Alexander may have thought he was having a bad day, but it was nothing compared to what long term, buy and hold E&P investors have seemingly endured on an almost daily basis for quite a while. Several media articles have appeared recently describing the “unmitigated disaster” the past 10 years have been, and certainly there are many SA readers who can vouch for that.
I normally provide some of the most recent financial and reserve figures for the industry, as well as the stock performance for the YTD, and in this version will expand upon that where stock price performance is concerned. I will caution readers upfront that, with as many numbers as are included for the full table of 70+ companies that follows, there will undoubtedly be errors and possibly differing interpretations of the data, but I have obtained the data from public and private data providers that I consider reliable, and tried to check for major errors. No specific stock recommendations are made by me in this article, and readers are advised to conduct their own research before making any investment decision based on their own criteria.
The picture below is a pretty accurate snapshot of the E&P equity markets in '19 (as well as other recent periods):
Source: Getty Images
I thought about trying to claim the fish were "trading sardines," but I figured most readers would immediately recognize them as salmon swimming upstream.
In the table below, Columns D-J show returns for the 1, 3, 5- and 10-year periods ending 6/30 … corresponding to what most sources would call the “shale era.” I have gone through and highlighted the “top performers” in each period in green and the “bottom performers” in red. Companies highlighted in yellow are those which began trading sometime during the past 10 years. I decided to put “top” in quotes because, as you will see, over some periods the top performers still had a negative return (see, for example, the 1- and 5-year returns). Returns do not include dividends, just stock price changes. The “---” designation means that a company was not trading for the applicable period
June 30, 2014 essentially marked the cycle top for oil prices and a major top for E&P equities, and June 30 has been a fairly ominous day throughout the past 10-11 years. Only Diamondback Energy (FANG) has posted a positive stock price return over the past 5 years among the independents, so obviously you see a lot of red numbers for the period. Of course, including the companies that went bankrupt during the period would only increase that result; I have separated them because their current trading does not correspond to trading prior to bankruptcy, and recent results would effectively represent how much former creditors have lost as new shareholders post-bankruptcy.
From the 5-year list, Anadarko (APC0, Concho (CXO), Conoco (COP), EOG (EOG), Hess (HES) and Pioneer (PXD) appear more frequently than others in the top performer list, reflecting their status as institutional favorites. You can pretty much take your pick as to which companies’ stocks performed the poorest.
Recent media articles have picked up on a speech, the transcript of which appears here, given by the former chairman of EQT, in which he referred to the “unmitigated disaster” that shale company investors have faced over 10 years. He was referring to the bigger natural gas producers in the Marcellus/Utica, but readers have extrapolated that to include all producers from shale plays. Although that might also not be a bad overall conclusion, Column J shows that companies like PXD +493%, Callon (CPE) +303%, CXO +264%, Continental (CLR) +207%, EOG +107% and PDC Energy (PDC) +119% all managed to post stock price returns greater than 100% during that 10 year period.
As indicated above, the yearly “anniversary date” of 6/30 happens to fall on a particularly negative time of year, at least based on the past several years. Buy and hold investors have certainly borne the brunt of the extended down market … the “lower for longer” period of the past 10+ years. However, since so many Seeking Alpha readers are not strictly buy and hold investors, I also decided to divide up the past 20 year period into various “swing” or trend periods, as follows:
(1) from 7/99- 7/08 (Column K),
(2) 7/08-1/09 (Column L),
(3) 1/09-7/14 Column M),
(4) 7/14-2/16 (Column O),
(5) 2/16-12/16 (Column P),
(6) 12/16-7/17 (Column Q),
(7) 7/17-9/18 (Column R),
(8) 9/18-7/19 (Column S) and
(9) 7/99- 7/19 (Column T); (i.e. a 20 year period).
