy has slowed down and Chinese stocks are under pressure. The company's US securities trade for 3.5 times business value to 2019 Ebitda, and price expectations for around $ 50 Brent. The company has a dividend of 4.5% and a 10% free cash flow dividend. PetroChina is on her knees at the moment. Expectations are low.

We also like
Noble energy

[NBL] An American exploration and production company that begins to produce at the turn of the year from a vast Mediterranean gas field off the coast of Israel. When production reaches 2020 and 2021, you can get 30% growth volumes. At $ 23 you pay 3.5 to four times EV / Ebitda. Finally,
Halliburton

[HAL] is the second largest global oil service company. It offers a good mix of business lines, balance strength and exposure to US shale oil activity. There is a short-term disadvantage risk for consensus revenues as the US shale system falls early in 2019, but with the stock market around $ 30 there is potential for earnings to recover and the stock price should respond positively.

How do you look at the other super maids?

Waghorn: We do not own Exxon Mobil because of valuation. At around $ 78, it is 8.2 times the corporate value to 2019 Ebitda. Chevron is trading six times. They have similar businesses and have recently announced major investments in the Permian Basin. Chevron has a great place to deliver strong cash flows from a variety of new projects, giving it a higher cash flow than Exxon.

As a group, super mares offer attractive dividends and strong free cash flows. flow generation. For 2019, the average dividend rate is around 4.9%, compared to a five-year average of around 4.1%. At $ 60 a barrel of Brent, we expect the Group to easily cover dividend payments and still have free cash flow to repurchase or repay debt.

David, which stocks are at the top level?

] Heikkinen: We also like Noble Energy, which will have a dividend of 5% to 6% during 2020. It is not so, because people do not fully believe that the company will be able to produce gas in Israel and on the regional market in Egypt. Noble's new team in Egypt should arrange contracts, which, in combination with the procurement and testing of an existing but non-commissioned pipeline to Egypt, will enable new volumes and higher realized pricing. We believe that Noble can trade into the $ 30s when the market looks forward to 2020.

  2019 Energy Roundtable: Prospects for Oil Bearings


Photograph by Andrew White

We see some of the best values ​​in companies with Permian potential. Several of the companies in the Midland Basin [a section of the Permian] have been compressed. We consider
Pioneer Natural Resources

[PXD] and
Diamondback Energy

[FANG] favorable, followed by
Parsley Energy

[PE] in that order. Each has reset the growth expectations and the reduced estimates. They are now heading for a widespread string of estimates for beats and raises, and better price realizations by 2020 as Permian pipelines come online and production ramps. Pioneer has the deepest inventory, running a net asset value of $ 200 per share. It trades for less than seven times 2020 estimated EV / Ebitda. Parsley trades for 5.4 times, and Diamondback, for 5.2 times. Everything is on our focus list.

EnCana

[ECA] also offers an attractive valuation, free cash to buy back shares and growth potential. It has recently acquired Newfield Exploration, a major operator in Oklahoma, but the market hates the deal when Newfield's primary assets are in the independent Stack / Scoop game. The shares have sold, and the company's Texas assets are traded at a large discount to peers. Encana has a headwind, as attractive 2019 oil price hedges roll up to 2020.

What stocks rank your rankings?

Heikkinen: The market has priced
Hess

[HES] as free cash flow will grow to $ 6 billion a year in 2025. But 2025 is a long time from now. The company has significant influence on deepwater production near Guyana, but historically, as the oil companies are starting to generate Ebitda from large-scale projects, their valuations are compressed. At a recent $ 58 per share, the market is underwriting meaningful resources findings in Guyana. But the story will not hold when Hess begins to bring these projects online over the next two years. Hess is ahead of herself on appreciation of more than 10 times Ebitda.

Oil company services have tried to keep up with the revolution. They have used too much, and return has begun to fall. Other 2019 earnings estimates for clean-play small and mid-cap oil services companies are too high, and we expect them to suffer as estimates are cut. On the other hand, shares of integrated oil service companies such as
Baker Hughes

[BHGE] and
Schlumberger

[SLB] has probably fallen too much. I favor Schlumberger and Baker Hughes a little more than Halliburton because of their international exposure. Schlumberger offers a dividend of nearly 5%, and Baker Hughes, almost 3%. Both act well under historical multiples.

I wanted short fracking-sand companies, for example
Hi-Crush Partners

[HCLP] and
U.S. Silica Holdings

[SLCA]. They are effectively mining dirt. It's a low-margin business, and the US is translated. There is no barrier to entry. The maps look awful, but their estimates must fall, and the multiples must compress.

Among the citizens we see the opportunity in
Helmerich and Payne

[HP]. The shares have underperformed the VanEck Vectors Oil Services Exchange-traded Fund [OIH] by more than 9%, and have more estimate stability and an improved free cash flow outlook after a 23% reduction to Capex. The company's surplus value of more than 5% is safe, and their superspecific fleet will take market share in the shales, as more complex, longer horizontal wells will be drilled. Like Chris, we like Enterprise Products Partners and Plains All American for their exposure to Permian and exports. Reverse,
Targa Resources

[TRGP] and
EnLink Midstream

[ENLC] tend to be more capital intensive and do not generate the cash flow that competitors have.

What is a big topic that energy investors should focus on this year?

Heikkinen: The increasing stability of businesses makes it possible for investors to distinguish themselves from quality. Companies have set the balance; They generate free cash flow and there is some return component. Valuations are low. It is likely to free up cash flow, capital efficiency and oil prices. Thus, it is provided upside down from an investment perspective over the next few years.

Waghorn: I also ask investors to be aware of this sector, although large energy companies are talking about capital discipline, cost regulation, and free cash generation. This industry does not need 100 dollars of oil to be acceptable profitable again. With stock pricing in a long-term price expectation of around $ 52 a barrel, it's an opportunity.

Eades: Published midstream assets trade with lower cash flow multiples than assets that change hands in the private stock market. This is upside down and probably not sustainable. Consolidation can be the catalyst for medium-sized businesses to tear off their disadvantage. Also, do not exclude private-equity buyers.
Black stone

[BX] and
KKR

[KKR] recently bought midstream energy assets. It is a signal that some midstream assets are cheaper in the public market than in private markets.

Croft: President Trump mainly got OPEC to move 180 degrees on production policy, which had significant implications for energy prices. We expect him to continue to strive to bend the organization to his will. This is where the Nopec bill [No Oil Producing and Exporting Cartels] becomes important. It would apply to antitrust law to OPEC, which declares it a cartel, which may make it subject to government lawsuits. Presidents have vetoed Nopec in the past, but Trump said in 2011 that he would support it. Then again, he is also strongly supportive of Saudi Arabia. We expect Saudis to lobby heavily against the bill. Defense and airline companies will also lobby against it because they deliver weapons to the OPEC countries. Calm, American manufacturers will probably tell Trump this is a bad idea. People continue to write OPEC's death sentence, but OPEC plays a critical role in setting a floor during the oil price.

Duly noted, and thank you all.

Write to Lauren R. Rublin at lauren.rublin@dowjones.com


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