The great thing about investing is that there's no one right way to make money. Some investors do quite well surfing along with the crowd and have the dexterity to get in or out just as the mood starts to shift. Others succeed by boldly trusting their own analysis and going directly against prevailing sentiment. Investors considering Norwegian oil and gas company Statoil (NYSE:STO) need to be more of that latter mindset. While Statoil has changed for the better in some significant ways over a relatively short time period, the company is hardly a darling on the Street.
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Second Quarter Results Suggest the Bears Have a Point
Some of the bear thesis on Statoil revolves around the idea that Statoil is still locked into uninspiring productive assets (like the North Sea), and that it will take considerable capital to grow and diversify the asset base. At the same time, the new growth opportunities will cost more to exploit and cap the company's returns.
Well, some of that seemed to be the case in the company's second quarter. Although production was strong - up 20% or 17% depending on whether you look at entitlement or equity production - and actually better than expected, the company missed the average sell-side operating income target again. Adjusted operating profit rose 5%, missing expectations by about 4% as the company saw higher operating and exploration expenses.
SEE: Understanding The Income Statement
Production Ought to Grow ... But at What Price?
Q2 earnings do reflect the basic dichotomy for these shares. Among the oil and gas majors, only Italy's Eni (NYSE:E) has been more successful in discovering new oil and gas reserves over the past two or three years, and Statoil's rate of discovery is well ahead of the likes of Anadarko (NYSE:APC), BP (NYSE:BP) or Exxon Mobil (NYSE:XOM).
The question, though, is how much this will actually benefit the company. Statoil has shifted toward higher-risk/higher-impact exploration and development and has significantly increased its footprint in unconventional plays. Unfortunately, deepwater, harsh environment and unconventional shale plays typically cost more to develop. As a result, most analysts seem to expect a return of 20-25% on Statoil's discoveries - well below the estimated return of companies like Exxon Mobil or Apache (NYSE:APA).
It's actually a two-pronged problem. First, Statoil's exploration and production will cost more. Land drillers will charge thousands of dollars a day for a simple well, but Transocean (NYSE:RIG) gets hundreds of thousands of dollars per day for deepwater drilling. Likewise, the services and equipment from companies like Halliburton (NYSE:HAL) and National Oilwell (NYSE:NOV) get more expensive when they go unconventional.
But that's not all. Finding robust reserves in Angola or Tanzania is all well and good, but there's not much local demand for the oil and gas. Consequently, companies like Statoil have to build infrastructure (like FPSOs) to get those resources to markets that value them, and that requires capital.
The Bottom Line
If you look at the commentary around companies like Exxon Mobil, Total (NYSE:TOT) or Chevron (NYSE:CVX), it's pretty clear that what Wall Street wants more than anything is higher dividends and share buybacks - but at the same time, it will happily punish any apparent or perceived shortfall in production. So, basically, it wants oil companies to hand back all of their cash, spend as little as possible on exploration/development, but still grow production. Neat, huh?
SEE: A Breakdown Of Stock Buybacks
Well, Statoil isn't going to do that. The company realizes that it takes money to make money, and divdend/buyback growth will take a backseat to asset/production development. All of that said, Statoil's operating expenses are high (the cash breakeven price would seem to require $100+ oil), and that's a concern.
Given Statoil's higher expense structure and elevated capital needs, I give the company only two-thirds of the forward multiple that I would a company like Exxon or Chevron. At three times 2013 EBITDA, though, the shares still look as though they should trade into the $30s. This isn't a stock for everybody, and it will take time and patience to work out, but the value proposition seems interesting all the same.
At the time of writing, Stephen D. Simpson did not own shares in any of the companies mentioned in this article.