Trend watchers should be able to easily identify the trend from 7/99- 7/08 (Column K) as a particularly strong period for E&P investors, with oil prices rising due to Chinese and other developing countries’ demand, as well as natural price rises due to an expected shortage of long-term reserves/supply. During this time, 9 companies had stock price increases exceeding 1,000%. Unfortunately, the Great Recession of ’08-’09 (Column L) took a good part of that increase away. Still, the shift away from natural gas to oil and liquids-rich shale plays from ’09-’14 (Column M), with 9 companies posting returns of 400% or better. The cycle high in ’14 and the resulting battle for market share by OPEC resulted in another sharp selloff, which lasted until a cycle low in early ’16 (Column N). Two subsequent swings upward (Columns O and Q) have led to two swings lower (P and R).
Possibly a surprise to many readers, Column S shows that returns since ’99 have been positive for almost all E&P companies that existed for the entire period, although certainly not anything to write home about (with the possible exceptions of COG, EOG and PXD). That prior run allowed those companies to better withstand a lower price environment compared to the companies who only started trading in the past 10 years (the companies highlighted in yellow).
[Note: The tables are best viewed by opening up the image in a new tab and zooming in or out for ease of reading and/or printing]
Sources: OilandGas360, Seeking Alpha, Yahoo Finance, company websites, author
Rather than go through and discuss how one company’s returns might relate to another company’s, the real point of the exercise is to show that, at least over the past 10-20 years, there are times when it has been good to be an investor/trader in E&P stocks, and other times when it paid to move to the sidelines … or short stocks, for those so inclined. Despite the fact that circumstances change, investor sentiment even in days where algorithms and high frequency trading rule remains somewhat consistent, in that stocks tend to “over-react” in one direction or another, then move in the counter direction. Nimble traders (or even investors) recognize this and avoid the urge to simply buy and hold E&P stocks forever, at least for the most part. Even during my career, several of my colleagues and I would shake our heads at the swings and volatility in the E&P sector as an indication that “renting” (trading) was often much better than “owning” (investing long term) in such companies. Investors in the major, integrated companies and those that pay decent dividends may disagree, but I have always focused on companies that are seeking growth as well as income, with growth in shareholder value being the best metric for performance.
Company Financial and Operational Metrics
The following chart is pretty densely packed with data relating to companies in the E&P sector. It effectively serves as my “cheat sheet” heading into earnings season, something that allows me to compare reported results to existing metrics to gauge the impact of any changes from what may have been reported or guided to so far this year. I tend to ignore 1Q results as not being particularly representative of the full year, but by the time 2Q results are announced, things are pretty well-established, operationally as well as financially. So, I will update and expand upon these figures once 2Q earnings have been released.
The table is somewhat of a “Frankensheet,” as the data is taken from several different sources. As a result, there may be errors or inconsistencies, most of which will become apparent when 2Q numbers come out, if not before that when readers may readily point them out. For high-level screening of 70+ companies, though, it serves its purpose for me, and does contain some of the more important metrics that analysts and investors will update and focus on.
As a final note, one reason I feel particularly comfortable using this screen is that I do not expect 2Q results to be very positive, nor do I expect investors’ reactions to forward guidance to be any better. I would rather lose out on an opportunity than lose real capital, so I am content to wait for better market action before wading in again … something I have not done for over a year now, for reasons that I have expressed before and consistent with the direction of the data in the above chart.
The following metrics are captured in the table:
Enterprise Values (Debt + Market Cap), as well as Debt as a % of Enterprise Value (Column W). These are key metrics that investors should focus on, because they can indicate whether the market considers companies too highly leveraged. I used the same convention of highlighting top companies in green and bottom performers in red to illustrate; companies like Ultra Petroleum (UPL), Alta Mesa (AMR), Halcon (HK) and Rosehill (ROSE) all sport ratios of > 90% leverage, although at some point I will check on the ROSE figures. Computer programs that “scrape” data from public sources can sometimes come up with funky results, which is why when I delve into more detail, I prepare my own numbers. Antero (AR), Approach (AREX), California Resources (CRC) and Chesapeake (CHK) were not far behind at >75% leveraged … all as of 3/31/19. Market caps can change daily based on market perceptions, so are not conclusive measures of equity value.
