Structural rather than cyclical
It may not be exciting, but this is a sector that should offer investors multi-year TSR not volatility in capital value. Something has gone wrong. Since the start of 2012 the group has underperformed by 25% as confidence in the long-term outlook for dividend growth has been undermined. Returns have halved. Organic net cash flow has been negative since ‘09. But with a 0.7x rating of IC consistent with 2013e CROCI & 4.5% implied dividend growth in-line with 50% retention at a 9-10% ROE, it is difficult to argue that the sector is ‘cheap'.
Strengthening cash cycle offers some encouragement
Our analysis suggests that the outlook for FCF is improving. IF current guidance is adhered to, spend will stabilise after growing at 10% p.a. for the past decade. New projects offer cash margins which are, on average, >50% higher than the base business. $100/bbl Brent and flat capex would see the sector fully covering dividend from organic FCF in 2015; surely a signal for improving sentiment. But is this realistic? Possibly, but with the frontier of spending growth and oil price generating surplus Net Cash Flow finely poised, and with an expected doubling in deepwater spend (to 40% of budget) by 2016 flagging the next area of inflation risk, we argue that investors have little reason to pay for the promise of FCF growth until its delivery is more assured.
Eoin Treacy's view European oil companies do not have the exploration friendly domestic environment that US majors enjoy and also have the challenge of growing their resource base internationally. Howeer, they are nonetheless among the world's largest explorers, with particular expertise in deep water drilling.
BG Group has one of the more noteworthy chart patterns in the European sector. The share found support near 1000p in November and continues to hold a progression of higher reaction lows. A sustained move below 1200p would now be required to question medium-term scope for additional upside
Royal Dutch Shell has fallen back to retest the lower side of the more than yearlong range near 2150p over the last week. It steadied somewhat today and a sustained move below 2100p would be required to question potential for an additional bounce from this area.