Very few energy companies can claim to be more successful at finding oil in 2013 than Eni SpA (NYSE:E). The Italian energy giant, which is 30% owned by the government, has made some of the biggest oil and gas discoveries this year in Africa, Europe and Asia but in the last 52 weeks, due to its own inefficiencies and the problems with its oilfield services subsidiary Saipem SpA, its ADR has been up just 4.28%. Several analysts have identified (such as here), that Eni is undervalued as compared to its peers like Total (NYSE:TOT) and Royal Dutch Shell (NYSE:RDS.A). I believe that its undervaluation is justified and the company will continue to underperform in the coming quarters.
In 2013 alone, Eni has confirmed 11 discoveries representing a total of nearly a billion barrels of oil equivalents. Some of the bigger ones have been in Ghana, Pakistan, Egypt and Mozambique. More recently, Eni hit a massive 717 million barrels oil equivalent deposit in offshore Congo at the Marine XII Block. The company is the operator of the bloc and holds a 65% stake. It plans to drill in Vietnam, Norway, Australia and the Gulf of Mexico in the near future.
Exposure to The Developing World
While Eni's discoveries are impressive in terms of their size, most of them are in the relatively volatile regions of the world. The company has significant exposure to the developing world, particularly Africa, from which it gets 55% of its annual production.
Eni has been operating fairly smoothly in Pakistan but it has frequently reported production drops in Africa. In Libya, Eni lost nearly 20,000 barrels per day in the first half of the current year due to security issues and disruptions. Moreover, the situation hasn't improved so I wouldn't be surprised if Eni continues to report production losses in Libya in the coming quarters. Similarly in Nigeria, Eni lost nearly 30,000 barrels of oil per day in the same period due to "flooding, bunkering and sabotage."
There are risks (as well as rewards) associated with operating in the developing part of the world, particularly the security issues, and the problem is usually of a long-term nature. I believe that the market has factored in those risks, which is why its stock has underperformed in the past and might not shine in the future if it reports more oil discoveries in these regions.
Eni is also significantly exposed to the "extremely weak" market of Italy and "just weak" market of Europe. Italy is currently going through a recession with record unemployment levels of 12.2%. Moreover, the situation is getting worse. For instance, in Italy, quarterly consumption of gas fell 11% from last year due to a 30% drop in gas demand for electricity generation. This represents a total 49% drop since the mid-2008 levels.
Similarly, the demand for refined products in Italy also continues to fall and is down 26% since 2008. There are not going to be any improvements in the coming months and the situation will remain challenging.
Eni has received a lot of negative publicity due to the ongoing investigations by European and U.S regulators into several activities of Eni and its subsidiaries in Libya, Kazakhstan, Kuwait and Iraq. Its subsidiary Saipem is being investigated over corruption charges related to its activities in Algeria.
Eni owns 43% of non-controlling stake in Saipem. Earlier in July, Saipem reported a massive Q2 net loss of $910 million and is expecting an annual loss for the current fiscal year of more than $310 million. Saipem is facing political challenges in the developing world (Algeria) and rising costs in the developed world (Canada). Saipem contributes less than 10% to Eni's bottom line but with mounting losses coming from operational failures, litigation costs, fines and penalties, Saipem is going to drag on Eni's earnings in the future.
Based on data provided by Financial Times, in the last three quarters, Eni has failed to meet the market's consensus earnings and revenue estimates - although it did manage to touch the low-end of earnings expectations. In its most recent results announced earlier this month, Eni's adjusted income plummeted by 55% to $768.15 million, missing the market's expectations by $169.37 million. The poor performance was due to the reasons discussed earlier - problems in Europe and Africa and Saipem's massive loss. Its production dropped slightly from 1.656 million barrels of oil in the same quarter last year to 1.648 million barrels. But the company is expecting "significant improvements" in the second half - this caused a 3.3% gain in its stock at Milan.
Eni has significant exposure to the volatile regions of Africa and the recession-hit economies of Europe. It is one of those companies that have mostly met the low end of market's expectations; therefore, its stock has never really shined.
Eni has also generated significantly lower return on equity, or ROE, than its rivals. While on one hand, both Total and Shell have generated ROE of more than 13%, Eni's came in at just 3.67%.
So far this year, its shares are down 5.33% -- which makes it better than Shell, which is down 6.57%. Total has been up 7.42% in the same period. Eni has one of the lowest EV-to-EBITDA ratio among its peer group but due to reasons explained above, I believe that it will remain undervalued in the future.
Sources: Relevant links provided in the article. All other data has been taken from Eni's Q2-2013 conference call transcript (Pdf version available here), Yahoo Finance and Thomson Reuters.