The correction in oil and gas prices presents an attractive opportunity for long-term investors to consider exposure to stocks that are value investments in the sector. While choosing stocks, one of the important considerations is the company’s balance sheet health besides the quality of assets. Among the bigger names in the oil and gas sector, I like Statoil (STO, Financial); the stock is worth buying at current levels. This article discusses the company’s balance sheet health and other critical factors that make Statoil worth considering.
The first point worth mentioning about Statoil is the company commands a credit rating of Aa2 from Moody's and AA- from Standard & Poor's. Both the credit rating agencies have assigned a “stable” outlook for the company. I mention this at the onset to underscore the point that the company’s fundamentals are sound even as oil prices have remained lower and the stock has declined by 47% in the last one year. The decline in the stock has been in-line with lower oil prices, but the company is not struggling from a balance sheet perspective.
The second reason to mention the company’s credit rating is the fact that Statoil has significant debt maturity coming in 2016 and 2017. The company would need to refinance debt and I don’t see that as a challenge considering the quality credit.
From an asset perspective, one of the key reasons to like Statoil is the company’s development of Johan Sverdrup, an oil field in the North Sea. Statoil has a roughly 40% stake in the field with a gross recoverable contingent resource range of 1,700 to 2,900MMboe. The first phase of field development will require funding of nearly $14 billion, and this is another reason to start this analysis with the company’s credit health. With strong credit rating and robust cash flows, I don’t see funding the massive development being an issue.
When oil is first delivered by Johan Sverdrup in 2019, the first phase of production is estimated at 315,000 to 380,000 barrels per day. This will drastically change the company’s cash flow outlook as oil prices are likely to be significantly higher in 2019. Further, it is estimated that Johan Sverdrup has break-even at $40 per barrel and even if oil is at $80 to $100 per barrel, the asset will generate robust EBITDA. Therefore, with sentiments depressed, this is the best time to consider exposure to the stock.
While the company’s funding of big investments in the next 3-5 years is likely to come from internal cash flows and debt, I also believe that noncore asset sale will be a source of funding. In the first half of 2015, Statoil generated $2.8 billion in cash from its asset sale, and the company will continue to explore attractive divestment opportunities. This will help keep the leverage in control.
From a valuation perspective, Statoil is trading at trailing 12-month EV/EBITDA of 2.7, price to sales of 0.69 and enterprise value to revenue of 0.9. These metrics indicate that Statoil is undervalued. While the stock is unlikely to surge any time soon, I believe that there is minimal downside from these levels but significant upside potential.
I would still recommend gradual exposure to the stock as the Iran oil supply factor might have a negative impact on oil prices. Once there is more clarity on the amount of supply, further positions can be considered in this long-term value creator.