Readers looking for the least leveraged companies may look at Cabot (COG), Concho (CXO), Conoco (COP), Diamondback (FANG) and Hess (HES). Still wonder why these continue to attract the most institutional interest? Bonanza Creek (BCEI), Riviera (OTCQX:RVRA) and Sandridge (SD), all formerly bankrupt companies, also possess low leverage now, but the quality of their assets may not be premium.
Liquidity: E&P companies usually do not fail for lack of reserves, or high debt levels alone, or lack of cash flow; they fail because they cannot survive a liquidity crisis. Columns X-Y detail each company’s current liquidity position (usually availability of debt under their revolving loan facility), and express that liquidity as a % of the total debt outstanding. Companies with a greater % of liquidity to pay debt as it comes due, in conjunction with cash flow, have more flexibility not only to withstand periods of low prices, but the ability to use that liquidity for growth purposes. As expected, the companies with the least amount of liquidity, like EP Energy (EPE), Alta Mesa, Halcon, Roan (ROAN) and Sanchez (OTCPK:SNEC) are severely distressed.
Many of the formerly bankrupt companies have the greatest liquidity currently, largely because their debt was converted into equity. Sandridge’s liquidity at 1,400% of its debt is particularly impressive (although its assets are not), while Bonanza Creek, Harvest, Riviera and Midstates all have more than enough liquidity to repay 100% of their debt when it comes due. Among the healthier companies, Cabot and Conoco stand out. Some of these companies may have elected borrowing bases lower than what their banks permitted (to save on fees for unused capacity, usually), so total liquidities may be understated. Still, $80+ billion in availability will fund a lot of capex.
Reserves: Reserve metrics are the lifeblood of most E&P companies, or at least they used to be before the advent of shale plays. Now, reserves are merely one piece of a property valuation, undeveloped acreage being another piece … and one that is extremely hard for outside investors to quantify. Nevertheless, statistics like Reserve BOEs, Enterprise Value/BOE and Debt/BOE (Columns Z-AB) can be useful as screening tools. The breakdown of BOEs between oil, natural gas and NGLs is a necessary, second-level analysis, as is the breakdown between proved developed and proved undeveloped reserves. This screen does not attempt to do that, and therefore produces some strange results, something that readers should be cautious of when reviewing media reports of M&A activity, for example. Natural gas producers tend to have very low EV/BOE figures, largely because natural gas BOEs are converted at 6 mcf/boe rather than their economic equivalent that would be based on a ratio of (6*$2.50)/$60 = 25% of their heating equivalent value.
Permian oil producers and rapidly growing companies like Diamondback, EOG, Pioneer, Jagged Peak (JAG), Conoco, Hess and Matador (MTDR) have the highest ratios of EV/BOE, possibly because of growth expectations and possibly due to large undeveloped acreage positions with many remaining locations to drill, potentially at least. Debt/BOE without such expectations and/or potential further suggests leverage issues. Alta Mesa, Anadarko (APC), California Resources, Denbury, EP Energy and Halcon all screen poorly on that metric alone, but look how well Anadarko did with its merger/sale to Occidental (OXY)!
EBITDA and DACF: Columns AC-AG detail ’18 Adjusted EBITDA and DACF metrics, which are typically a prime focus for investors. I still use the ’18 figures until 2Q comes out, then begin the serious comparisons, since this is still such an unstable pricing environment. Plus, I want to see if companies are comparing ’19 results to ’18 results for the full year in computing their % increases … or whether they are increasing from the most recent quarter(s). In the former, what appears to be growth may actually be the start of a decline from recent levels, if the company ramped up drilling during ’18, for example, and is now cutting back.
