Large stock buyback plans have been popular among public exploration and production (E&P) companies with strong free cash flow (FCF), but informed industry-watchers offered mixed views on whether they are the best option for companies at this time.
NGI’s Patrick Rau, director of strategy and research, ticked off a list of share repurchase advantages.
Buybacks “are discretionary, they can actually reduce the amount of future dividend payments by lowering outstanding shares and, if the company is undervalued, they can replace investing in the drill bit as a way to boost returns on capital,” he said. “Buybacks aren’t perfect, but they may very well be the most flexible option for producers right now.”
E&Ps, he said, likely are not “buying back shares as any kind of real defense against takeovers,” particularly when the float – the percentage of outstanding shares available to the public – in most cases tops 90%.
“It would take many years of periodic buybacks to control the majority of their shares,” he said.
“No, I think they are buying back shares because in many ways that is their best option right now.”
Dividend Rewards, Risks
Public E&Ps face something of a conundrum, Rau said. Investors typically do not reward publicly traded companies in any industry to hold large amounts of cash, instead expecting management teams to “put cash to work.
“Except investors are not paying publicly traded producers to grow right now, so that option as a use for free cash flow is largely off the table.”
Cash-rich E&Ps could also acquire properties or other companies, but pursuing that option when cyclical commodity prices are high would hurt long-term returns on investor capital, he said.
Raising dividends has been a “popular strategy” for E&Ps and “will likely continue while commodity prices are high,” Rau noted. “But the drawback here is that dividends lead to a lingering commitment,” he said. “Higher dividends today will be harder to pay in the future, and that matters in a cyclical industry such as oil and gas.”
Some E&Ps have been aggressive on shareholder payouts by issuing variable dividends, which tend to be paid regularly but in changing values based on earnings. However, said Rau, “even small increases to the base dividend represents a higher required payment down the road.”
In other cases, E&Ps have opted to pay one-time special dividends – an extra payment tied to, say, a company windfall – to shareholders.
Rau noted, however, that a special dividend “just represents straight cash out the door. Companies don’t get any long-term benefit from that.”
One E&P buying back stock and hiking dividends is Permian Basin-focused Diamondback Energy Inc. The board of the Midland, TX-based independent last year began to repurchase up to $2 billion in stock. As of late June, Diamondback had spent about $690 million for more than 6.1 million shares.
Diamondback management also said last month it would raise its “return of capital commitment to at least 75%” of FCF, up from 50%, starting in the third quarter. In addition to the ongoing share repurchase, the capital return plan includes a base-plus-variable dividend, the firm noted.
Also in June, Southwestern Energy Corp.’s board authorized a buyback program of up to $1 billion through 2023. Management said the repurchase would complement the Lower 48-focused E&Ps’ ongoing efforts to pay down debt.
Several other E&Ps that have sought to return cash to shareholders via share buybacks and dividends include Centennial Resource Development Inc., Chesapeake Energy Corp., Coterra Energy Inc., Devon Energy Corp., ExxonMobil and Ovintiv Inc.
Oklahoma City-based Continental Resources Inc. serves as a potential exception. Majority owned by the Hamm family, a proposed buyback to take the company private could make the E&P more operationally nimble.
Not Strategic Enough?
Chiron Financial LLC’s Tom McNulty, managing director of investment, expressed a less-than-favorable view of share buybacks. For now, they are “not a compelling use of free cash flow,” he said.
“C-level teams that are using free cash flow to buy back shares need to do a much better job of finding productive and substantive uses of that capital instead,” McNulty told NGI.
Describing share repurchases as an example of “tactical thinking,” he urged a more “strategic” course of steering “massive amounts of capital” toward maintaining traditional energy for national security and economic reasons.
McNulty said that energy is “at a critical juncture. Crude oil is still very important, regardless of the demand profile from North America and Europe. This is due to the fact that Asia is still very dependent upon crude oil and refined products.”
In the case of Europe, McNulty said that natural gas “remains absolutely critical, even life or death in certain cases.”
The energy transition as it plays out, has a voracious appetite for capital too.
“At a minimum, it will require natural gas, liquefied natural gas, and renewable natural gas for a very long time,” he said.
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