[Editor’s note: this article was updated on April 21 to correct the name of a source quoted in the story.]
A resurgence in the energy sector at the start of the year ended abruptly following the global outbreak of novel coronavirus. But with some countries offering a glimpse of how quarantines and shut-downs can stall the spread of virus, Covid-19 is an opportunity for investors to buy strong oil companies on the sector dip. They would do well to remember that the companies that survive the economic fallout of weak energy demands will be those that best preserve cash.
Dean J. Mike Stice, of the Mewbourne College of Earth & Energy at The University of Oklahoma, honed in on the importance of oil companies’ spending plans. Per Stice, “deferring capital projects [and] cutting operating costs to accommodate the new environment” are cost avoidance strategies generally considered acceptable by shareholders.
Conversely, “looking to more difficult sources of cash, like cutting dividends and share buyback programs” can ensure the long-term viability of a company’s stock. But by punishing investors hungry for dividend income, companies opting to raise debt to pay a dividend can avoid a stock sell-off.
Job cuts are a natural response for any firm seeking to quickly cut costs. But oil companies shouldn’t hastily layoff staff before considering the long-term growth impact of these decisions.
Vikas Mittal, the J. Hugh Liedtke Professor of Marketing for the Jones Graduate School of Business at Rice University, said that oilfield services companies that invested in technology should exercise special care in job cutting. Those firms made “massive investments in technology that only raises fixed costs, which cannot be recouped when projects are scrapped. Instead, they need to figure out ways to provide more value — through ongoing service and support, better communication and higher-quality project management — to clients.”
To that end, there are seven oil stocks that have the necessary liquidity to survive the current crisis:
- Exxon Mobil (NYSE:XOM)
- Suncor Energy (NYSE:SU)
- Enbridge (NYSE:ENB)
- Schlumberger (NYSE:SLB)
- Cheniere (NYSE:LNG)
- BP (NYSE:BP)
- Royal Dutch Shell (NYSE:RDS-B)
While oil spot prices have seriously declined in recent weeks, there is still money to be made in the sector.
Exxon Mobil (XOM)
Exxon Mobil may have ~$11 in debt-per-share against 72 cents in cash-per-share but its debt-to-equity ratio is just 0.2. Exxon CEO Darren Woods has said that the company will lower its yearly capital expenditure by 30% and its cash operating expenditures by 15%. With those adjustments, the company maintained its long-term outlook.
Exxon is in a strategically strong position as it readies itself for the near-term economic downturn ahead. It is preserving long-term value and further increasing cost-efficiency. So when the market eventually recovers, Exxon may flourish once again. In the interim, XOM stock will continue to pay a dividend, thanks to the preservation of cash.
Exxon’s Permian Basin faces the largest share of the capex reduction. Management selected this location because it responds most quickly to adjustments. So, when market conditions improve, Exxon may resume drilling while benefiting from the well completions.
The average price target on Exxon Mobil stock is $51.15 (per Tipranks).
Suncor Energy (SU)
Suncor Energy boosted its financial liquidity on April 7 when the company announced an offering of 1.25 billion CAD in senior unsecured notes. These would be due in April 2030 and pay a 5% coupon. Previously, the company secured 2.5 billion CAD from its credit facilities.
Suncor said that the increased “financial flexibility ensures the company will have access to adequate financial resources should it be required.”
The company is preparing for a worst-case scenario in which the lock-down will have long-lasting negative effects. With excess liquidity on hand, Suncor will continue operating at minimal losses.
The tougher economic climate means weaker companies with too much debt will declare bankruptcy. This will lower the overall output of oil and gas, helping to stabilize the sector.
In February, the company canceled a multibillion CAD Montreal refinery project to process heavier barrels of oil. The cancellation will help the company preserve its cash. Plus, with no pipeline build in the country, Suncor does not need to continue this project.
Enbridge bucked the trend this quarter by pushing ahead with its Great Lakes tunnel project. By linking Lakes Huron and Michigan, the company will replace older twin pipes that operated in northern Michigan since 1953.
Enbridge scores a ‘B’ on the Morningstar financial health grade (per Stock Rover). For Q4, the company reported a discounted cash flow per share of $1.02, down slightly from $1.03 in the previous year.
