Articles

30.09.2015

Undervalued oil companies

Since the end of 2014 there has been a correction on commodity markets lead by the oil market. As a result, many commodities are trading at the lowest prices since the Great Recession. Slower growth in the emerging markets, particularly in China, resulted in a fall of demand for commodities. At the same time production of many of those commodities continues to grow despite the fundamental changes of market conditions. A perfect example would be the oil market in the US, which was booming with the help of shale revolution and cheap financing.

When the price of oil was around $100 a barrel the shale boom was largely driven by small companies. According to the Manhattan Institute for Policy Research, more than 20,000 small and mid-size firms lead the "hydrocarbon revolution" in the U.S. that has helped the oil and gas industry thrive in past years, and they produced more than 75% of the nation's oil and gas output. After oil prices have halved many of those smaller players are doomed to go bankrupt, while big companies are cutting capital spending and jobs.

At the end of the day, big energy companies will inevitably have a higher market share. In picking the best energy companies it is important that those energy producers have low debt levels and high liquidity so that they could cope with the market pressures and low oil prices. Also, it is critical that companies have a well-diversified revenue stream coming not only from exploration and production (E&P), but also a high proportion of downstream production and petrochemical production.

Based on our analysis, in the US energy sector two companies satisfy these criteria: Exxon Mobil Corporation and Chevron Corporation.

It is critical for these companies to maintaining high levels of production. Both Exxon and Chevron in 2Q 2015 have increased production, despite the fact that crude oil prices have declined 29.4% since the peak in May and 22% YTD. In 2Q 2015 Exxon Mobil Corp.'s production went up 4% YoY reaching a daily production of 3.98 million boe. Chevron Corp.'s production has also increased, but at a slower pace of 2% reaching 2.6 million boe.

Both Exxon and Chevron have very low debt load with Debt-to-Capital standing at 15.9% and 17.0% respectively. It is worth mentioning that Exxon Mobil has a rather low current ratio of 0.88. Low debt levels allow these companies to be active in acquiring smaller companies and increasing their market share.

Both companies have a decent dividend yield despite falling oil prices and lower profits. Exxon Mobil has a dividend yield of 3.88%, while Chevron's dividend yield is even higher standing at 5.52%.

It also has to be noted that both Exxon and Chevron have low price-to-book ratios compared to the general market. Currently, companies in the S&P 500 Index have an average P/B of 2.6. Exxon's and Chevron's peers' average P/B stands at 1.34. At the moment, Chevron's P/B is very low standing at 0.95. Exxon's P/B of 1.77 shows signs of overvaluation compared to its peers.

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