These oil giants are shedding assets

Some of the industry's largest companies are pruning costs to beef up cash flow.

Vikram Barhat 21 March, 2017 | 5:00PM
Facebook Twitter LinkedIn

Persistent geo-political uncertainty, supply glut, lower oil prices and shrinking profits have left the oil industry fighting a multi-pronged battle.

The industry's struggle is clearly reflected in the performance of oil-designated indices. On a year-to-date basis, the S&P Global Oil Index is down 6.5% whereas the Dow Jones Commodity Index Crude Oil has fallen 11.9%, compared to a 6.4% gain for the S&P 500, as of March 10.

Unable to grow revenue as consistently as they once did, oil companies are taking some tough measures to cut costs and investments to ride out the crude price slump that's buffeted the business for more than two years.

The recent US$7.25 billion divestment decision by Shell was only one in a series of similar moves made or being considered by some of the industry's largest constituents. Cutting the chaff from their portfolio, many others are taking massive charges, shelving projects and selling non-core assets in order to contain losses, shore up cash to fund debt reduction and buybacks, as well as improve underlying margins.

While oil prices are widely expected to remain lower for longer and any recovery to be modest, the following oil behemoths are recalibrating their business models, getting thrifty and pulling various levers to stay profitable at current oil prices. While each of these stocks pays a juicy dividend, investors may want to wait a while for the margin of safety to improve.

Royal Dutch Shell PLC ADR Class B
Ticker RDS.B
Current yield 6.75%
Forward P/E 11.6
Price US$55.68
Fair value US$62
Data as of Mar. 20, 2017

An integrated oil and gas company,  Royal Dutch Shell (RDS.B) explores, produces and refines oil around the world.

The Anglo-Dutch company, which owns and operates gas stations worldwide, is taking strategic steps to compete in a world of low oil prices. "Shell is working to reduce its [bloated] cost base by reducing headcount and improving its supply chain," says a Morningstar equity report.

The integration of BG Group, acquired last year, holds potential for cost-reduction synergies, while "BG's low-cost production reduces Shell's per-barrel operating cost," the report notes.

At the same time, the oil giant is tightening its purse strings and shedding risky assets. "Shell plans to dramatically reduce investment levels by capping yearly capital spending at US$30 billion through 2020, versus the nearly US$50 billion it spent in 2014," says Morningstar sector strategist, Allen Good. "The sharp decrease should improve capital efficiency, but should not completely sacrifice growth."

The spending reduction, he adds, is partly a function of cancelled marginal projects that are no longer economical, but is also achieved through cost cuts and improved performance, improving potential returns.

"As a result of its collective efforts, Shell should boost margins and improve returns by 2020, leaving it in a better competitive position," says Good whose fair value estimate of US$62 per American Depository Receipt (ADR) indicates room for price growth.

Good warns the firm is unlikely to meet its goal of 10% return on capital, but is more optimistic about management achieving its free cash flow target of US$20 billion with oil at US$65 and some additional cost-cutting.

Exxon Mobil Corp.
Ticker XOM
Current yield 3.66%
Forward P/E 17.4
Price US$82.00
Fair value US$81
Data as of Mar. 20, 2017

 ExxonMobil (XOM) is an integrated oil and gas giant with operations around the world. The company is the world's largest refiner and one of the world's largest manufacturers of commodity and specialty chemicals.

"ExxonMobil has historically set itself apart from the other majors as a superior capital allocator and operator, delivering higher returns on capital relative to peers as a result," says a Morningstar equity report.

In a bid to stay competitive in the current environment, the firm is considering selling assets in Australia, the U.S. and Norway, following its industry peers, according to Reuters. Further, to improve returns and cope with lower oil prices, Exxon is shifting investment toward shorter-cycle projects. "The combination of long-life assets and flexible investment in short-cycle assets should safeguard free cash flow in a volatile oil price environment, leaving Exxon able to cover the dividend at oil prices as low as US$40 per barrel," says Good who recently raised the stock's fair value from US$79 to US$81.