For the full year, DCF rose by 21%, helped by an increase in the buy-in of its sponsored vehicles. So Enbridge “retains all the cash flow from those assets.”
The company has excess equity earnings from its Seaway and Bakken assets. Last year, its maintenance capital fell as it sold assets in 2018. Given the strong asset utilization history, investors should expect continued performance this year despite the headwinds ahead in the energy sector.
Schlumberger implemented a salary and job cut last month in a move to handle the sharp drop in oil revenue. Executives will take a voluntary 20% base salary cut, while support personnel will face a shortened work schedule that will save the company on staff costs in North America. Net net, the company’s 2020 capital spending budget will fall by 30%.
Since the announcement, SLB stock bounced from an $11.87 bottom reached in March. If the company succeeds in sustaining its rich dividend yield, then shareholders will have one less reason to sell the stock. As one of the two largest oilfield services firms, Schlumberger is reading for a shale crash is bigger than the one that North America faced around five years ago. So, if it lowers its costs and minimizes the use of cash on hand, it should survive the harsh downturn ahead.
At an energy conference on Mar. 24, the company put managing the Covid-19 outbreak as a top priority. And as it protects the health of its staff, it expects to survive with more than 80% of free cash flow generated internationally. On the other hand, accelerated land and staff restructuring in North America will reduce costs.
Cheniere Energy (LNG)
Cheniere Energy, a U.S. liquefied natural gas (LNG) firm, said that protecting its employees from the virus will not have an impact on production. And after following with a strong distributable cash flow of $780 million on revenue of $9.7 billion in 2019, the company reaffirmed its guidance for 2020.
Cheniere expects consolidated adjusted EBITDA of $3.8 billion – $4.1 billion. Distributable cash flow will rise from last year to $1.0 billion – $1.3 billion.
LNG has a sustainable business because ~85% of its business is contracted. This includes Cheniere’s sale and purchase agreements, as well as integrated production marketing transactions. Though contract cancellations are a risk, its customers will make every effort to meet obligations, rather than pay a penalty.
By 2030, Cheniere forecasts that LNG’s market will expand to ~200 million tonnes per annum. The firm had over 1000 cargoes representing over 70 million tons exported from its liquefaction projects. Not to mention, in the first half of 2023 capacity at the Sabine pass liquefaction project increases. Train 6, which is currently under construction, will be completed.
BP plc (BP)
BP has cut capital spending for the 2020 fiscal year to $12 billion, 25% below its previous full-year guidance. Downstream, spending will fall by $1 billion. And within its divestment program, BP will deliver $15 billion in asset sales by the middle of next year. That will bring in $10 billion in proceeds, which will shore up its balance sheet.
By the end of 2021, BP forecasts cost savings of around $2.5 billion. As a result, efficiencies will improve while the company avoids more damage to its balance sheet stemming from the weak energy markets.
Since last year, the vertically integrated firm announced $9.6 billion worth of transactions. It received $3.4 billion from asset sales so far.
On Wall Street, analysts did not update their price target on BP stock for at least two weeks. The average price target of $35.75 (per Tipranks) may remain, as the OPEC and allies finalize the production cut of a record 9.7 million barrels a day.
Royal Dutch Shell (RDS-B)
Royal Dutch Shell has raised $12 billion from a revolving credit facility in order to shore up its cash reserves. The liquidity injection will also lift investor confidence, even though (perhaps because) the firm does not need the funds.
RDS acknowledged major uncertainty as a result of the pandemic but did not notice much of an impact on results in the first two months of this year. It forecast no meaningful declines in sales volumes and margins for the current quarter. The firm expects to take a $400 million to $800 million impairment charge for the quarter.
Investors should look forward to RDS stock continuing to pay a dividend at the same rate. Although taking on debt to finance the dividend isn’t sustainable in the long run for the company, the commitment will limit the downside for share prices in the near-term. So as other firms cut their dividend and their stock price falls, Royal Dutch is positioned to buy those firms out.
Chris Lau, contributing author for InvestorPlace.com and numerous other financial sites. Chris has over 20 years of investing experience in the stock market and runs the Do-It-Yourself Value Investing Marketplace on Seeking Alpha. He shares his stock picks so readers get original insight that helps improve investment returns. Disclosure: Chris Lau owns shares of BP.