Closing the dividend gap… more to come in 2017
● Coverage universe: nine companies; the European large-cap IOCs and US supermajors Exxon and Chevron. Aggregate market capitalisation is cUSD1.4trn.
● What’s changed: MTM 2017 oil price to USD55/bbl (EPS +16%, CFFO +5%), upgraded Repsol to Outperform, closed ENI Short.
● Top picks unchanged: BP, Total and Galp
● Top level views: Macroeconomic outlook remains cautious: low-cost producers bring oil to market faster than consensus expects. Challenging industrial outlook for Big Oil: Low growth, low returns, higher operational and financial risk, decarbonisation. Positive equity proposition: based on a FCF turning point that is now accelerating for the next 12 months.
● What’s the debate: With OPEC and Non-OPEC agreeing to manage oil supply, what are the risks to the upside and the downside? Can Big Oil sustain dividend yields that are meaningfully higher than the market while investing sufficiently to maintain its upstream portfolio?
● Framework: A Big Oil Scorecard for 2017, which encompasses
1) Financial resilience, 2) Operational resilience, 3) 2017 cash flow bridge, 4) Balance sheet stress, and 5) The path to 2020 & long-term dividend coverage. We overlay our scorecard against valuation to drive our recommendations.
● Ratings: (+) BP, Total, Galp, Repsol (=) Chevron, Royal Dutch Shell, ENI (-) Exxon, Statoil Exane BNP Paribas
● Where are we versus consensus? We remain lower than consensus on both our oil price assumptions and cash flow estimates. Within the supermajors we continue to favour BP & Total. We upgraded Repsol to Outperform based on: 1) potential upside from lower capital intensity in the medium term, 2) the removal of the credit rating overhang, and 3) an ability to positively surprise on cash return.
● How to pitch the sector: Still positive on a 6- to 12-month time horizon. If we are right on a >520bps improvement in 2017 FCF yield, driving cash dividend coverage to 1.2x, Big Oil multiples will expand further this year. Mean reversion to the historical relative dividend yield premium versus the market (140bps) implies further 20% upside. Poised to benefit from any extension of the reflation trade.
● Risks/Pushback? Oil deck overly conservative… based on historical deal, which includes both OPEC and Non-OPEC producers. Been here before…FCF dependent on a combination of growth, execution and restrain on future capital investment.
Calls remain too defensive: Statoil, ENI & RD Shell highly geared to rising oil price. Repsol‘s outperformance in 2016 limits further upside.