· Revisiting Refining – Where do we stand? Prefer VLO, MPC… TSO (Underperform), HFC (Neutral)
OTHER NEWS AND VIEWS
· Royal Dutch Shell… Looking at the future with confidence.
· SBM Offshore… Strengthening the long-term strategy
· Subsea 7… No signs of a let up in orders
· Technip purchases GLBL for $8/share
MOST IMPORTANT TODAY
1) Revisiting Refining – Where do we stand? Prefer VLO, MPC…TSO (Underperform), HFC (Neutral)
· Brent-WTI watch…. While Brent/WTI is holding $23, we remain wary of presuming this is sustainable beyond a short term view. Declining inventories at Cushing, and pending increases in physical storage, both contradict infrastructure bottlenecks in the lower 48 that is still being cited as the primary reason for WTI/Brent at current levels. We believe Libya and North Sea production outages that have coincided with peak Atlantic basin demand have been the primary drivers of the gap, with a real risk of reversal through year-end. From here risks to elevated WTI-Brent expectations look skewed lower. It is worth noting that there is up to 400k bls of North Sea crude that has been offline since April expected to recover by October.
· West Coast Weakness may weigh on TSO following outperformance… The recent strength in PADD V crack spreads has unwound, following a quadrupling (from $6 to $26) in just two weeks. This has since pulled back to ~$10, leaving TSO at risk following a period of outperformance, where TSO has risen 27% in the past 3 weeks. While Self help remains a key driver of the investment case, regional challenges and seasonality on the West Coast may weigh on TSO. It is also worth noting that ultimately Asian access to what has long been viewed as a protected West Coast market, also presents a longer term challenge. TSO has the greatest exposure to California, which remains the weakest market in the lower 48.
· 3Q EPS will be big, but seasonal risks may weigh…VLO stunned the market at the Barclays conference suggesting that 3Q11 EPS could top $2/share. We have also known that with 2/3 of the quarter over our preliminary estimates suggest HFC can exceed $2 per new (split) share vs consensus that currently stands around $1.86. Critically, for as long as WTI - Brent remains dislocated, HFC's earnings momentum likely remains strong vs consensus. Lastly, we would note that MPC also has significant leverage to Mid-continent strength, and along with VLO has largely failed to participate in the strong sector performance – in spite of EPS momentum that is in place. We believe now is the time to get defensive in refining, leaving MPC and VLO as our top refining picks vs TSO, and HFC.
Specialist Sales Conclusions: Seasonality, coupled with near term risks to the WTI/Brent spread as North Sea Crude production recovers leaves us defensive at a time when the refining sector has outperformed (Refiners have outperformed the S&P 500 Energy Index by 600bps over the past month). While pending 3Q estimate revisions may present a catalyst we would also argue that this is a known entity at this point. Our preferred names offer a strong combination of operating catalysts and valuations that are attractive on both an absolute and relative basis. With organic project visibility that can drive significant earnings momentum irrespective of margins and upside to fair value that stands as the highest of its peers, VLO and MPC are preferred for any sector exposure. Near term, seasonal margin risks will challenge all stocks so that a pairs strategy may be attractive for those with a short term investment horizon Preferred long / short pairs VLO / TSO and MPC / HFC respectively.
OTHER NEWS AND VIEWS
1) Royal Dutch Shell… Looking at the future with confidence… Shell's investor day last week brought a confident and reassuring message, albeit limited news. E&P performance remains strong, with 1) the Canada & Qatar mega-projects (Pearl GTL; QG4 LNG and Athabasca upgrade) ramping up in line with expectations: 2) drilling in the GoM is now back at full speed with 5 rigs operating since August; and 3) the new wave of projects (eg, Appomattox and Vito fields in the US; the Arrow acquisition in Australia unconventional gas) to sustain growth post-2015 is steadily maturing…. Downstream remains challenging but the measures taken (cost reductions, growing efficiency gains, disposals) should gradually improve its performance. Capex going into downstream has been significantly reduced and the new investment in the segment appears to target selective growth in marketing and some opportunities in chemicals (eg, Qatar). Management appears extremely confident in reaching their targets of 50-80% increase in op cashflow (09-12) in a US$60-80/bbl world with the business generating positive free cashflow at US$60/bbl… Alejandro Demichelis stays Neutral on the name, as Shell’s valuation relative to peers is extreme (a 23% premium to peers BP, Eni and Total), although clearly Shell faces far less trouble than its Euro peers, making it attractive in uncertain markets.
