With global financial markets seized up and credit scarce, energy companies that have cash on hand may be able to take advantage of overlevered, distressed firms in the near future, Raymond James & Associates Inc. analysts said in a report issued Monday.
In the latest Stat of the Week, Raymond James energy analyst J. Marshall Adkins noted that ongoing global financial woes are likely to have far-reaching consequences.
“Investors need to understand that the global financial changes that occurred over the past few weeks will not only affect over-levered Wall Street financial firms, but that these problems will permeate the entire global economy and negatively impact virtually all businesses, including the energy markets,” wrote Adkins.
The recent economic turmoil brings with it major fundamental changes to the energy outlook, according to Adkins, including:
Exploration and production companies, which traditionally outspend their cash flow, should see lower production growth and reduced drilling activity, along with a continued slowing of the pace of M&A, which is already well off its 2005-2006 peak levels, Adkins said. The oilfield service group has low debt leverage and very few companies will need to tap the credit markets in coming months, but the group could be hurt by reduced drilling activity, he said.
“Strong cash flows and limited reinvestment opportunities have allowed most oil service companies to build strong balance sheets,” Adkins wrote. “In fact, the recent stock price plunge could be a catalyst for further oilfield service M&A, as many oilfield service companies are sitting on piles of excess cash.”
Adkins sees a better outlook for coal companies, which he said should see strong cash flows and substantial delevering in 2009. While the industry remains somewhat highly leveraged, it will start to benefit from meaningfully higher priced coal contracts next year. “As the coal sector begins to generate substantial free cash flows from largely already locked-in contracts, most companies should begin to see meaningful delevering next year with no help from the capital markets,” he said.
The alternative energy sector’s rapid build-out of capacity has outpaced the cash flow of most companies in the sector, which means many of those same companies need regular infusions of outside capital to drive growth. The credit crunch could be particularly hard on some alternative energy companies, but others — especially solar companies, which have often avoided leverage — may avoid the worst of the slowdown.
The potential higher cost of capital environment will likely lower the slope of the cash flow growth curve for midstream master limited partnerships (MLP), where access to the capital markets is of vital importance, Adkins said. “With current yields having widened to historic proportion, the ability to raise public equity for MLPs had all but evaporated,” he wrote. “As such, partnerships are relying more on excessive cash flow coverage for working capital purposes, as well as focusing on increasing debt levels to fund growth.”
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