On Track to Recovery
I believe in the upside potential of British Petroleum (BP), which is one of the big positions owned by Seth Klarman, the legendary value investor who founded Baupost and author of the value investing bible, "Margin of Safety."
The upside at British Petroleum is materially greater than any further downside risk from the 2010 oil spill that has put the company into disruption over the last few years. The sell-off that followed the platform explosion in the Gulf of Mexico has erased more than $50 billion of the company's market capitalization, creating a historical investment opportunity. The shares currently discount the worst-case scenario as British Petroleum trades at a 13% discount to its European peers.
That said, bumpy earnings should be expected as the heavy restructuring that followed the oil spill disaster has made the company sell more than $36 billion of assets. Last quarter's results were proof of my "bumpy earnings theory." Adjusted earnings of $2.7 billion were 22% below consensus, down 26% year-over-year, driven by weak upstream and Rosneft (British Petroleum owns 20% of Rosneft after selling its 50% share in TNK-BP).
Given the above, combined with the fact that the company expects to maintain its annual exploration spending to double the level in recent years while planning to complete 15 to 20 deep-water exploration wells as part of its strategy to create long-term value, I expect British Petroleum to be able to reach its cash flow target of $30 billion by 2014.
Being lowly geared (net debt ratio is at 0.6 times EBITDAX), buying back shares ($1.9 billion a year), trading at 5 times EV/EBITDAX in 2013 and offering 5% cash dividend yield, it is time to buy British Petroleum if you can bear a bumpy ride.
Keeping Your Eyes Set on the Future
Occidental Petroleum (OXY), just bought by George Soros for his family-owned hedge fund, is more highly leveraged into oil than most of its large exploration and production (E&P) peers. That said, the company presented slightly disappointing quarterly earnings. Earnings were down 4% from a year ago and 7% sequentially despite the good results at the oil and gas division. Nevertheless, the future performance of the stock will mainly depend on what the board decides about corporate restructuring.
Occidental appears on track to announce restructuring actions before 2014 starts. The company's divestitures will most likely involve its Middle East assets and its operations in California. The Permian assets could be next on the monetization list. Occidental also plans to sell a share of its 35% stake in the general partner of the Plains All American MLP.
Management plans to boost value not only through divestitures but also through spinning off its non-core divisions. Divestiture proceeds will be (at least partly) used to buy back 20% or more of the company's shares. Trading at 7 times EV/EBITDAX in 2013, Occidental could be a good buy thinking of the future.
Share Buy-Backs Likely Remain
Hess (HES) is present in the portfolios of value investing legend Mario Gabelli and also in the portfolio one of the street's hottest managers, Daniel Loeb, the activist investor who owns Third Point LLC.
Hess expects to achieve a five-year compounded annual growth rate of 5% to 8% through 2017 from its 2012 base line. The good news for investors is that the company knows how to achieve such growth. Hess will focus its attention on un-conventionals (mainly investing in the Bakken and Utica formations) and in rich areas such as Ghana.
My short-term interest in Hess comes from the earlier-than-expected start of its $4 billion share buy-back program, as well as the 150% dividend increase this quarter (which appears sustainable).
Financially, the company is performing amazingly well thanks to the $4.5 billion divestiture proceeds that funded a $2.4 billion debt reduction. I think Hess will keep on selling assets (up to $3 billion) in the next two to six months in order to close the existent capex funding gap (operating cash flow of $1.2 billion is significantly below the $1.5 billion capex).
Trading at 5.6 times EV/EBITDAX in 2013, I think Hess has a huge valuation upside going forward .
The three companies named above are selling assets, restructuring operations and buying-back shares. They are also focusing on higher margin projects and preparing themselves for the future. While British Petroleum is still a risky asset (since its fate ultimately depends on decisions made by U.S. courts), Occidental and Hess represent unavoidable options for anyone looking for high-quality growth within the U.S. oil and gas sector.