Analysts Forecasting Record Earnings for E&Ps, Integrateds in 2005
In a report forecasting performance by both integrated and exploration and production (E&P) companies in 2005, CreditSights analysts said they expect earnings and cash flow to be at or above record levels, aided by commodity prices and stronger production. Current commodity price estimates are too low, they said, "leaving ample room for upward earnings revisions in the coming months."
In the report, Brian M. Gibbons Jr. and Spencer Siino noted that the recent positive earnings momentum should allow the industry to continue to outperform the broad markets next year.
"We expect 15% and 11% earnings and cash flow growth, respectively, in 2005 across the sector...based on our $42/bbl oil price assumption versus an average 2004 price of $39/bbl -- far exceeding 5-10% growth expectations for the broad market," they wrote. They pegged natural gas prices next year to hover between $4.50-$6/Mcf.
Gibbons and Siino wrote, "We expect the eventual uptick in commodity price estimates should lead to upward earnings revisions in the 13% range. Credit metrics should only get stronger as companies pile up free cash flow in 2005."
Amerada Hess Corp., Marathon Corp., Murphy Oil Corp., Kerr-McGee Corp., GlobalSantaFe and Transocean were forecast to post the largest earnings gains next year, "at 35%-plus with cash flow gains of 4-6%." Their top picks are ConocoPhillips equity, Anadarko Petroleum Corp. equity and credits, Devon Corp. equity and credits, EOG Resources equity and Valero equity and credits.
"We find Amerada Hess and Kerr-McGee interesting as both companies are poised to post significant earnings gains and balance sheet improvements, offering equity multiple and credit spread repair trades." Among the integrated producers, they said Anadarko and Marathon "should benefit from new production gains and lower hedge volumes in a better oil price environment, while Murphy should benefit mostly from strong production growth and to a lesser extent commodity price gains."
The CreditSights analysts wrote that oil and gas stocks have traded at a discount to the broader market over the past 15 years, which has followed with significant consolidation. Now, larger companies have larger asset bases to spread high fixed costs. They also are better capitalized and have stronger balance sheets.
"This has greatly improved the credit profile of the industry, leading to spread tightening and ratings upgrades, however, the industry remains mature with low growth opportunities, leading equity investors to discount the industry versus higher growth, higher return sectors."
Even if oil and gas prices were to drop, the analysts still expect to see support for a 9% gain in the sector. "We think the market can at least be comfortable closing the gap assuming a $35/3.50 mid-cycle assumption, which should put the sector at a relative gain of 9% versus the market in 2005. Clarity on a $35/4.50 mid-cycle view could push stocks 38% higher to fully close the valuation gap, however, we think this type of multiple expansion will take longer than the next year to overcome."