Statoil – Iffy Operations, But Serious Potential Value

By Stephen D. Simpson, CFA | February 29, 2012 AAA

There are not many freebies in oil and gas, so if an investor wants to own an E&P company trading at a low valuation, there is a price to be paid in quality. The question with Norway's Statoil (NYSE:STO) is just how much of a discount is really fair. Although Statoil does indeed have issues with its cost structure and reserve base, the company's above-average growth potential and capacity for additional deals argues that the discount today is too steep.

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Familiar Problems Show up in Q4
Statoil's fourth quarter results weren't too surprising to long-term followers of this story. Although production slightly beat expectations, it grew less than 1% overall, as declines in Norwegian production offset better than 25% growth from international projects.

Profitability is still a concern as well. While net results looked good due to a lower-than-expected tax rate, the so-called "clean" EBIT missed expectations by about 4%. The miss was driven entirely by the international operations, were a variety of costs and claims pressured margins. (For related reading, see A Look At Corporate Profit Margins.)

Modest Growth Expectations For Now
Statoil had logged several years of unimpressive reserve replacement, but 2011's results were better than 100% (117%). With a level of reserves that are fairly low in absolute terms, that's no minor accomplishment. Moreover, management did reiterate an expectation to average about 3% production growth out through 2020.

That doesn't sound great, but a little perspective is in order. Compared to other majors like Exxon Mobil (NYSE:XOM), ConocoPhillips (NYSE:COP) or Total (NYSE:TOT), these are actually pretty solid results and put Statoil near the top of the chart in terms of growth potential.

What's more, Statoil is investing heavily in exploration and growth through the drillbit, and early results have been encouraging. While finding large reserves of natural gas in Africa is a mixed blessing (since it will require expensive processing and transportation), oil discoveries haven't been too bad either.

What About the Costs?
Perhaps the biggest issue for Statoil is the cost of this oncoming production. While Statoil may score well in terms of production growth expectations, it does not score nearly so well in terms of finding and development or cash production costs.

Part of the problem is how and where the company operates. Statoil is an expert in offshore and harsh environment production; while this means that Statoil can find and deliver oil where others simply lack the ability to go, it comes at a higher cost. If oil prices stay high, that may not matter much, but oil prices much below $75 a barrel put this company in the unenviable place of spending more than average to make less than average.

At the same time, there is a risk that the company overspends to add reserves. The deal for Brigham brought the company good exposure to unconventional oil in the Bakken, and a deal with Chesapeake (NYSE:CHK) likewise gave it a stake in the Marcellus. But these deals were not cheap and it remains to be seen if there's a compelling long-term return case to make for Statoil continuing to write fat checks for unconventional U.S. plays.

The Bottom Line
I don't necessarily believe that there's a proper price for every stock, as some companies are just garbage. I do believe, though, that there is a point where companies like Statoil are unfairly or unreasonably discounted on the basis of the operational shortcomings.

Major oil and gas companies are trading for around 4.5 to 6 times 2012 EBTIDA estimates, while Statoil trades at less than half of that. Is Statoil truly less than half as good as Exxon or Total? I accept that the company has too little in reserves and needs to jettison low-return assets in the North Sea. But I don't accept that the company's prospects are so poor as to be truly worthy of such a low multiple. While I'd probably want to pair a buy of Statoil with one or two other names (like Apache (NYSE:APA) or maybe another U.S./European major), I think this is a stock worth a serious look today. (For related reading, see A Clear Look At EBITDA.)

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At the time of writing, Stephen Simpson did not own shares in any of the companies mentioned in this article.

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