Progress but Big Oil has much to do
The 2017 financial framework for the supermajors has been reset towards a USD 50/bbl outlook. The strategic model though is still wanting. We outline: 1) to compete for capital, Big Oil needs to move further down the cost curve towards the US shale producers. The concern is that the industry is more structurally impaired if OPEC is more aggressive on increasing market share. 2) Financial risk is rising. A path to deleverage balance sheets is not obvious, absent a material rise in oil prices. Big Oil becomes a more risky asset class that operates in a more challenging operational, geopolitical and regulatory environment. 3) A rethink on dividends is required, given the cyclicality of oil prices and we argue for a fixed and variable component to payouts.
A scorecard for the supermajors
We review: 1) operational and financial resilience; 2) cash generation from growth projects; 3) cost reductions and disposals; and 4) cash burn and dividend coverage. We then review these results against valuation metrics.
Business models more robust in the US but Europe 'cheaper'
With the sector discounting USD 55-60/bbl, we do not regard the fundamental risk-reward for the equities as attractive. Global Big Oil is trading at a 2017E EV/DACF of 9.3x, a 35% premium to the 10-year historical multiple, with a 5.3% dividend yield that compares with a free cash flow yield of 4.5%. The US supermajors have lower oil price break-evens in terms of 2017 cash cycles alongside superior balance sheets. The European supermajors are 'cheaper' on EV/DACF (7.1x versus 10.8x for the US) and dividend yields (6.2% versus c4%), but have a more indifferent record in terms of investment decisions and greater risks to dividends if low oil prices persist into 2017. However, given the implied 35% discount on cash flow multiples versus a 10-year historical average discount of 15%, we think these factors are somewhat discounted.
Total upgraded, Shell (Buy), Exxon (Reduce), Chevron and BP (Neutral)
We upgrade Total to a Buy reflecting: 1) less near-term exposure to the US, complemented by PSCs and Middle East ‘fixed’ margin contracts; and 2) increased capital flexibility beyond 2017. RD/Shell (Buy) is on a watching brief given the level of cash burn in the absence of disposals, while a cut in 2016 capex guidance is now partly priced in (NMRe: USD 27bn). If these tools are not executed, Shell is most at risk of a review of its dividend payout in 2017. We see a weak set of 1Qs before a positive 7 June strategy update. BP (Neutral) sees 2016 cash burn exacerbated by Macondo cash outflows of USD 3bn-4bn. There is E&P growth with c850kboe/d of potential start-ups/ramp-ups to 2020 but the profile is back-end loaded. We initiate coverage of Exxon with a Reduce on valuation grounds. XOM’s downstream integration/resilience is well understood, but the 40% EV DACF premium is stretched given a narrowing in forward-looking ROACE and cash returns. Our Neutral rating on Chevron reflects the balance between providing the highest rate of FCF growth (2015-17E) against aggressive 2016 cash burn and project execution risks.