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Finding, producing and selling oil used to be a relatively easy process akin to sticking a pipe with a pump attached into the ground. In some regions (Iraq) it is still as easy as this but resource nationalization across the globe has shut the gates to cheap oil production for international producers and majors such as Royal Dutch Shell (RDS.A) (RDS.B), Exxon Mobil (XOM), Chevron (CVX), Total SA (TOT) and ConocoPhillips (COP) have been driven the ends of the earth (literally) to search for the world's remaining oil reserves.

Unfortunately, this requires larger, more complex, capital intensive projects that are rarely delivered on time and on budget. According to Schlumberger (NYSE:SLB), the oil services group, annual capital spending for the industry has more than tripled in the past 10 years, reaching $550bn in 2011. Moreover, a recent study by Independent Project Analysis revealed that the average big exploration and production project is 22% late and 25% over budget.

Indeed, the world's top seven international oil & gas companies, most of which are listed above, have increased their development capital expenditure by 255% over the last ten years, yet last year the average reserve replacement ratio fell to 92% - 92% of the year's production was replaced with new reserves.

The scale of the decline in production but rise in spending became clear at the end of the second quarter, when the majority of the majors results came in below target and cash flows seemed to be under significant pressure:

Exxon

Exxon's size has not been its savior and like the rest of its peer group, the company has suffered attrition as spending rises and the amount of oil that it pumps stagnates.

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

10-Yr Average

TTM

Difference

Return on Equity %

23.9

24.9

32.5

34.7

33.4

40

17.4

20.7

26.6

27.1

28.12

21.50

-23.54%

Return on Assets %

12.3

13

17.3

18

16.8

19.8

8.3

10.1

12.4

13.4

14.14

10.70

-24.33%

The company's return-on-equity has averaged 28.1% for the last ten years but variance has been high - with a low of 20.7% and a high of 40%. Over the last 12-months the company's return-on-equity was 21.5%, a 23.5% discount to the 10-Yr average. However, this figure is still with the 21%-40% range seen over the past ten years.

A more telling figure is return-on-assets, which stands at 10.7% for the last twelve months. This number is 24.3% below the 10-Yr average and at the low end of the range for the 10-Yr period.


(Click to enlarge)

Exxon also saw free cash flow plunge during the last quarter as CAPEX exceeded cash inflow from operations. As shown below, the company's cash conversion ratio collapsed as well.

10-Yr Average

Jun-12

Sep-12

Dec-12

Mar-13

Jun-13

Cash Conversion Ratio

75.53%

11.77%

56.59%

31.83%

64.19%

-14.11%

Exxon's cash conversion ratio was negative during Q2. In fact, this is the first time the ratio has been negative during the past ten years. Moreover, the table below shows the strain that the heavy spending and deteriorating returns are having on the company's balance sheet.


(Click to enlarge)

Exxon has issued more debt to fund operations during the last two quarters than it has done during the entirety of the last decade! Still, the company's debt to asset ratio only stands at 5.6%.

Chevron

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

10-Yr Average

TTM

Difference

Return on Equity %

19.90

29.50

22.50

24.90

24.20

27.60

11.40

18.10

22.20

19.20

21.95

17.50

-20.27%

Return on Assets %

8.90

14.30

11.20

12.90

12.60

14.80

6.40

10.30

12.80

11.20

11.54

10.20

-11.61%

Chevron's TTM return-on-equity and return-on-asset ratios are actually the lowest that the company has achieved during the past ten years, apart from 2009 when the whole industry had to grapple with lower than average oil prices due the financial crisis.

Chevron's cash flows have been under pressure as the company has ramped up spending to drive output. However, according to the declining ratio figures shown in the table above it would appear that this extra spending is going to waste.


(Click to enlarge)

10-Yr Average

Jun-12

Sep-12

Dec-12

Mar-13

Jun-13

Cash Conversion Ratio

52.53%

39.50%

4.57%

31.66%

-40.11%

-0.99%

Like Exxon, Chevron's debt issuance in the past two quarters has exceed the total debt issuance during the last decade.


(Click to enlarge)

Ringing debt and falling cash conversion has led some analysts to question Chevron's ability to continue its sector leading shareholder returns (Q2 conference call). However, with a debt-to-asset ratio of only 8.2%, I doubt investor payouts will come under pressure anytime soon. Indeed, the company is still in a net cash position (end of Q2).

Royal Dutch Shell

Shell's figures are actually more concerning than those of both Exxon and Chevron. The company's trailing-twelve-month return-on-assets and return-on-equity figures are almost the lowest the company has been able to achieve during the past ten years.

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

10-Yr Average

TTM

Difference

Return on Equity %

16.4

21.6

27.8

24.1

25.3

20.6

9.2

13.6

18.2

14.1

19.09

12.90

-32.43%

Return on Assets %

7.4

9.5

11.5

10.8

11.6

9.3

4.3

6.2

9

7.4

8.70

6.70

-22.99%

Brent Crude Average Price (Barrel)

$30

$40

$50

$60

$80

$50

$55

$75

$105

$105

$110

To highlight the scale of Shell's problem, the company's returns can be compared to the average price of Brent for the period. During 2009 and 2010 when the company's return-on-asset and return-on-equity were below the TTM figure, the price of Brent was more than 30% below where it has been for the same period this year. So, despite the price of Brent rising, Shell is still achieving lower returns.


(Click to enlarge)

Having said all of that, Shell's free cash flow remains positive and cash conversion is pushing over 100% during some periods.

