Bullish On Oil? Bet On Ecopetrol

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About: Ecopetrol S.A. (EC)
by: Ethan Wagner

Summary

Ecopetrol has demonstrated the ability to maintain margins during periods of low global oil prices.

Oil prices are projected to rise over $100 per barrel during the next few months adding to the company's revenue growth.

Compared to the industry P/E of 25.16, Ecopetrol is undervalued at its current P/E of 13.59.

As an integrated Oil & Gas company, Ecopetrol S.A. (EC) is positioned to continue outperforming competitors on an operating and profitability basis, substantially growing revenues as oil prices cross the $100/barrel level and offering industry-low levels of risk by maintaining a healthy balance sheet and diversified operational segments.

Operating Performance

The company has been able to grow its top line and bottom line significantly faster than its competitors and is better at maintaining profitability during oil bear markets.

According to FactSet (NYSE:FDS), EC has grown its refining revenues over the past quarter by 35% and overall Q2 revenues by over 27% on a YoY basis, significantly outperforming the broader energy sector at 28.09%. With the United States being Ecopetrol's second-largest buyer of crude oil, the company has been able to grow revenues in conjunction with growth and heightened demand in the United States. Solid US fundamental data and a strong US consumer will see oil demand from the US steady through the next twelve months at a minimum. This translates to revenue growth for EC without factoring in changes in oil prices.

Profitability metrics also favor EC over the industry and broader market, signifying competent management and increased operating efficiencies. The company has been able to limit EBITDA margin losses at 10% between 2011, when oil was above $100/ barrel, and 2016 when a barrel was priced at roughly $40. This signifies the company's ability to maintain profitability even in an oil rout. I see this as a result of its refining business. In market downturns, the cost of oil and inputs to refineries are reduced. This signifies a diversified business that can maintain profitability in recessionary environments and reduce risks to investors. Additionally, the cost restructuring and increased efficiencies over the past five years have resulted in steady YoY EBITDA margin increases.

Regarding Ecopetrol's operating success, the firm has been able to grow net income and earnings per share at an 83.5% 3-year CAGR (compound annual growth rate). The company's ability to generate profits and return them to shareholders can further be demonstrated by the outstanding ROE generated. At 22%, equity holders are realizing returns much greater than the S&P 500 (14.8%) and the industry (12%) in 2018.

Oil Price Outlook

Geopolitics, production outages and harder-to-reach crude will drive up prices in the coming months.

The Oil & Gas sector's earnings have a strong correlation with crude oil prices. Therefore, when analyzing an equity investment in this sector, it is important to consider the future of oil prices that drive profitability. Currently, Brent is priced at $81.29 per barrel of light, sweet crude. At this level, Ecopetrol has shown outstanding margin growth and performance. However, the company will likely see more future growth as oil prices continue to rise.

Money managers and investors alike have publicly expressed their belief that oil could reach $100 a barrel within the near future and even higher for the long term. In the short term, increased demand has driven up prices as OPEC has maintained its agreed-upon production levels and failed to adjust for U.S. sanctions on Iran. These sanctions mandate decreased oil production by Iran, one of the world's leading oil producers, which significantly subtracts from global oil supplies. Additionally, production outages in Venezuela and downsizing of the rig count in the country have dwindled their contributions to the global crude oil supply. Lastly, easily accessible U.S. shale reserves are dwindling, a catalyst likely to contribute to the rise in prices. In the longer term, demand from global growth is projected to drive prices up to ~$95/ barrel.

Experts are forecasting that within the next twelve years, crude oil producers in middle eastern countries will have exhausted their easily extracted reserves and will be drilling more expensive wells for harder-to-reach crude. Analysts project that when this occurs, the price for a barrel of oil will skyrocket to well about $120/ barrel.

Oil companies engaged in E&P operations not in the middle eastern region, in areas where it is still cheap to drill, will be the biggest winners in this scenario. Ecopetrol stands to see margins widen at this time, even when they are already beating the industry in the current oil price environment.

Debt

Ecopetrol has been able to maintain lower levels of leverage risk than the overall industry.

In a capital-intensive industry, oil & gas companies are often burdened with large sums of debt on their balance sheets and are subject to increased risk with oil price volatility. Looking at EC's balance sheet, the company has a debt-to-capital ratio of .45, which is significantly lower than the industry. Its quick ratio is 1.09 as well, increasing in conjunction with decreased leverage and increasing cash flows from operations. Ecopetrol's decreased risk of insolvency when compared to peers mitigates risks associated with oil price volatility and makes the company in an attractive risk-off position for investors wanting to maintain oil & gas exposure.

Valuation

With share prices rising by over 160% over the past year, this company has outperformed all competitors and the S&P 500 significantly.

After all of this overperformance, shares of EC are still cheap. On a price-to-earnings basis, EC is trading at 13.59. This is well below the industry average of 25.16 and the S&P 500 at 22.28. On a price-to-cash flow basis, EC is trading at 7.45, again below the industry average of 8.35.

Summary

For the reasons outlined above, Ecopetrol SA is an attractive addition to investors' portfolios from an operating perspective and a viable strategy for betting on sustained global growth and rising oil prices. Ecopetrol is beating its competition in revenue growth, margins, profitability and stock performance. The macroeconomic environment is favorable for both oil prices and EC, paving the way for continued outperformance in the future. With all fundamentals favoring future growth in Ecopetrol's shares, the company is trading at a significant discount across multiple metrics. I suggest investors buy EC and add shares to portfolios.

Disclosure: I am/we are long EC.

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.