I don’t particularly like relying on other sources for their EBITDA calculations, and prefer Adjusted EBITDA in any event. Only recurring items should be included in estimating future results, so adjusting accounting EBITDA figures is most appropriate. Then, because even Adjusted EBITDA is not the same as cash flow, I use DACF, or Debt-Adjusted Cash Flow, to come up with a better approximation. DACF is simply Adjusted EBITDA less interest expense, something that provides actual cash amounts that can be used to pay costs and expenses, unlike EBITDA which is primarily a tool for creditors to assess (weakly) ability to repay debt. Investors in an ongoing business should be more concerned with actual cash flows, how long it takes to repay debt with actual cash at current cash flow generation rates, etc. Traditional EV/EBITDA or Debt/EBITDA just don’t reflect the actual cash, where DACF does.
Actual ’18 EBITDA and DACF (Columns AC and AE) will be interesting to compare with annualized figures for YTD ’19 numbers for direction. Because oil prices were > $60 and $3 for ’18, I expect 2Q results to reflect continued weakness, not that investors need any further reasons to exit the sector than they have seen already. One thing in particular is to look for the trends in the Debt/DACF ratio, as companies try to get back into what has been a traditional range of 2X, vs. much higher multiples that were allowed temporarily after the ’14 price crash. Five years into a period of price decline is no longer a temporary situation, especially with reserve life indices being reduced as a result of shale play decline rates.
Apparent outliers on the negative side of the Debt/DACF side include California Resources, Chesapeake, Comstock, Range … and the EP Energy, Halcon, Sanchez and Ultra quad squad of extremely distressed companies. Cabot, EOG, Pioneer and many others come in with the lowest ratios, reflecting their strong financial condition. Obviously, readers may look through the data presented in the table(s) and come out with their own picks and conclusions for further research.
CAPEX and Production: The first figures reported during the year are usually the capex and production numbers, which appear in Columns AH-AM. These are annual actual figures for ’18 and guidance for ’19. There will undoubtedly be further discussion and guidance given in 2Q releases, in conference calls and in presentations. Comparing the ’19 figures to ’18 shows whether either capex or production, or both, are growing, and whether one is growing faster or slower than the other. Based on early ’19 disclosures, capex for the independent group was scheduled to be lower by roughly 15%, which production was estimated to grow by nearly 10%. Several companies have pre-announced changes in these figures, but I have left the original numbers in the table so that the cumulative changes can be charted. Most companies are being pressed to reduce capex even from the levels here, which is fine for some companies but will be possibly disastrous for others who are already too leveraged and have high fixed costs. However, that is what capitalism is all about.
Company Financial and Operational Data
Sources: OilandGas360, Seeking Alpha, Yahoo Finance, company websites, author
The Macro Outlook
The market’s assessment of the macroeconomic outlook for the E&P sector is evidently pretty bleak, as evidenced by the continued decline in stock prices. Rather than extend this article to include my current thoughts in depth, I will refer you to an earlier article of mine, along with the brief comments in outline form to follow:
Lower for Longer: The first table above certainly shows the “lower” part of the equation, as far as E&P equities are concerned. While oil prices have increased from their 2016 lows, the decline below $50 is mostly on the charts “for show,” in that those levels would have bankrupted virtually the entire sector over time. Investors who believe that their companies “survived” low prices ignore the fact that short-term cash flows in such an environment would have led to longer-term declines far more severe than what we have witnessed to date.
The following chart shows historical oil prices to re-emphasize the fact that prices in the $100+ range over the period 2008-2014 are still significantly higher than today. However, the impact of investments made in that environment is still being felt today, especially by companies with legacy debt.
Natural gas prices peaked in the 2005-2009 period, in excess of $10/mmbtu (vs. the 12-month futures strip price of roughly $2.60 currently). Most E&P companies were oriented towards natural gas then, but rapidly shifted to oil or “liquids-rich” natural gas … just in time to witness the fall in oil prices, caused at least in part by that shift in capex.