10-Yr Average

Jun-12

Sep-12

Dec-12

Mar-13

Jun-13

Cash Conversion Ratio

29.09%

154.37%

14.99%

-11.41%

45.22%

199.02%

… and unlike Exxon and Chevron, Shell is actually paying down debt. Nonetheless, Shell has one of the net-debt-to-asset ratios in this group, currently standing at 4.6%.


(Click to enlarge)

Total

French major, Total sits in the same position as Shell, returns are falling while the price of Brent is rising. In fact, this could easily be more of a European factor.

Indeed, both Total and Shell are heavily involved in refining in Europe, an industry which has seen profit margins shrink to almost nothing in recent years. Philips 66 is cutting its European refining operations.

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

10-Yr Average

TTM

Difference

Return on Equity %

16.4

21.6

27.8

24.1

25.3

20.6

9.2

13.6

18.2

14.1

19.09

13.00

-31.90%

Return on Assets %

7.4

9.5

11.5

10.8

11.6

9.3

4.3

6.2

9

7.4

8.70

5.60

-35.63%


(Click to enlarge)

While returns have been contracting, Total's free cash flow has steadily and consistently declined.

10-Yr Average

Jun-12

Sep-12

Dec-12

Mar-13

Jun-13

Cash Conversion Ratio

46.61%

128.62%

21.24%

-7.40%

-77.74%

-60.16%

Nonetheless, despite falling cash inflows, Total, which offers a 5.5% dividend yield does not appear to be feeling the pressure. In particular, the company has been forced to issue debt to bolster cash flows, finance CAPEX and pay the quarterly $1.3 billion aggregate dividend. However, debt-to-assets has remained stationary as a ratio, albeit one of the highest in the sector.


(Click to enlarge)

ConocoPhillips

It is hard to compared concoct before the spin-off of Philips 66 however, the current benefits from the spin-off can easily be seen in rising margins and returns.

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

10-Yr Average

TTM

Difference

Return on Equity %

13.8

19

25.8

18.8

13.4

-30.8

7.8

16.6

19.1

17.6

12.11

15.40

27.17%

Return on Assets %

5.7

8.8

12.7

9.4

6.7

-11.9

3.2

7.3

8.1

7.2

5.72

6.40

11.89%

While not in the same vein as the rest of this article, it would appear that Conoco's returns have grown rapidly after the spin-off, although more data is required to draw a suitable conclusion as to whether or not Conoco is suffering the same attrition as the rest of its peers.


(Click to enlarge)

Having said that, rising margins from the spin-off have meant that Conoco has been able to pay down historic debt at a rapid rate.


(Click to enlarge)

Valuations

Falling returns and rising CAPEX budgets have spooked some investors, depressing valuations. For those investors who believe that any weakness in the oil majors is a good opportunity to buy, this could be the opportunity of the decade. Indeed, with debt levels at such low levels, despite recent issuance there is still possibility for these majors to be able to buy growth, especially in the now, highly lucrative US oil market.

Exxon Mobil

10-Yr Average

Current

Discount/Premium

Stock Price

$87.25

TTM P/E

13.23

8.99

-47.10%

TTM P/S

1.15

0.84

-26.94%

Book Value

$37.40

TTM P/B

3.58

2.43

-47.04%

At a current stock price of $87.25, Exxon's price-to-earnings ratio is 47% below its historic 10-Yr average and the company's price-to-book valuation presents the same kind of discount.

Chevron

10-Yr Average

Current

Discount/Premium

Stock Price

$121.20

TTM P/E

11.00

9.10

-20.89%

TTM P/S

0.85

1.00

17.02%

Book Value

$74.34

TTM P/B

2.31

1.63

-42.00%

Chevron's discount to historic valuations is not as large but on a price-to-earnings and price-to-book basis the company still trades significantly below its 10-Yr average. That said, on a price-to-sales basis the company looks expensive.

Royal Dutch Shell

10-Yr Average

Current

Discount/Premium

Stock Price

$67.50

TTM P/E

9.17

7.96

-15.14%

TTM P/S

0.58

0.44

-25.07%

Book Value

$56.00

TTM P/B

1.69

1.12

-50.22%

Shell offers a discount to 10-Yr averages on both a price-to-earnings and price-to-sales basis. In addition, the company trades at the lowest price-to-book (1.1) value of the group, which indicates to me that the company is potentially one of the most undervalued companies of the four. Indeed, the company trades at a 40% discount the sector average price-to-sales ratio of 0.7.

Total SA

10-Yr Average

Current

Discount/Premium

Stock Price

$55.60

TTM P/E

10.41

8.95

-16.22%

TTM P/S

0.81

0.52

-34.98%

Book Value

$41.90

TTM P/B

2.52

1.33

-89.86%

On a price-to-book basis, Total offers the largest discount to its 10-Yr average, although it is not as cheap on an absolute basis compared to Shell. Still, all other valuations are below their 10-Yr averages so the company appears cheap on many ratios.

Conclusion

All in all, big international oil is suffering from falling returns despite rising spending as the search for oil becomes tougher. That said, with very low gearing ratios and general levels of debt, it is entirely possible that these majors will be able to buy themselves growth from independent producers within the US, Middle East or Africa.

Whichever way you view the situation, right now, big oil is cheaper than it has been at-all during the past decade after considering the price of Brent and rising demand for oil from Asia.

Note: I have not included BP (BP) in this analysis as the company faces an uncertain future due to its liabilities regarding Macondo. In addition, the company's figures have been somewhat distorted recently by higher than average oil-trading income and asset disposals.

Disclosure: I am long RDS.B. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. My long position in RDS.B is through derivative CFD's