John Herrlin has been advising clients to expect potential news headlines-driven downdrafts in 2017 for U.S. E&Ps. He thinks the Street will need to be vigilant on the sector, and that OPEC cuts and oil inventory balance will be very critical for 2017.
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Paul Grigel covers U.S. E&Ps. Mr. Grigel says 2016 was a volatile year for E&Ps; however, the resiliency of the sector has been tremendous on the stock front and the operational front. For 2017 he is looking at the back half of 2016, which had more favorable tailwinds with rising crude prices and service costs that had remained flat after declining earlier in the year. For 2017, is looking for some of those tailwinds to die down or even become headwinds, mainly service cost inflation starting to come back. He says that while there are a few select places you can find value, generally the E&Ps are looking more fully valued right now.
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Evan Calio covers U.S. large-cap E&Ps, integrated oil companies and refineries. Mr. Calio says investor sentiment has improved on the sector, but he doesn’t see a positive consensus outlook looking into 2017. He thinks there will be some tempered performance relative to a pretty phenomenal performance in 2016. Therefore, Mr. Calio is constructive on all the sectors he covers and shares his top recommendations in the current environment.
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Daniel Katzenberg covers the E&P sector and says sentiment is improving. He says for E&P companies, what has helped the group is the balance sheet restructurings during 2016. What he is now seeing are capital market activities and equity offerings used for acreage. Mr. Katzenberg also says what is top of mind is rig count add, which has led to concerns from some investors that that might lead to oil service cost escalation. He thinks that there’s still enough excess capacity to continue to keep costs down for a bit longer. After being bearish for the last two years, Mr. Katzenberg is now recommending that investors increase their allocations, especially in oil-exposed equities.
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Oil and gas producers had a volatile 2016. Oil prices declined precipitously, and producers rushed to restructure their balance sheets with the aim of surviving the downturn and live within their cash flow. As oil prices have risen, though not to their former glory, investors seem to be more optimistic about the sector. OPEC has pledged production cuts and the new U.S. presidential administration is expected to reduce regulation and generally favor the energy industry. Analysts also add that, as balance sheets are now healthier, companies on the upstream are looking to expand operations.
The higher rig count does raise the concern that oil service costs will escalate, and there seems to be analyst consensus that an increase in production will inevitably lead to it. There is, however, disagreement in the timing, with some analysts wary of it already, while others say there is still excess services and equipment that should keep these costs contained through the end of 2017.
Some analysts recommend exposure to oil-based equities now, after two years of being bearish. Analysts don’t expect oil prices to rise to previous levels, but the momentum is there now and they say investors could take advantage of it.
Some analysts, however, say the performance in 2017 will not be as good as it was last year. The positive sentiment that comes from a new presidential administration could be tempered if Democrats push back on EPA and Department of Energy nominations, and analysts add that infrastructure could be good for the industry, but wouldn’t take place until 2018. On the longer term, they also say macroeconomic factors could negatively affect the industry, among them a stronger U.S. dollar, India’s currency controls, Brazil’s recession and slow Chinese growth.
More importantly, analysts say, the most important factor will be the price of oil, more than any other macroeconomic event. The positive sentiment could be cooled if OPEC producers delay in their promised production costs. Some analysts say, however, that Saudi Arabia has an incentive to increase the price of oil to increase the valuation of Saudi Aramco’s IPO in 2018.
Some analysts say the E&P industry’s strategy is development driven, which means lower operations risk, though they raise the concern that E&Ps don’t generate meaningful earnings or fund their own growth. They even say some could argue the E&P outperformance we’ve seen is a result of a previous underweight in the sector.
Domestically, analysts favor companies that have core contiguous acreage positions in the top shale plays. Some of the top geographies include the Permian, Eagle Ford, Bakken and Niobrara, as well as Marcellus and Utica.
U.S. producers are expected to respond to more stable crude prices with more production, and as operations expand analyst expect some companies to face new logistical and operational challenges. As they expand, they are also expected to buy acreage, but not to acquire companies. Generally, analysts say E&Ps are looking fully valued at this point.
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Henry S. Beukema III discusses Guyasuta Investment Advisors, Inc. The firm focuses on two key areas: strong client service and excellent risk-adjusted returns. Guyasuta manages individual securities for client portfolios and manages a small-cap portfolio. There are four key attributes that Mr. Beukema looks for in potential equity investments. He wants companies with revenue growth, free cash flow, strong balance sheets and economic moats. Then, for the fixed income investments, Mr. Beukema seeks high-quality corporate and municipal bonds.
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Kenneth Crawford discusses his firm’s large-cap strategy. Mr. Crawford says the firm looks for a change when investing in $3 billion-market-cap-and-above domestic companies. He looks for changes such as changes in management or products, and he wants that change to drive betterment.
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Randell A. Cain Jr. discusses Herndon Capital Management. While Mr. Cain does not consider Herndon Capital Management to be a value firm, valuation is very important in his investing discipline. Within the value strategies that Mr. Cain manages, he seeks to invest in value-creating opportunities. He’s looking for a minimum of 30% upside. Mr. Cain views his process as both scientific and artistic. In analyzing securities, Mr. Cain begins by screening quantitative data and tries to determine what a company is really made of through SWOT analysis. He breaks the company down into its four building blocks: strategy, management, operations and financials. This allows him to determine his investment thesis on a company. Overall, he aims to diversify the portfolio by number of holdings and by sector.
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John C. Carraux and Howard D. Punch Jr. discuss Punch & Associates Investment Management, Inc. Mr. Carraux and Mr. Punch run a small-cap and a microcap strategy. The median market cap of both strategies is below that of the benchmark index. When choosing investments, Mr. Carraux and Mr. Punch look for value first and then growth. Their process involves a traditional valuation assessment. From there, Mr. Carraux and Mr. Punch decide which names should get a deeper dive. This involves a qualitative analysis that helps them figure out what makes a management team tick. According to Mr. Carraux, what makes their portfolios different is that many of their holdings don’t get much attention from investors, allowing the research they perform to provide them with unique insights.
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Julian Pick discusses his firm’s Global Growth Fund. Mr. Pick says the theme around the fund is to invest where the great businesses are. It is long-term, quality-oriented investing with a large-cap basis. Mr. Pick says the heart of the philosophy is the concept of margin of safety, as it is important to filter out the macro, currency, political and other risks that come with global investing. He also says preservation of capital is very important.
Full interview available here.
