Global Oil and Gas stocks have been rerated to levels not seen since 2000. Exhibit 1 (below) maps their relative decline in Price to Book Value (PBV) terms. In this respect, they are experiencing the mirror image phenomenon to that of Tech and Internet stocks, whose valuations have been rising. Energy companies are also asset heavy whereas Tech and Internet is often asset light.

Relative Price to Book Ratio Oil and Gas

Source: Cerno Capital, Bloomberg

Within the sector, Integrated Oil & Gas majors appear particularly cheap, trading on 1.2x book value on average (as recently as 2008, they were trading at multiples of 2-2.5x) a circa 40-50% discount to their peak valuations due to a combination of stagnant commodity prices and rising costs that have squeezed margins. Relative to the western groups, emerging National Oil Companies have fallen out of favour even more despite having greater access to resources and government support as investors are wary of a misalignment of interests between the shareholders and the government. The combined market value of state-controlled national oil companies fell 15% in 2013, while the value of the large western groups rose in aggregate by 9%, according to the analysis group IHS.

The Oilfield Services industry, on the other hand, has fared much better in general, having benefitted from the high capex of the big oil groups over the past few years. However, going forward we anticipate a reversal in industry trends as major integrated oil groups are under greater pressure from shareholders to curb spending and improve capital returns after years of heavy capex engaging in increasingly challenging environments as companies pursue opportunities in high cost ventures (e.g. ask seek knock . deep-water, arctic, oil-sands) and acquisitions. Many, independents and NOCs alike, have trimmed their capex projections in recent months and announced divestment programmes to dispose non-core operations (downstream and mature upstream) to re-emerging as leaner, more efficient businesses geared towards higher quality growth.

Price to Book vs ROE Oil and Gas

Source: Cerno Capital, Bloomberg

Aside from the attractive valuations, this sector offers a superior dividend yield and a low debt to equity ratio, on average. The trade-off between return on equity and book value is compelling on both absolute and relative terms, as displayed in Exhibit 2, in which a basket of equally-weighted global integrated O&G majors (red) sits at the bottom of the spectrum against other MSCI sectors in terms of book value with an above trend ROE.

Rather than take on the clearly high level of company specific risk entailed by stock picking in a sector with heavy government and regulatory overhang, a basket approach makes sense.

Table 1 features a putative basket of companies from Bloomberg’s global O&G universe. The criteria in this case were 1) attractive valuation 2) commanding asset position (exemplified through high proven reserves relative to market capitalisation) 3) high reserve replacement ratio from existing claims and 4) favourable cost structures. The resulting basket incorporates a mix of independent and quasi state owned majors from both developed and emerging economies, which helps to achieve diversification benefits, thereby minimising the impact of any company-specific risk.

a putative basket of  oil and gas companies

Source: Cerno Capital, Bloomberg

Global Oil & Gas companies have low growth implied in their current share prices. They have bona fide value credentials.Global Oil and Gas stocks have been rerated to levels not seen since 2000. Exhibit 1 (below) maps their relative decline in Price to Book Value (PBV) terms. In this respect, they are experiencing the mirror image phenomenon to that of Tech and Internet stocks, whose valuations have been rising. Energy companies are also asset heavy whereas Tech and Internet is often asset light.

Relative Price to Book Ratio Oil and Gas

Source: Cerno Capital, Bloomberg

Within the sector, Integrated Oil & Gas majors appear particularly cheap, trading on 1.2x book value on average (as recently as 2008, they were trading at multiples of 2-2.5x) a circa 40-50% discount to their peak valuations due to a combination of stagnant commodity prices and rising costs that have squeezed margins. Relative to the western groups, emerging National Oil Companies have fallen out of favour even more despite having greater access to resources and government support as investors are wary of a misalignment of interests between the shareholders and the government. The combined market value of state-controlled national oil companies fell 15% in 2013, while the value of the large western groups rose in aggregate by 9%, according to the analysis group IHS.

The Oilfield Services industry, on the other hand, has fared much better in general, having benefitted from the high capex of the big oil groups over the past few years. However, going forward we anticipate a reversal in industry trends as major integrated oil groups are under greater pressure from shareholders to curb spending and improve capital returns after years of heavy capex engaging in increasingly challenging environments as companies pursue opportunities in high cost ventures (e.g. ask seek knock . deep-water, arctic, oil-sands) and acquisitions. Many, independents and NOCs alike, have trimmed their capex projections in recent months and announced divestment programmes to dispose non-core operations (downstream and mature upstream) to re-emerging as leaner, more efficient businesses geared towards higher quality growth.

Price to Book vs ROE Oil and Gas

Source: Cerno Capital, Bloomberg

Aside from the attractive valuations, this sector offers a superior dividend yield and a low debt to equity ratio, on average. The trade-off between return on equity and book value is compelling on both absolute and relative terms, as displayed in Exhibit 2, in which a basket of equally-weighted global integrated O&G majors (red) sits at the bottom of the spectrum against other MSCI sectors in terms of book value with an above trend ROE.

Rather than take on the clearly high level of company specific risk entailed by stock picking in a sector with heavy government and regulatory overhang, a basket approach makes sense.

Table 1 features a putative basket of companies from Bloomberg’s global O&G universe. The criteria in this case were 1) attractive valuation 2) commanding asset position (exemplified through high proven reserves relative to market capitalisation) 3) high reserve replacement ratio from existing claims and 4) favourable cost structures. The resulting basket incorporates a mix of independent and quasi state owned majors from both developed and emerging economies, which helps to achieve diversification benefits, thereby minimising the impact of any company-specific risk.

a putative basket of  oil and gas companies

Source: Cerno Capital, Bloomberg

Global Oil & Gas companies have low growth implied in their current share prices. They have bona fide value credentials.

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