TD Notes We Recommend Buying Energy Equities on MTD Correction
Here is Why...
Since reaching recent peak share prices earlier this month, the price of upstream energy equities has fallen sharply. The median E&P in our coverage group fell 30% from peak levels, before regaining some of those losses over the past two trading sessions. In our view, the recent pullback provides an attractive opportunity for shareholders to increase positions in energy equities — including generalist asset managers who may be underweight the sector (i.e., if you felt as though you had missed an opportunity last month, the recent share-price decline provides another chance).
Although there has been strong share-price performance in energy equities over the past couple of trading days, the prices of energy equities remain well below recent peaks. Moreover, despite the share-price erosion, oil futures have remained very resilient and consensus CF estimates have been nudged higher — a trend we expect to continue as sell-side analysts update commodity price assumptions in conjunction with the quarter-end.
Key Takeaways
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Share Price Performance; Lots of Ground to Reclaim: The median E&P in our coverage universe fell 30% from recent peak levels. Although there has been a median 8% recovery from the recent trough, this leaves the median E&Ps' share price down 24% from the levels reached in early-June. [Exhibit 1]
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Consensus Estimates Walked Higher this Month; More Upward Revisions Possible: Interestingly, as share prices were eroding, consensus estimates for the sector were slowly being raised. This may reflect sell-side analysts incorporating higher 2023 commodity price assumptions into their models as they roll out updated models in conjunction with the end of Q2/22. [Exhibit 2]
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We estimate that consensus estimates are predicated on ~US$87.50/bbl WTI and ~US$5/mcf HH in 2023. Given the current spot oil price of US$110/bbl WTI and spot HH gas price of US$6.25/mcf, we believe that Street CF estimates could continue to be nudged higher (even after incorporating rising royalties, cash taxes, and inflation).
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Valuation Once Again Comfortably Below 3-year Average for Most: Earlier this month, many upstream energy equities had traded up to their trailing three- year average multiples. Given the recent share-price correction, the median E&P is now trading at a multiple that is 1.2x below their trailing three-year average. [Exhibit 3]
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Share Price Pullback with Resilient CF Enhances Return-of-capital Benefit to Equity Holders: Given the MTD share-price weakness, investors purchasing the equity today not only benefit from a higher current base dividend yield, but also an increased likelihood that shareholder return commitments will be returning more FCF to equity holders than can be accomplished by the base dividend and maximized NCIBs (i.e., base dividend increases and incremental special/variable dividends increasingly probable). [See TD Industry Note, June 28, 2022]