The journey has been long and hard, but there’s a good chance that 2018 will mark a “sweet spot” for oil majors Royal Dutch Shell (RDSB) and BP (BP.).
That’s the view of UBS analysts, who believe there’s now a clearer picture of the industry after three years in which companies have scrambled to bring down costs and investment levels in line with oil prices.
In their note “The end of the beginning”, UBS’s European oil and gas team said an oil price in the $60 to $80 a barrel range now looked increasingly plausible.
They added: “We could be entering the sweet spot for the integrated sector with oil prices recovering, the downstream strong and spending under control.”
Having reset their businesses between 2015 and 2017, UBS estimates that the point of cash neutrality for oil majors is likely to be $51 dollars a barrel in 2018. This figure crossed below the oil price in the second half of 2017.
They said: “The prospect for 2018 and 2019 is a sector that funds its investments and dividends and can generate attractive free cash flow (FCF) over and above that.
“We expect the excess FCF to be used to reduce debt, reduce equity in issuance and perhaps some tactical M&A.”
Cash returned to shareholders is calculated to rise by 48% in 2018 versus 2017.
UBS makes no apology for having the same two top picks for 2018 as in 2017 – Royal Dutch Shell and Eni (E).
It said Royal Dutch Shell continues to represent the best example of the integrated business model. Its preference for Shell is based on a qualitative judgement of its portfolio and an upside comparison with the much higher-rated international peer, ExxonMobil (XOM).
UBS believes that 2018 will be a year of execution for Shell, having been through the pain of resetting its financial model and dealing with the market’s negative reaction to its acquisition of BG Group.
UBS said the criticism of the BG deal misunderstood the weakening competitive position of the legacy Shell portfolio and the quality of the acquisition.
It added that recent Shell investor days have highlighted the value that this deal has brought, and the catalyst it represented on the wider restructuring of the group, which is not fully appreciated by the market.
UBS has a price target of 2,675p, which is based on a 2018 enterprise value (EV)/ debt-adjusted cash flow multiple of 7.4. This is about a 25% premium to the three-year average, reflecting improved capital productivity, and a modest premium to European peers reflecting the company’s portfolio advantage.
BP and Total (TTA) are also ‘buys’ as they join Shell in the “sweet spot” for shareholder value generation.
BP has made significant strategic progress in 2017, while its Gulf of Mexico oil spill payments are expected to tail off significantly in 2018. Six of its seven major projects for 2017 have started up, with the other about to get underway.
UBS forecasts 2016-21 production growth at about 3% per annum.
The company’s downstream operations have also been surprisingly strong, with retail, brand driven marketing and lubricants justifying a premium to the corporate multiple.
UBS has a ‘buy’ recommendation and 550p price target based on an EV multiple of 7.0, with projected 2018 dividend yield of 6.1%.
This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.