Deeply Undervalued And Well Positioned

Summary

• Eni trades at a 60-70% discount from its peers based on an EV/EBIT valuation. Multiple expansion would help close the gap.
• Cash Flow from Operations increased 22%, while Adjusted EBIT increased 47% year over year in Q1.
• Eni has a portfolio of projects planned for the 2018-2021 year period with a break-even below $30/bbl and production growth of 3.5%.
• Eni's high sensitivity to Brent pricing and refining efficiencies outweigh the potential negative impact of exchange rate risk.

Eni SPA (NYSE:E) the energy giant remains a buy after reporting strong Q1 results on April 27th. The company posted solid operational results and remains an excellent buying opportunity even with the price running up from $34 to $39 per share.

Eni's share price has muddled along for since oil retreated in late 2014, their ADR shares on the NYSE have mostly traded in the low 30s and occasionally dropping below 30. I expect the recent price run-up to continue as oil prices inch higher and the company continues to execute.

Income Valuation

Eni is cheap. The stock is trading at a low valuation. It is one of few excellent opportunities in the market. By EV to EBIT (TTM), Eni is barely the second cheapest of the world's largest oil producers. Only Lukoil (OTC:LUKOY) has a lower EV to EBIT. Over half of Eni's hydrocarbon production comes from Egypt, North Africa, Kazakhstan, and the Rest of Asia. If OPEC decides to turn the taps on, or if higher oil prices cause discontent and greed among members, Eni will be competing geographically against both the Middle East and Russia; not a pretty scenario. It is against OPEC's collective interest to tank oil markets, but the risk is very real.

I prefer using EV to EBIT as it values not just the company's equity but represents the price of the business as a whole. EBIT considers depreciation, a major real business expense for Eni. EV to EBIT is a great valuation metric when companies that do not have the same capital structure. It is amazing how little investors value Eni. The company trades at a 60% discount to Royal Dutch Shell (RDS.A) and a 69% discount to BP (BP) and an even greater discount when compared with Exxon Mobil (XOM).

E EV to EBIT (TTM) data by YCharts

The cherry on top of it all; adjusted EBIT increased 47% year over year in Q1. The increased EBIT does lower their EV/EBIT, but, to me, it implies their enterprise value should increase to reflect the increase in profitability, which has yet to happen. Eni shareholders have the potential to reap rewards from both multiple expansion and growing profits.

Operating Profit And Cash Flow From Operations

Eni's business performance is tied to the price of oil and market forces for the commodity. Eni experiences cyclical results as noticed from their dismal 2015 profits. With oil back on even footing, Eni will experience robust profitability in 2018.

Data per ADR ($)	2017	2016	2015	2014	2013
Operating profit (loss):	5.03	1.33	-1.9	6.59	7.59
Net profit (loss) attributable to Eni basic and diluted	2.12	-0.9	-5.41	0.96	3.9

Click to enlarge

Eni has turned the corner since the 2014-2016 slump. The Company will produce strong results with barrel pricing above $60 and mediocre results in the $50-60 range. I expect operating profit to increase in 2018 from 2017 assuming a stable Euro/USD exchange rate.

Eni's cash flow from operations increased 22% year over year pre-working capital costs in Q1, which I see as a good indicator fortune for the next quarter. The increase is due mainly to two factors Brent Crude pricing and the Euro/USD exchange rate which will be discussed later.

Production And Capital Expenditures

Production in the first quarter averaged 1,867 kboed a 4.4% increase year over year. Expect to see a 4% growth rate in 2018 full year production.

"The increase in production will be supported by the growth of existing projects, the launch of new projects and optimization interventions that will contribute in total to about 900 thousand barrels of oil equivalent a day (boed) in 2021." Claudio Descalzi, Eni CEO

Eni's upstream hydrocarbon production is expected to 3.5% a year over the 2018-2021 period with a broad portfolio of new conventional projects with a break-even of less than $30/barrel.

Eni is planning on spending less than 8 billion Euro ($9.6 billion) per year on capital expenditures in their strategic 2018-2021 period, slightly less than past years. Of Eni's planned capital expenditures, 80% will be upstream focusing on high-value projects with rapid returns. Eni's capital expenditures averaged 9.53 billion Euro ($11.46 billion) from 2015 to 2017. The reduction in capex alone will increase their free cash flow by 1.5 billion Euro ($1.8 billion) per year for the next four years. 2018 capital expenditures are an estimated 7.7 billion Euro ($9.24 billion). Expect to see free cash flow making its way to shareholders via increased dividends and small leverage ratio.

Reward Outweighs Risk

The sensitivity to Brent Crude makes Eni an attractive play if oil doesn't experience another major contraction. For the next few years, it is possible for Eni to experience record profits with Brent ranging from $60 to $70 per barrel.

Below is a sensitivity factors analysis from Eni's website.

Sensitivity*	Adjusted EBIT (€ mln)	Net Income Adjusted (€ mln)	Free Cash Flow (€ mln)
Brent (+1 $/bl)	310	175	205
Standard Eni Refining Margin (+1 $/bl)	160	115	160
$/€ Exchange Rate (+0.05 $/€)	-310	-120	-200

Click to enlarge

Eni's management is expecting the current pricing to remain the trend over the next four years.

Brent price scenario of 60$/BBL in 2018 and a gradual recovery in the subsequent years up to our long-term case of 72$/BBL in 2021 and going forwards." (Eni's 2017 Form 20-F, Business Overview, Exploration and Production, April 6th, 2018)

I prefer to be conservative and believe that forecasting prices that far out is too prone to error. I could envision the status quo to continue, oil averaging in the $55-70 per barrel range for the next few years. At the higher end of the range, price runs the risk of collapsing again as producers get greedy. It could be something as simple as self-interest that could shake OPEC members causing one of the major producers to increase production. How much can Russia and Saudi Arabia be trusted to act for the collective's interest instead of their own? US swing shale gas producers will help to cap the upside of oil prices.

Since 2013, Eni has halved its refining break-even bringing it down to less than $4/bbl in 2017. Eni is expected to bring down its break-even to $3/bbl by the end of the year, another factor that will improve its bottom line.

The strong showing of the Euro against the USD in 2017 significantly boosted Eni's ADR performance. The ADR's performance is highly sensitive to exchange rate risk. Strengthening of the USD will hurt ADR holders, but its effects' profitability will be outweighed by stronger Brent Crude prices.

Conclusion

Eni is experiencing a nearly perfect force of tailwinds and trades for less than half the price as it's peers. The company is currently deeply undervalued. Management has positioned the company to perform well in the future by taking on a portfolio of new projects with a break-even of less than $30/bbl and increased production at a moderate rate. Eni's profitability is highly sensitive to Brent pricing, with sustained pricing above $60 per barrel Eni's bottom line will grow. The compounding impact of increased production, higher/sustained oil prices and refining efficiencies could bring record years for Eni in the 2018-2021 period.

Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.

Analyst’s Disclosure: I am/we are long E. 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.