Equinor: Focus On CSR Still Delivers High Return On Capital

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About: Equinor ASA (EQNR)
by: Tudor Invest Holdings
Summary

Equinor is leading the way in the transformation from a hydrocarbon-based energy provider to a more environmentally sustainable provider.

Despite paying large parts of their earnings in taxes, shareholders are also well taken care of.

Their corporate social responsibility will attract investment from large funds.

Investment Thesis

In the past, investors generally focused less on CSR (Corporate Social Responsibility), and more on maximizing profits. However, there are big changes taking place, as the world’s largest asset managers have over the last few months made it very clear, that CSR will be one cornerstone in their investment decision process.

Larry Fink of BlackRock (BLK), in his 2018 letter to CEOs made this very clear. Norway’s SWF, also the world’s largest, last week announced that they would exit oil & gas exploration stocks. In the short term, this may put some pressure on prices, but the long-term outcome should be more engagement by the industry in order to comply and excel in the reduction of harmful consequences to the environment.

Equinor (EQNR) of Norway is a class leader in the implementation and development of activities which limits their environmental impact.

Does this mean the company is less profitable?

Latest Financial Results

On 6th of February 2019, EQNR presented their 4th quarter and full year results. Like most of their peers results were positive.

The group’s profit for the last quarter came in at $4.39 billion before taxes. This was 10.9% higher than the 4th quarter of 2017. However, after taxes, the profit shrank to just $1.54 billion. In other words, $2.8 billion was paid in taxes over the last quarter. This gives an effective tax rate of 64.9%, and must surely be the highest tax rate of any oil and energy company.

On the debt side, throughout 2018, EQNR managed to reduce net debt to equity ratio from 29% to as low as 22.2%.

Their organic free cash flow for 2018 was $6.3 billion, after taking into account paying out $2.67 billion in a dividend.

It is also worth noting that all the cost-cutting which has been taking place since 2014 have brought down break-even prices tremendously. Examples such as digitization and standardization have helped to bring down their operating costs. They have also negotiated much lower prices from their suppliers. This has also left many suppliers with very low (single-digit) margins. Consulting firm EY has just conducted research amongst 1,119 companies serving companies in the North Continental Sector. On aggregate, their profit margin was only 2 to 3% last year. If the demand for suppliers services were to return to the level seen before, I would expect some of EQNR’s savings might get clawed back from suppliers.

Benchmarking

During their annual investor presentation in London, one question from an analyst came up with regard to EQNR’s benchmarking. EQNR has chosen to benchmark their performance amongst Anadarko (NYSE:APC), Eni (NYSE:E), BP BP), Shell (NYSE:RDS.A) (NYSE:RDS.B), ConocoPhillips (NYSE:COP), Repsol (OTCQX:REPYF), Chevron (NYSE:CVX), Total (NYSE:TOT), Exxon Mobil (NYSE:XOM), OMV (OTCPK:OMVJF) and Marathon (NYSE:MRO).

In terms of Return on Average Capital Employed (RoACE), EQNR is second best in class.

Return on average capital employed (ROACE) is 12% and expected to grow to more than 14% by 2021. If we look at Total Shareholder Return (TSR), they claim to be best in class. One could in fairness say that EQNR is not in the same league as Shell and Exxon Mobil due to its much smaller size.

Therefore, to expect companies with four to five times larger revenue to garner the same return on capital might be unrealistic. Nevertheless, they choose to benchmark against them, so will do the same.

Source: Equinor

I have looked at how EQNR stack up against their peers, in terms of their Net Profit Margin, and also how much debt they have in relation to their annual EBITDA. Source: Tudor Investment (figures are all USD and in billion)

Replenishing reserves

EQNR have been busy replenishing their reserves. They started 2018 with 19 billion BOE (barrels oil equivalence) in total reserves. Last year saw them adding around 1.6 billion new barrels to their reserves. Their reserves-to-production ratio is now 8.7 years.

Furthermore, they have started off 2019 by being awarded 29 of the 83 new licenses the Government of Norway offered at the mature oil fields in the North Sea in January this year.

According to EQNR Head of Norwegian Continental Shelf, Arne Sigve Nylund, the company will drill as many as 3,000 wells within the next 20 years. This is almost as many wells to be drilled as what they drilled in the previous 40 years. All this should bode well for offshore drillers such as Seadrill (SDRL) and Transocean (RIG), which have the required harsh environment drilling rigs which are required at NCS. That market has, in fact, recovered fairly well as there is a limited supply of such rigs. Fellow author Vladimir Zernov has just published an article on this topic. Should the dayrates increase further it would increase the cost of exploration for EQNR.

A gradual shift to more renewable energy

EQNR is successfully growing its renewable portfolio. Based on such projects they have in hand, they are able to generate about 1.3 gigawatts electricity from renewables. Traditionally, wind farms at sea were only feasible where the water depth was shallow enough to fix the windmill to the seabed. However, EQNR has now come up with a solution that offers floating wind farms. This means they can be placed in deeper water. Apparently, they are the first to introduce this technology.

Source: EQNR

Back in 2016, EQNR won a U.S. federal auction to lease 80,000 acres off Long Island shores with a purpose to build an offshore wind park there. They believe this wind park can produce as much as 2,000-megawatt electricity for New York. The first phase should produce at least 800 megawatts. New York is expected to choose a supplier in the spring.

EQNR expects to allocate between 15% to 20% of their capital expenditures to new energy solutions by 2030, providing the projects meet their required return on capital.

At this week’s annual energy conference in Houston, CEO Eldar Saetre said that the industry should promote more transparency and public engagement with regard to their action to improve on climate changes. He pointed to EQNR's leading position in this field, having roughly half the carbon dioxide emissions on average compared to their peers.

Conclusion

EQNR is at the forefront in terms of applying new technology and improving operations to literally squeeze out more oil and gas from each well. Importantly, they also do this through the lowest environmental impact in the industry.

They have built up a very attractive portfolio of assets with average break-even costs below $50 per barrel, putting them in a position to be ready for volatile prices in the oil and gas industry. At $70, they expect to deliver around $14 billion in free cash flow after investments and after dividend.

On the topic of dividend, they are confident in the sustainability of their business going forward, and this is the reason they increased the quarterly cash dividend by 13% to $0.26 per share. I believe they will also be in a position to continue to grow the dividend, providing we do not get any large drop in oil and gas prices.

Possible Risks and challenges are two-fold in my opinion. Should the price of Brent go down considerably, like $40 to $50 level, all predictions will go out the window. This is not likely but could occur if large exporters decide to dump the market with excess supply. A more plausible risk to lower earnings, is as I have already stated above, that costs will increase faster then EQNR budget for.

Nevertheless, all in all, I believe EQNR is a good investment. They have proved that it makes financial sense to focus on CSR, and in the process develop technological solutions which can benefit many, and also add value to shareholders.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.