No good deed goes unpunished might serve as a caption for the early group of first-quarter earnings announcements made by E&P companies.
A May 1 report from KeyBanc Capital Markets found while 12 out of 17 E&Ps that had reported to date had “surprised to the upside,” beating production expectations and/or cash flow, 10 had sold off on the news. This occurred despite relatively strong oil prices.
“We think that this highlights the lack of buyers in the space right now as there isn’t the incremental investor that is willing to step in and reward good results with a new position,” Leo Mariani, KeyBanc analyst, said in the report.
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While only five out of those 17 companies reporting had what the market considered excessive capex for the first quarter, the report’s authors think that capex concerns will persist as the earnings season continues. “We also expect Permian-focused E&Ps to report weaker oil price realizations with first-quarter 2019 as well,” the report said.
The problem of not-enough buyers is likely to persist and continue to pressure E&P stocks, but the analysts think that stronger earnings for the second quarter indicate a buying opportunity at present.
As such, the analysts said their “high-conviction” ideas include Continental Resources Inc., EOG Resources Inc., Diamondback Energy Inc., Pioneer Natural Resources Co., Whiting Petroleum Corp. and WPX Energy Inc. They like these E&Ps for their low-cost oil assets and ability to generate free cash flow.
In addition, estimated free cash flow analysis by KeyBanc found EOG, Pioneer, Continental, Diamondback as well as Occidental Petroleum Corp. and Concho Resources Inc. leading oily E&Ps out of the companies that had reported as of May 1.
Bernstein Energy said May 2 the results of a marginal oil cost survey were in line with current spot prices but higher than the long-term oil forward strip price of $61.
In the survey of 50 of the world’s largest listed oil and gas companies, the analysts found that the marginal cost of oil was $71 per barrel based on 2018 reports from the group.
The report found that the global marginal cash cost of production for these top-sized companies increased by 16% to $36 per barrel from $31 last year. “This represents the floor price for oil,” the Bernstein analysts said.
The breakeven price on a net income basis, based on the global unit production cost of $32.90 per barrel of oil equivalent (boe), was $51.
“Industry profit ability is at the highest in the last five years with [return on average capital employed] at 10%,” according to the Bernstein report. “With oil prices rising more than costs, industry margins increased by more than 200% in 2018.”
Net income margins for the 50 companies doubled to 18% last year from 8% in 2017.
Cash flow numbers were also impressive. Average organic free cash flow at $9.80/boe was the highest since 2000; operating cash flows rose by 23% year-over-year to $23.10/boe.
The Bernstein analysts look for the capex cycle to begin to turn this year for the industry, as the re-investment ratio (capex/operating cash flow) is the lowest since 2000, at 57%. Organic reserve replacement for 2018 was 183%, significantly greater than the last five-year average of 115%, according to the report.
Inflation trends may deliver a slightly higher marginal cost this year, the analysts noted.
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