Would be interested to know your reaction to the following article, from CBS Market Watch.
Indie E&P sector unearths new metric
Old rules for exploration and production no longer apply, analysts say
By Kristen Gerencher, CBS
MarketWatch
Last Update: 5:34 PM ET Mar 14, 2000
Personal Finance News
Mutual Fund Center
HOUSTON, Texas (CBS.MW) -- Has the well of investing
wisdom run dry in the independent oil and gas
exploration and production sector?
Not yet, but fundamental changes in
the industry should convince investors
to raise their standards, according to a
new report by energy industry research
firm Simmons & Company.
A schism beneath the surface of E&P
stocks is calling for a new way to
evaluate them, analysts say. Crude oil
prices have tripled from their year-ago
lows while stocks have languished in
the last six months, so historical
yardsticks like cash flow no longer
measure up.
"The metric is shifting," Dan Pickering,
managing director of research, told
CBS.MarketWatch.com. "It's saying forget about growth.
These guys can't grow fast anymore."
Tougher physical environment
Pickering and macro energy analyst Dave Pursell said
firms should ground themselves in geological reality.
Since oil-producing basins are maturing rapidly,
companies have to drill more wells this year than last
year just to keep production flat. Meanwhile,
independents in the capital-intensive industry now face
the same earnings pressure as their big oil counterparts.
"For years E&P got paid in the stock market to grow
volumes," said Pickering. "Now the demand from
shareholders [is] to grow volumes profitably. That is a
sea change for a lot of these companies to think about
and no longer kid themselves about what the returns are
associated with projects."
Simmons followed 18 E&P companies in the report,
including Apache (APA: news, msgs), Anadarko (APC:
news, msgs), Burlington Resources (BR: news, msgs),
Barrett Resources (BRR: news, msgs), Devon Industries
(DVN: news, msgs), EOG Resources (EOG: news, msgs),
Forest Oil (FST: news, msgs), Kerr-McGee (KMG: news,
msgs), Louis Dreyfus Natural Gas (LD: news, msgs),
Mitchell Energy & Development (MNDA: news, msgs),
Newfield Exploration (NFX: news, msgs), Ocean Energy
(OEI: news, msgs), Pogo Producing Company (PPP: news,
msgs), Stone Energy (SGY: news, msgs), Unocal (UCL:
news, msgs), Union Pacific Resources (UPR: news,
msgs), Vintage Petroleum (VPI: news, msgs), and Vastar
Resources (VRI: news, msgs).
From 1993 to 1998, these companies' average return on
capital was about 6 percent, while the cost of capital was
12 percent, said Pickering. "That alone should tell you
something has to change. That's what the market has
been willing to ignore for the last quite a few years, and
we don't think they're willing to ignore it anymore."
Harder scrutiny
Mark Meyer, Simmons' lead E&P
analyst, said companies need to be
more disciplined investors and better
financial managers who execute on
their reserves. In the meantime, retail
investors should be looking for an
initial multiple range of 15 to 25 times
earnings as well as the more elusive
factor of returns.
"That requires you to look individually
at companies with a much harder
scrutiny along several more complex
dimensions," said Meyer. "If you accept
E&P for what it is -- and I've
characterized it as cyclical, (with) low
margins (and) problematic returns --
then there's really no rationale for the
group to trade on any kind of premium
to other cyclical sectors that offer maybe
more earnings stability or a little bit
better growth than earnings or better
returns."
The attraction of cheap prices has worn off and been
replaced with questions of whether a company's
generating strong returns, if it's drilling in basins with
good money-making potential, and if it's a good operator,
said Meyer.
Some companies have embraced the call for change more
readily than others, said Pickering, who estimates the
transition will take 12 to 24 months to sink in. "It took
three years in big oil and it will take some time in E&P,"
he said.
Meyer pointed to Burlington Resources' move away from
shallow water drilling and its substantial maintenance
costs in the Gulf of Mexico as evidence of one "major
portfolio shift." Apache, on the other hand, remains
committed to growth, he said.
Putting growth in perspective
Wooing investors away from high-flying technology
stocks into a sector that's slowing its growth won't be
easy, said Meyer, adding that demand for E&P grows at
2 percent a year "at best."
"Not everyone needs to grow at 20 to 30 percent a year,"
said Meyer. "There's a margin issue there that erodes
your returns if you overcapitalize or overinvest and try to
grow for the sake of growth's sake when it's way in
excess of demand."
Meyer noted that investors have many more choices
outside of energy than they had in the last economic
expansion. Then "it was okay to look at these guys in the
context of explosive growth rather than the low to
moderate growth cyclicals that they really are."
While the Simmons report challenges the conventional
wisdom about how to measure the sector, Pickering said
the firm is still bullish on opportunities in E&P long
term. "The market will always come back to a good
story," he said. "The problem is you're trying to figure out
what are the good stories in E&P and that's not clear. As
the market figures it out, I think there'll be some
interesting stocks."
Kristen Gerencher is a personal finance reporter for
CBS.MarketWatch.com.
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