Commodities | Mar 11 2020
Where will the latest stoush among major oil producing companies land the global economy as the spread of coronavirus interrupts trade and frightens markets? How will energy stocks fare?
-Most oil stocks trading well below JPMorgan base-case valuations
-Significant uncertainty over whether projects will be deferred
-Amcor a notable beneficiary of lower oil prices
By Eva Brocklehurst
[Editor's note: This article was sourced from analyst research published by Morgan Stanley on the evening of March 9, by JPMorgan on the morning of March 10 but dated March 9, and by Macquarie on March 10. On March 9 the Australian energy sector fell -19%, pre-empting a -25% plunge in oil prices on the Monday night. Of the three, Macquarie published after that -25% plunge, but research from the other two is no less relevant following share price falls on the Monday.]
Given the backdrop outlined in Part 1 of this article (https://www.fnarena.com/index.php/2020/03/10/opec-pours-oil-on-coronavirus-part-1/), it is no surprise energy stocks are under pressure. Morgan Stanley calculates Australian energy stocks are implying an oil price in the mid US$40s/bbl region. Nevertheless, the risk/reward appears more attractive compared with the position they were in circa 2014-16 as costs are lower, balance sheets are better and uncommitted expenditure can be pulled.
In 2014-16 Morgan Stanley points out a number of companies needed to raise equity because they were midway through a heavy LNG construction cycle. Now, expenditure has not commenced on many expansion opportunities and there is the chance to delay until the situation improves.
JPMorgan still finds value in the sector, as most stocks are trading well below base-case valuations. The oil sector is implying a price of just US$42/bbl and balance sheet risks could emerge, the broker acknowledges, should weak oil prices continue. Those most at risk are considered to be Woodside Petroleum ((WPL)), Santos ((STO)) and Oil Search ((OSH)).
Beach Energy ((BPT)), Cooper Energy ((COE)) and Senex Energy ((SXY)) are less sensitive, given exposure to east coast gas. Canaccord Genuity notes gas makes up 95% of Cooper Energy's reserves and there are fixed-price contracts for FY21, where 86% of the company's expected production is contracted. Cooper Energy, therefore, remains the broker's preferred exposure.
The material slump in oil prices is likely to squeeze operating margins, with Macquarie calculating 2020-21 break-even prices for Woodside Petroleum, Santos and Oil Search are US$34/bbl, US$31/bbl and US$37/bbl respectively.
The slump in the oil price has also put BHP Group's ((BHP)) petroleum growth plans at risk, as Macquarie notes both Scarborough and Trion are not generating an acceptable return at spot prices. The petroleum business accounts for around 14% of group operating earnings using Macquarie's forecasts but only 7% using spot prices. Morgan Stanley also suspects Scarborough is likely to be delayed.
Resolving the uncertainty over supply now remains the catalyst for the sector, as Macquarie notes Woodside, Santos, Oil Search and Beach Energy all have decisions to make regarding project approvals this year.
Growth projects include Scarborough/Pluto and Browse for Woodside, Barossa for Santos, Alaska for Oil Search and Waitsia stage 2 for Beach Energy. Dorado (80% Santos 20% Carnarvon) is still likely, Macquarie suggests, although the required expenditure of around US$1.2bn may be a hurdle. Should growth options be deferred for the majors, then respective balance sheets would remain robust at spot prices, in the broker's view.
Energy-exposed contractors are also expected to endure pressure. While Worley ((WOR)) has diversified its business with the acquisition of ECR, its energy division is 47% of revenue, which includes both oil & gas, and it remains the most exposed in the sector.
However, modification and sustaining capital expenditure is now 48% of revenue and major capital projects, which are more greatly exposed, are just 7%, Macquarie adds. Monadelphous ((MND)), is relatively less exposed, as oil & gas is 30% of revenue and most of this is maintenance related, as the construction portion has been reduced now Ichthys has rolled off.
At the other end, Downer EDI ((DOW)) has only small exposure to oil & gas while CIMIC ((CIM)) announced in January it was leaving the Middle East and is not exposed to further cash losses beyond existing debt guarantees/shareholder loans.
Morgan Stanley suggests the oil stocks are now starting to imply prices below even the most conservative long-term expectations and may be finding a floor, although remains less confident in the short term given coronavirus is still spreading.
Any stocks that may benefit?
Macquarie highlights Amcor ((AMC)) as the most defensive stocks under coverage. The company is expected to enjoy lower resin and other raw material costs stemming from a lower oil price. Citi agrees, noting significant falls in the oil price affect cost curves in products such as ethylene, PVC and urea, supportive for Amcor.
As shares sell off, the broker points out more opportunities are being created, although it may be too early to jump in. Fiscal stimulus could take time to evolve and rate cuts are not a cure for a virus.
The broker is also unsure about a rebound in 2021, unable to assess what the appropriate 2020 base for earnings per share actually is, in order to consider a recovery in profits.
Part 3 to follow.
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