2) SBM Offshore… Strengthening the long-term strategy… SBM Offshore's backlog structure today looks to have de-risked significantly vs the last few years. With more emphasis being placed on FPSO units and turrets, SBM Offshore is clearly focusing on its core skill set. We believe the incoming CEO will further develop this strategy and may look to further broaden the opportunity in FPSO’s, maximising their market leading position. We also see
securing local content relationships in regions such as Brazil and fully utilising the Paenal yard (Angola) could bring a key competitive advantage over the near term… Having seen the backlog grow 14% in 1H we believe the backlog can end the year at US$15bn, giving growth of 30% YoY. During 2H we expect to see a number of awards: (1) The conversion of LoI's into firm contracts for Xikomba (US$1.2bn) and Guara Norte (US$3bn+), (2) a turret for Ichthys (US$400m), and (3) several extensions to existing lease contracts, FPSO Brasil, FPSO Marlin Sul, Kuito… SBM Offshore provides one of the most compelling valuation cases in the sector, coupled with earnings and backlog growth, and there is 91% upside to our EUR26 PO.
3) Subsea 7… No signs of a let up in orders… Despite worries about oil prices and global macroeconomics, Subsea 7 is seeing no material changes to its bidding pipeline. The tax increase in the UK has also failed to suppress the appetite for subsea installation. Overall global bidding activity remains strong, with improved pricing in the UK, new tenders announced in Brazil and LNG projects gaining momentum in Australia… Subsea 7 has already seen a 24% increase in the order book YTD, with the backlog currently standing at US$7.9B, giving 18 months of revenue visibility. We see several strong prospects globally which could further push up the backlog and extend the earnings visibility. Norway is likely to be the stronger segment of the North Sea, conventional work is nearing award in West Africa and awards should continue to come in from Brazil and Asia, mainly Australia… Subsea 7 continues to be Fiona Maclean’s preferred name in the subsea installation. With 33% potential upside to our PO of NOK160, we retain our Buy rating.
4) Technip purchases GLBL for $8/share… Technip announced today an agreement to acquire Global Industries (GLBL) and reinforce its leadership in the fast-growing subsea segment of oil services. The transaction values Global Industries at $1,073mm, including approximately $136mm of net debt. Global Industries brings to Technip its complementary subsea know-how, assets and experience, comprising 2,300 employees operating 14 vessels, including notably two newly-built leading edge S-Lay vessels, as well as strong positions in the Gulf of Mexico (US and Mexican waters), Asia-Pacific and the Middle East… Strong revenue synergies are expected as the acquisition will substantially increase Technip’s current capabilities and expand its addressable market by around 30% in deep-to-shore subsea infrastructure. Cost synergies are estimated to be at least US$30 million. Given the anticipated synergies, the transaction is expected to be accretive to Technip's earnings per share by around 5 to 7% in 2013. The transaction is expected to close early in 2012.
From Andy Crispin (European Specialist Sales): Technip is paying 8.9x 2012E EV/EBITDA, or 1.3x book 2011, on consensus estimates. Global has 14 vessels with 2 state of the art S-lay vessels, with heavy lift, and traditionally GLBL has been a shallow/mid water player in GoM and Mexico, with a poor execution track record (company has posted negative EBITDA for 3 out of the last 4 years). GLBL’s backlog is $201.3m (shorter term than Technip's given GoM focus)… We believe this is a sensible deal for Technip given that: 1) enhances its position in the GoM, 2) brings 2 quality vessels and 3) offers significant restructuring potential.