Included in each of the charts are gray bands that signify periods of recession. With slower demand growth currently becoming an oft-discussed topic going forward, it is important for investors to consider prior impacts of such economic conditions on E&P stock prices, which has been severe.
It is important for E&P investors to watch world natural gas prices as well as oil prices, since a growing part of US natural gas production is targeted for export as LNG. Unfortunately, warm winters in Asia and Europe, along with greatly increased supplies of LNG from other countries, have resulted in a worldwide glut of natural gas and decreased prices currently. In fact, as the following chart shows, LNG prices delivered to Europe have caused storage levels to approach capacity and prices to approach a level where US LNG export variable costs may result in reduced export levels and/or shut-ins of facilities temporarily this fall, a result not expected by US investors seeking higher prices based on increased levels of LNG exports.
World Fundamentals and Geopolitical Risk: Nothing going on here, right? Sheesh, every day brings new issues to the fore. Iran sanctions, Venezuela sanctions, Russian sanctions, Libyan unrest, US-China trade wars, etc. etc. Rather than delve into a deep discussion of the foreign policies of any of the countries involved, suffice to say that investors should watch the reaction of stocks in general and E&P stocks specifically, to gauge the impact that such actions have. I included a more detailed discussion in my earlier article, referenced above.
OPEC and World Production: The biggest “takeover” in the first half of ’19 had nothing to do with E&P equities directly (sorry, Occidental and Anadarko), it had to do with OPEC. As readers should know, OPEC announced in early ’19 that it (or really primarily Saudi Arabia) would cut production by roughly 1 mm bopd to bring oil inventory levels down to their 5-year average. I’ve expressed my feelings about the misleading nature of that target since it was adopted, with the misleading nature of the strategy being that the 5-year average would itself be rising artificially due to the significant over-production relative to demand in the period leading up to the price crash in ’14-’15.
Recently, there was a development that is stunning in its potential implications, in my opinion. In June, Russia (a non-OPEC or OPEC+ member) and Saudi Arabia met to determine what OPEC’s policy on production should be going forward, deciding ahead of the actual OPEC meeting that production cuts should be maintained for another 9 months. Needless to say, OPEC members were not thrilled to see their voice and vote effectively pre-empted with Russia’s involvement.
Recent discussions within OPEC centered around a common theme: US production up = OPEC production call down. In addition, the issue of possible lower demand growth has surfaced, to the point where even with the production cuts being continued into 2020, the excess supply they project is the range of 800,000 bopd, a significant number. Oil inventories are expected by OPEC and others to increase into 2020 as a result.
Another interesting topic of discussion was the possibility of changing OPEC’s targeted level of inventories from the 5-year average to the average for the period from 2010-2014, prior to the over-production era (as I have suggested is the better measurement period). Even with changes to inventory level targets, though, what OPEC really is targeting is higher prices; rather than specify an “acceptable” target range of price, they appear to be content to use inventory levels. Whether they will actually need to cut close to another 1 mm bopd to achieve an inventory balance is still an open question.
The slide below illustrates the inventory issue OPEC is wrestling with. Although these estimates are from EIA data as presented by the Fed in July, the data tracks pretty closely to recent data from OPEC and the IEA as well.
Before leaving the topic of oil and natural gas prices, I would be remiss not to note that Permian takeaway constraints that have existed for the past 1-2 years will be relieved in 2H '19 by the completion of the Grey Oak (900,000 bopd) and Gulf Coast Express (2 bcfgpd) pipelines. Some companies have reduced their Permian activities pending completion of these pipelines, and in the interim the majors have increased their positions and announced plans for fairly significant capex commitments and production increases of both oil and associated natural gas to come. I remain particularly wary of the impact that the majors will have on independents, since majors can rely on a multitude of profit centers to generate their income and cash flow, while independents rely on production and, in some cases, midstream assets only. Majors tend to take a longer term view to prices and capex commitments as a result, and can be somewhat immune to short term pricing outlooks.
