Catching Up With the Drillers

In this week’s monthly web chat for subscribers of The Energy Strategist and MLP Profits, someone asked the following question:

Q: When is safe to start looking at producers again and which do you feel are the strongest prospects?

I answered:

A: I think it’s probably time for an update on the producers, which I haven’t done recently. I personally like EOG, and have it in my own portfolio. Even though the multiple is a bit higher than competitors, they have outperformed their peers. But this gives me an idea for this week’s Energy Strategist. I updated them a few months ago, but a lot of them have moved significantly higher. Time for an update.

So I’ll update the oil and gas producers today, after a relevant detour.

Last week I was invited to give a talk to a group of oil and gas producers in the Uinta Basin in Utah. The meeting is put on by the state government, and is well-attended by producers in the area. I was invited to give the talk by John Rogers, the associate director for oil & gas for the Utah state government.

The meeting gave me a chance to trade stories with the industry professionals directly affected by the fall in oil and gas prices, and to better understand the price range that will incentivize them to increase drilling activity. While Utah ranks well behind better known oil-producing states like Texas and North Dakota, the state has participated in the shale oil boom. The bulk of the oil and gas activity there takes place in the Uinta Basin, which is in the east and northeast part of the state:

160725tesuintamap

The meeting I attended was in Duchesne, which is shown on the map just below the “Uinta Basin” title. This is an area that boomed as shale oil production ramped up, but has been hard hit due to the downturn in prices. Oil production trends in the area mirror what’s happened across the U.S.:

160725tesutahoilprod

For perspective, production next door in Colorado is presently 320,000 bpd, but Utah production ranks ahead of Montana. In his opening remarks, the state official hosting me said drilling in the state stopped back in February when oil prices dropped below $30/bbl. But now with the increase to ~$50/bbl there are four rigs in the state drilling for oil. Again, perhaps a microcosm of the country as Baker Hughes data shows an increase in drilling in the U.S. in seven of the past eight weeks.

So, activity is picking up a bit. However, most oil producers’ stocks have moved substantially higher since my previous update. (See “Squeeze Play,” from the April 20 issue.) Apache (NYSE: APA) was identified as “the best value of the group,” and has since seen its share price rise by 10%.

Today I am going to divide the top 30 oil and gas producers in the U.S. into three groups of 10, ranked by enterprise value (EV). I will only be looking at pure upstream producers, and not the large, integrated ones with refining operations.

Here are the 10 largest:

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  • EV – Enterprise Value in billions of U.S. dollars as of July 15
  • EBITDA – Earnings before interest, tax, depreciation and amortization, in billions for the trailing twelve months (TTM)
  • FQ – Fiscal quarter
  • Debt – Net debt at the end of the most recent fiscal quarter
  • FCF – Levered free cash flow in billions
  • YTD Ret – Total shareholder return (TSR), including dividends, thus far in 2016   

The average EV of this group is $36 billion, and with the exception of ConocoPhillips all have solid returns year-to-date. Even after a 30% YTD rise, Apache still looks like the most attractively-priced company on the list with a low EV/EBITDA multiple, relatively low debt, and positive free cash flow (FCF) for the past year. Concho Resources (NYSE: CXO) and Hess (NYSE: HES) are also attractively priced. On the more expensive side, Anadarko Petroleum (NYSE: APC) and Noble Energy (NYSE: NBL) both have high EV and debt multiples.

Here is the next group, again ranked by EV:

160725tesscreen2

The average size of the companies in this group is only about a third that of those in the previous group, yet the average cash flow generated is similar. Further, this group is cheaper on average, with a lower debt multiple and a better YTD return. As with the previous group only one company, Chesapeake Energy (NYSE: CHK), has failed to generate at least a double-digit return for the year.

Among this group, Antero Resources (NYSE: AR) and Encana (NYSE, TSE: ECA) have very low EV multiples, but they are also both predominantly natural gas companies. EQT (NYSE: EQT) and Cabot Oil and Gas (NYSE: COG) are both among our favorites here. They are both Best Buys, and each has generated more than 40% returns YTD. Newfield Exploration (NYSE: NFX) also looks attractively priced.

Here are the 21st through the 30th largest pure-play drillers in the U.S.:

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This group’s average EV is about half that of the previous group. It also generated about half the EBITDA, but is cheaper based on the EV/EBITDA multiple, as you might expect. Debt levels of the two groups are similar, but this group’s YTD performance lagged that of the previous groups, primarily because there were more YTD losers in this group (and one big one). Within this group, QEP Resources (NYSE: QEP) stands out as having lower than average EV and debt multiples, while generating positive FCF for the most recent quarter.

Conclusions

If I was putting together a diversified portfolio of oil and gas producers, or building an energy-themed mutual fund, there are 8 companies from these tables that I would almost certainly include. They are Apache, Concho Resources, Hess, Antero Resources, EQT, Cabot Oil and Gas, Newfield Exploration, and QEP Resources. Several of these companies are in our portfolios. I would strongly consider some others that might be a bit more expensive or have a bit more debt than the average of each peer group, such as EOG Resources (NYSE: EOG), Rice Energy (NYSE: RICE), and Devon Energy (NYSE: DVN). I would avoid those that have high EV or debt multiples, as well as those that consistently have difficulty generating positive free cash flow.

(Follow Robert Rapier on Twitter, LinkedIn, or Facebook.)

 

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