Exploration and production (E&P) companies’ earnings and cash flow this year are expected to be at or above record levels, up 10-15%, driven by commodity price and refining margin strength, said CreditSights analysts in a new report. Along with strong year-over-year earnings growth, the analysts believe current price estimates are too low, which would leave “ample” room to revise earnings upward in the next few months.
The positive earnings momentum will allow the energy industry to continue to outperform the broad markets in 2005, said analysts Brian Gibbons Jr. and Spencer Siino.
“Our analysis shows that six of the 19 companies in our coverage universe will finish 2004 with over $1.0 billion in cash and 14 companies are poised to have over $1.0 billion in cash on the balance sheet by end-2005, based on our operating cash flow and capital spending expectations,” said the analysts. “The average cash balance as a percent of market capitalization is expected to be 15-20% versus a 10-year average of 2.5%.”
The analysts said most of the companies throughout the industry are expected to begin “significant” share buybacks and dividend increases, followed by debt reduction and incremental capital spending increases. They don’t expect any big increases in merger and acquisition (M&A) activity, “given high asset valuations, the completion of asset repositionings following the late 1990[s]/early 2000[s] M&A boom, and restructurings undertaken more recently in 2004.”
Companies expected to be the “leaders” in capital spending increases, share buybacks, dividend increases and debt reductions with the highest cash-to-market cap ratios for 2005 are “likely” to be Devon Energy, Burlington Resources, ConocoPhillips and Occidental. Also high on the list are Anadarko Petroleum Corp., Schlumberger and Sunoco. Those most likely to pay down debt are Devon, Halliburton, ConocoPhillips, Kerr-McGee and Valero, the analysts said, while those most likely to increase spending are Occidental, Murphy, Unocal, Valero and Anadarko.
“We expect operating cash flows to be 10-15% higher in 2005 with the Integrateds and E&Ps benefiting from production growth and improved commodity price realizations, and the Oilfield Services players benefiting from higher producer spending.” Cash flow for Refiners is expected to be “marginally higher” because of a flat refining margin tape. Capital spending should be 10% higher for the Integrateds, said the analysts, matching service cost inflation, and 10-25% higher for the E&Ps, leading to sizable revenue growth for the Oilfield Service industry. The analysts noted that the Refiners and Oilfield Services group should exhibit only mild spending growth. Capital discipline remains in full swing throughout the industry as companies continue to spend well below cash flow levels. Further, service cost inflation of 10% and nominal spending gains of 15% or less leaves real growth closer to 5%, rather small in the grand scheme, they said.
CreditSights’ baseline cash availability projections for 2005 begin with end-of-quarter 3Q2004 cash on the balance sheet and also included any other known uses or sources of cash such as asset dispositions. “We have not included known share buyback programs, scheduled dividend increases, or scheduled or unscheduled debt reduction, as the report will progress to ultimately include these items.”
For the full report, visit www.creditsights.com.
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