* Expecting inertia to prevail over mean reversion
With the macro not expected to improve, a lengthening track record of patchy execution across the value chain, and no obvious big valuation call we see little reason for the European Oil & Gas sector to reverse its underperformance of 2012 and 2013.
* Integrateds lack compelling bottom-up appeal
There is an absence of strong stories and continued failure to meet targets or expectations. While underperforming, the sector has risen with the market and is closer now to fair value. The 1Q reporting/outlook season may be important in re-setting targets and strategies as they relate to shareholder value but we would recommend waiting to see. Our top pick is BG Group (Buy, PT £14.00).
* Selective in E&Ps; negative in refiners
Faced with a flat/declining oil price, increased competition, cooling M&A, and project execution issues, clearly the environment is challenging for E&P equities. However the best should still be able to grow NAV and deliver returns in 2014. Our top picks share common threads of valuation upside, frontier drilling and/or exposure to Kurdistan: Afren (Buy, PT £2.00); Genel (Buy, PT £11.20); Africa Oil (Buy, PT SKr72.5); Lekoil (Buy, PT £1.10). We expect some respite from the low refining margins of 3Q/4Q13 but downstream conditions to remain under pressure. We see consensus expectations as risked to the downside and valuations as uncompelling. Our top pick and only buy
remains Motor Oil (Buy, PT €9).
* Cautious on Services
In the long term, we believe the case for oil services growth remains strong. However, in the near term, contract delays and a greater focus on capital discipline and value for money from the integrateds should impact earnings and sentiment across the sector. We think this will likely play out positively for the shares of Integrateds versus Services in 1Q14 at least. We prefer companies with high quality asset bases and good backlogs – this drives our positive view on Technip (Buy, PT €95) and PGS (Buy, PT NKr105). We also like Kentz (Buy, PT 730p) for its good earnings visibility and the earnings accretion from the Valerus transaction. We see the OCTG market as structurally challenged, with Tenaris (Sell, PT $41) our least preferred name in the sector.