Eni: Energy Prices A Drag On Results, But The Growth Story Is Playing Out

Summary

• Eni's headline numbers were disappointing, but its actual performance in the quarter was not really that bad.
• The company was able to continue to deliver production growth as it brought various new projects on-line or ramped up existing ones.
• It should be able to continue this growth heading forward.
• The company is working to ramp up its presence in LNG and is becoming a major producer of natural gas.
• We saw relatively strong reserve development here, which is always quite nice to see.
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On Friday, February 28, 2020, Italian energy giant Eni S.p.A. (NYSE:E) announced its fourth-quarter 2020 earnings results. At first glance, these results were quite disappointing, as the company failed to meet the expectations of its analysts in terms of either top line revenues or bottom line earnings. As was the case with many of the other European energy companies that have reported their results recently though, there were quite a few things to like here, and we certainly see the growth story that I have presented in various past articles playing out. The financial performance of the company was, unfortunately, not as good as last year, but this was somewhat expected.

As my long-time readers are no doubt well aware, it is my usual practice to share the highlights from a company's earnings report before delving into an analysis of its results. This is because these highlights provide a background for the remainder of the article, as well as serve as a framework for the resultant analysis. Therefore, here are the highlights from Eni's fourth-quarter 2019 earnings results:

• Eni reported net sales of €16.215 billion in the fourth quarter of 2019. This represents a 19.15% decline over the €20.056 billion that it had in the prior-year quarter.
• The company reported an operating loss of €178 million in the most recent quarter. This compares very unfavorably to the €1.456 billion operating profit that it had in the year-ago quarter.
• Eni produced an average of 1.921 million barrels of oil equivalents per day in the current quarter. This represents a 2.62% increase over the 1.872 million barrels of oil equivalents that it averaged during the equivalent quarter of last year.
• The company made significant progress in expanding the production from the massive Zohr field in Egypt that started operations in 2017.
• Eni reported a net loss of $1.891 billion in the fourth quarter of 2019. This compares very unfavorably to the $399 million net profit that it reported in the fourth quarter of 2018.

It seems likely that the first thing that anyone reviewing these results is likely to notice is that the company's financial performance was considerably worse than in the prior-year quarter. This is in line with what we have seen from the other large energy companies that have reported thus far. One of the reasons for this is that the prevailing gas and oil prices were lower during the most recent quarter than during the prior-year period. This is true despite the steep decline in asset prices that we saw in the fourth quarter of 2018. We can see this here:

Source: Eni S.p.A.

As we can see, Eni realized lower prices on average than it did a year ago. It should be obvious why this would have an adverse impact on the company's financial performance. After all, if it receives less money for each unit of product that it sells, then it will end up receiving less money in aggregate. The lower top line revenues mean that there is less money to make its way down to net income unless the company cuts its costs severely - and most energy companies cannot reduce their expenses that quickly.

Of course, all is rarely equal in the case of an energy company. As noted in the highlights, Eni produced more resources in the most recent quarter than it did a year ago. This is what I meant with my earlier statement that we are seeing the company's growth story playing out here. This had the effect of offsetting some of the impact that the lower energy prices would have otherwise had on the company's revenues. The reason for this should be fairly obvious. After all, Eni may have received less money for each unit of product that it sold, but it sold more products. This is essentially the business model of discount megastores like Walmart (WMT). Unfortunately though, the extra sales were not enough to make up for the lower prices, but it did at least prevent the situation from being worse.

This increase in production was not unexpected, as I have stated in various previous articles on Eni. This is because it was driven by new projects that came on-line over the past year or two. Perhaps the most significant of these was the massive Zohr field in Egypt. As I stated in a previous article, this field is located about 100 kilometers north of the coast of Egypt in the Mediterranean Sea.

Source: SweetCrudeReports.com

The Zohr field is the largest natural gas field ever discovered in the Mediterranean Sea, containing an estimated thirty trillion cubic feet in place. The field first started producing natural gas in late 2017, and Eni has been working to increase the field's output since that time. In 2019, the company managed to boost the field's production capacity to 2.7 billion cubic feet per day, which was well above the level that it had in the prior-year quarter. This naturally resulted in production growth year over year.

One of the unique aspects about Eni is that the company is essentially the natural gas and electric utility for the nation of Italy. This adds quite a bit of diversification to the company's operations that can help to offset the impact of lower energy prices. This proved to be the case in the most recent quarter, which we can see here:

Source: Eni S.p.A.

It is interesting how Eni managed to achieve this despite lower natural gas and flat electrical sales year over year. Unfortunately, the company did not provide any real reason for the improvements that we saw here other than to state that it optimized its natural gas portfolio in Europe. We can still see clearly, though, how this business can help offset weakness elsewhere.

Fortunately, it does not appear that Eni's growth story will end in the near future. One of the reasons for this is that the company started production at a few major projects in 2019. I have mentioned a few of these in past articles on Eni, such as Area 1 in the Gulf of Mexico and Agogo in the venerable 15/06 Block in Angola. These field start-ups should help the company grow its production throughout 2020 as it works to ramp up production to the fields' maximums.

One of the bigger stories in the energy industry over the next decade is the growing importance of liquefied natural gas. This comes from nations all over the world seeking to reduce their carbon emissions by switching from coal and oil to natural gas. This may require the compound to be transported across the ocean to reach the nations that wish to import it. The only way to do this is by converting it into liquefied natural gas. Eni has decided to expand its operations in this market to take advantage of the growing demand. It is doing this by expanding the Bonny liquefaction plant in Nigeria to a total capacity of 30 Mtpa of liquefied natural gas. The company intends to complete this work by 2024, so its production of the compound will be higher by that time. This should have a stimulative effect on growth.

One thing that we always want to keep an eye on with respect to energy companies is their reserve development. This is because the industry is, by its very nature, an extractive one. The companies in it literally obtain their products by pulling them out of reservoirs in the ground. These reservoirs only contain a finite quantity of resources. Therefore, if the company fails to discover or otherwise obtain new sources of resources to replace the ones that it pulls out of the ground, then it will eventually run out of product to sell. Fortunately, Eni did not have a problem in this area during the most recent period. Over the course of 2019, the company discovered or otherwise obtained 628 million barrels of oil equivalents after taking into account the resource divestments that it made in Indonesia and Ecuador. This was enough to give it a reserve replacement ratio of 117%, which means that the company acquired more resources than it extracted from the ground. This is a good sign because it should help ensure that the company's production is sustainable.

In conclusion, these were reasonably decent results for Eni despite the disappointment in the headline numbers. We definitely see the company's growth story playing out, as it delivered solid year-over-year production growth due to either new projects starting up or existing ones being ramped up. This is unlikely to be the end of the company's growth story either, as the firm has some new projects still in development. This should position the company well for when energy prices eventually recover, although this may be a while.

Analyst’s 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.