Capital Markets and Sentiment: Dead, dead and dead. That was short.
Neither debt nor equity markets showed much activity, unless you include such M&A transactions as Encana/Newfield, Chesapeake/WildHorse and the pending Occidental/Anadarko deals. The retail markets remain effectively closed as investors seek to enforce capital discipline on management teams.
As such, discussions in 2Q releases, conference calls and presentations will likely focus on 3 primary investor concerns: Free Cash Flow, Capital Discipline and Returns to Shareholders. If readers want to play “buzzword bingo” for the sector, those are the 3 phrases to watch and listen for.
Never mind that a focus on FCF in the short (and long) term is essentially meaningless without the context of what future net cash flows will look like with current capex. Never mind that capital discipline should not have to be imposed on management, but rather something that is obvious to anyone in a position of authority. Never mind that returns to shareholders, in the form of buybacks or dividends, often are counter-productive to the enterprise and its debt structure. If investors keep clamoring for it, management will respond in kind.
Of course, as I have said before, if managements adhere to what their investors think they want, most often the result is reduced production and cash flow levels, and therefore less attractive metrics than some of their competitors. When investors see that impact, they sell the stock of under-performing company A to invest in company B. We saw that in the market after 1Q results, and I expect 2Q results will result in the same reaction. That’s why I am waiting on the sidelines for the remaining growth investors to exit and for stock prices to reach levels where value investors step in on volume sufficient to raise prices. “The trend is your friend” is not always just a saying … just saying.
Companies are going to need to start focusing on any debt maturities they have in the 2020-2022 period, when a wall of debt in E&P comes due. While investors typically think that refinancing existing debt is as simple as changing an interest rate and extending maturities, all creditors use current and projected future economic conditions to determine risk and the likelihood for repayment in making new loans. Loans made in a $100 oil environment cannot be refinanced for the same amount as loans made in a $60 environment.
Equity prices bear the brunt of product price declines, in part because debt is a fixed obligation and in part because the equity markets can wipe away any losses by reducing share prices. Debt prices are much more stubborn because of their fixed price nature, one reason why bankruptcies may still be a potential issue for many companies. More debt swaps where increased rates, delayed maturities and possibly equity components are common may be attempted as managements and equity holders seek to share the pain. At $60/$2.60, that pain will continue, in my opinion, more slowly than when bank revolving credits were at risk, but rather now tied to the maturities of debt issued during the nearly “free money” period induced by the Fed following the ’08-’09 recession. “Risk on” was/is an apt term for the impact of lower interest rates.
Hopefully the data provided in the tables above helps provide the basis for further research and analysis on individual companies in the E&P sector, despite the lack of outright buy or sell recommendations. To me, having a broad picture framework is critical in assessing the sector outlook, as well as individual company outlooks and comparative numbers that can be developed for particular groups of companies. Although I think that tough times are still ahead for much of the remainder of ’19 and into ’20, I will be looking for signs of better performance by companies and, just as importantly, signs that stocks can make a sustained move upward (for long positions, anyway). Sometimes that happens when bad news doesn’t result in punishment in the market, which so far has not been the case, but could very well occur with changes in sentiment, etc. going forward.
So, for now my motto is “Keep on keeping on,” and I would advise readers to do the same. As a final reminder, remember that opportunities can be lost with no lasting impact, but financial losses can be devastating. Protection OF capital should be a primary concern, with returns ON capital a secondary one. Set appropriate sizes for positions, monitor them and adjust according to your own investment objectives and philosophies. Set sale targets that do not allow positions to turn into large $ or % losses, and try to approach investing as a business that requires hard work and reasoned, rather than emotional, decision-making.
Hopefully, like Alexander, patient E&P investors will be rewarded some day with performance that makes up for what seems like a very weak, very permanent situation.
Disclosure: I am/we are long AMR. 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.