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Business

How to play oil stocks according to the Chevron-Anadarko agreement.




In moving to buy
Anadarko Petroleum

$ 33 billion,
Chevron

made a smart decision – and yet was punished by Wall Street.

Its shares closed almost 5% on Friday. And unfortunately for Chevron (ticker: CVX), there is a good chance that investors will continue to stock up, at least in the short term.

However, the agreement gives new enthusiasm to other companies whose shares have been dormant for months, even though the price of crude oil has risen.

Drillers sitting on oil-rich land and offshore companies are now ready to surpass. It includes big American names like
Diamondback Energy

(LAP),
Concho Resources

(CXO), and
Noble energy

(NBL). Of these, we are most bullish on Diamondback, whose valuable land in the fast-growing Permian Basin and smart asset management should appeal to investors ̵[ads1]1; and possibly to an acquirer.

Chevron buys Anadarko (APC), a global oil and gas producer for $ 65 per share, a 39% premium on Thursday's closing price. The agreement values ​​Anadarko's equity of $ 33 billion, or $ 50 billion on a corporate value basis. Chevron pays 75% of the cost in stock and 25% in cash.

The logic of the agreement makes sense. The 39% premium may look relatively steep, but Anadarko traded over $ 70 as recently as October. When buying Anadarko, Chevron will increase its daily production to 3.6 million barrels, just below
Exxon Mobil
s
(XOM) 3.8 million barrels. Anadarko's oil supply is in regions where Chevron already has a foothold and will allow the company to scale in key areas.

The agreement makes Chevron the second largest player after Concho in the Permian Basin, the country's most productive oil field, according to IHS Markit. Chevron will now control a landmass 75 miles wide in the pool.

"You are thinking of driving 70 miles an hour in an hour, and you're in our area all the time," says Chevron's CEO Michael Wirth Barrons . "That area sits on top of teams by layer by layer of this slate. And we only restore 10% of the hydrocarbons in it."

Anadarko also has valuable assets in the Gulf of Mexico. A promising natural gas development that Anadarko controls in Mozambique will help Chevron expand more into liquid natural gas and at a much lower capital cost.

But energy investors have little patience for acquisitions right now. Large oil stocks are considered to be stable income investments, not growth engines, and are valued for the cash flow.

Chevron has a dividend yield of 4% and it has won arguments for reining in expenses and not splashing it out on megadeals. That discipline has contributed to the shares increasing by 16% to Thursday. The last thing Wall Street wants is that the company should spend money that can return to the shareholders. Nevertheless, Chevron will fund the acquisition in part by issuing 200 million shares and will assume $ 15 billion in net debt.

So why do investors clearly reverse?

CEO Wirth claims the deal will add to the company's annual cash flow so it can buy back even more shares in the future – $ 5 billion a year instead of $ 4 billion.

"We issue shares that we bought back in the last decade at around $ 100 per share, and we issue it as a currency at a much higher price. We take advantage of it," he said. shareholder distribution as a result of this transaction, and we will have the capacity to maintain them through the ups and downs of the commodity price cycle. "

Even with the promised return on capital, investors cannot reward Chevron in the short term. who like the Chevron deal, better profit from buying Anadarko, which increased 32% on the contract notice, but at $ 61.78, was still trading below the contract price.

Anadarko owners will own a 9% stake in Chevron if And there is still a chance that another buyer could turn in to offer a higher bid.

The potential for further contract development provides an opportunity for investors.

Other oil companies may feel pressured to do so. re acquisition to keep up with Chevron. And while other deals aren't coming through, the market has been chatting about acquisition tendencies to keep stocks in the sector high for several months, says David Heikkinen, CEO of Heikkinen Energy Advisors.

Other stocks reviewed possible acquisition targets rose Friday, including Concho, Diamondback and Noble. But even after gains of more than 6% each, they still look cheap.

This is because investors have disappeared the sector over the past three months despite rising oil prices. The
SPDR S & P Oil and gas research and production

The Exchange-traded Fund (XOP) has risen 6.8% even since the West Texas reference has risen 24%, to $ 63.89 per barrel.

Oil analysts say investors do not trust citizens to be wise about how they use cash and will see that they produce more cash flow. Heikkinen agrees that investors have the right to be cautious about this business cycle.

Nevertheless, the three US companies we have identified have good positions right now. Concho is the largest manufacturer in Permian and has "dramatically underperformed" the market after purchasing a company called RSP Permian last year. Noble is attractive because its Leviathan offshore gas field project will help make the company free cash flow by 2020.

And Diamondback has been among the most cautious companies to balance their spending while still collecting key oil and gas players. It has the fifth largest production in Permian, a resource that other companies will obviously want to pay for.

"Diamondback has lower risk [of overspending] in the first half, checks the box as a takeout candidate, owns minerals and midstream assets, and is a meaningful size, and a $ 20 billion business value company is meaningful to a large

Diamondback is also cheaper, with a business value of 6.9 times estimated 2019 earnings before interest, taxes, depreciation and amortization, compared to 7.2 times for Noble and 8.2 times for Concho. is valued at 6.2 times.

The Anadarko deal may take some time to help the Chevron stock, given the investor's feelings about spending, but it has shot at oil desks and it can last.

"I think they will close some of the valuation gap [of the drillers]"Heikkinen said." There will be a dissertation for at least a few months that [other big oil companies] will have a fear of missing out. "

Write to Avi Salzman at avi.salzma n@barrons.com



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