Among integrated players, Exxon remains the highest-quality with respect to generating "superior returns from the integration of low-cost assets combined with a low cost of capital," says Good. "This combination produces excess returns greater than those of its peers."

He cautions Exxon's returns could be lower than they have been in the past due to lower long-term oil and natural gas prices. But, on a more positive note, Good commends management's record of generating shareholder returns, assigning it Exemplary stewardship rating.

Total SA ADR
Ticker TOT
Current yield 5.36%
Forward P/E 10.9
Price US$49.54
Fair value US$53
Data as of Mar. 20, 2017

 Total (TOT) is an integrated oil and gas company with global presence. The French oil major also operates refineries, primarily in Europe, distributes refined products in 65 countries and manufactures commodity and specialty chemicals.

Like its rivals across the Atlantic, Total has been sloughing off assets to cut costs to offset the impact of lower oil prices. Morningstar forecasts capital spending to fall to US$15 billion-US$17 billion between 2017 and 2020 from US$18 billion-US$19 billion in 2016.

As a result of keeping a tight lid on costs, the oil behemoth was able to swing to a net profit of US$548 million in the fourth quarter of 2016 from a loss of US$1.6 billion in the same period a year earlier, posting a 12% revenue jump. Total is running an extensive program to slash operating costs at all its units and cut capital investment, while ratcheting up efforts to extract more oil from existing fields. "Total stands to meaningfully improve its cash flow generating power in the next several years through peer-leading production growth and operating cost cuts," says a Morningstar equity report.

The magnitude of the cost reduction should help improve margin. "Already one of the lower cost operators, Total aims to reduce per barrel operating costs to US$5 per barrel of oil equivalent by 2018, a 50% cut from 2014 levels," says Good, who recently hiked the stock's fair value from US$35 to US$53.

Ticker BP
Current yield 7.00%
Forward P/E 11.2
Price US$34.19
Fair value US$35
Data as of Mar. 20, 2017

British oil giant  BP PLC (BP) explores, produces and refines oil around the world. Like its European and American peers, BP is maintaining strict cash discipline, cutting costs, divesting assets and redeploying capital in low-cost oil extraction projects. The company aims for its exploration and production unit to generate US$13-US$14 billion in free cash flow by 2021.

Having reached a US$23 billion settlement with the U.S. Federal Government for the 2010 Deepwater Horizon accident, BP is now turning its focus to positioning itself to compete in a world of plummeting oil prices. "Its first step is to improve its cost structure and reduce its capital outlays so that it can cover its dividend at US$55/barrel oil by 2017," says a Morningstar equity report.

Good says while this goal is slightly ambitious, "it is likely achievable by 2018, making it one of the safest dividends among the European integrateds."

Further, BP's spending will fall to US$15-17 billion from 2017, a sharp contraction from the US$25 billion peak in 2013. "At this level, BP will continue to invest the least among the peer group for its level of production," says Good, noting that the firm "will continue to grow through a mix of projects already under construction or nearing completion."

BP plans to add 800 thousand barrels of new gross production to its capacity by 2020. "With these new volumes sporting margins 35% greater than the existing portfolio, BP's upstream margin should improve further over time," says Good, who recently upgraded the stock's fair value from US$33 to US$35.

Complete access to Morningstar's research on equities, mutual funds and exchange-traded funds is available to subscribers to Morningstar Canada Premium.

Facebook Twitter LinkedIn

About Author

Vikram Barhat

Vikram Barhat  Vikram Barhat is a Toronto-based financial writer specializing in investing, stock markets, personal finance and other areas of the financial services industry. He also writes for CNBC, BBC, The Globe and Mail, and Toronto Star.

© Copyright 2022 Morningstar, Inc. All rights reserved.

Terms of Use        Privacy Policy