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Big Oil Is a Buy as Cutbacks Pave Way for Recovery

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Screen Shot 2015-09-17 at 07.55.40by Rakteem Katakey and Angelina Rascouet: Oct 20, 2015

  • Shell has highest percentage of buy ratings in three years
  • Third-quarter earnings seen marking low point before rebound

Energy companies are finally starting to come back into favor.

After enduring the longest oil-price collapse in more than a decade, crashing profits and an investor exodus, Europe’s biggest producers are regaining fans as analysts bet earnings bottomed last quarter and will now start to recover.

While Total SA, the region’s second-biggest oil company, will probably post the worst quarterly performance since 2009, it also has the highest proportion of buy ratings in a year, according to analysts surveyed by Bloomberg. Despite similarly bleak forecasts, Royal Dutch Shell Plc, Europe’s No. 1, has the biggest share of buy recommendations since mid-2012 while BP Plc has the most since February.

The ratings show faith in the producers’ ability to weather the commodities rout, which has seen Brent crude tumble by 40 percent in a year and company valuations shrink to at least three-year lows. More analysts now believe that the industry’s sweeping spending cuts, job losses and shuttered output will be sufficient to bolster oil prices and foster profit growth.

“It is possibly a case of being darkest before the dawn,” Lydia Rainforth, a London-based analyst at Barclays Plc, said by e-mail. A pullback in production and delays to projects “make some form of recovery inevitable” in the oil market, she said.

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Shell’s B shares, the most widely traded, have increased 15 percent this month, heading for the best performance since April 2008, after previously falling 30 percent this year. Total has gained 12 percent, while BP is up 13 percent, the biggest jump since October 2011. Energy companies are the best performers on the MSCI World Index this month after languishing at the bottom for most of the year. 

Spending Cuts

The rebound comes after the companies made spending cuts to help them ride out the downturn. Drillers have reduced investments in exploration and production by a record 20 percent this year, International Energy Agency Executive Director Fatih Birol said Oct. 6. Companies also have divested assets, scrapped staff incentives and renegotiated contracts to lower costs.

“Across the board, we see companies working very hard to cut capital and operating expenditure levels and the speed at which this is going is very high,” Occo Roelofsen, Amsterdam-based leader of the oil and gas practice at consultants McKinsey & Co., said by phone Oct. 15. “A lot of business units are starting to cope with the new situation relatively fast as they start to adjust to the new normal.”

While the cutbacks help to buoy balance sheets and cash flow, they hamper explorers’ ability to add oil resources. Shell’s reserves and production have dropped in three of the past four years, while BP’s output has declined about 18 percent since the 2010 Gulf of Mexico oil spill that forced the company to sell assets to pay for the damages. 

Defending Dividends

As cuts bite, companies are making dividends a priority over production growth. Shell Chief Executive Officer Ben Van Beurden said this month he’s “pulling out all the stops” to safeguard shareholder payouts that Shell has maintained since the end of the Second World War.

Oil’s 16-month dive has been brutal, wiping out $397 billion from the value of the 23 companies in the Stoxx Europe 600 Oil & Gas index and driving down earnings.

Total will post adjusted profit of $2.5 billion in the third quarter when it reports on Oct. 29, according to the average of five analyst estimates compiled by Bloomberg. That’s the lowest since the fourth quarter of 2009. Profit at BP, reporting Oct. 27, will drop to $1.3 billion, the lowest in at least five years, while Shell will report $3.3 billion, near the lowest since 2013, analyst estimates show.

Results will subsequently improve, said Ahmed Ben Salem, a Paris-based oil analyst with Oddo & Cie. As a result of spending cuts, the oil companies’ break-even price — the level at which they can make a cash profit — is at about $80 a barrel and will fall to $60 by 2017 from $100 last year, he said, without giving an oil-price forecast.

“Oil companies are doing the job and adjusting to this lower-price situation,” Ben Salem said. “They’re resetting their companies to be leaner and more cost-effective, which will only benefit them in the future.”

SOURCE

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