Battered by the ramifications of rapidly declining oil prices, oil and gas company share prices continued to fall in the first quarter of 2015, but the share price declines have lagged behind the drop in oil prices, suggesting the market is pricing a recovery into the stocks, according to new analysis from IHS (NYSE: IHS).
According to the IHS Energy Oil Share Market Performance Report, which studied share price performance and total returns for the 200 publicly traded exploration and production (E&P) companies in the IHS Herold Global Upstream Performance Review universe, in the first quarter, the group posted a median loss, including dividends, of 8%, compared with a 34% loss in 2014.
“So far in 2015, like we saw in 2014, market returns continue to favor the larger companies who are better suited to withstand a period of sustained lower oil prices,” said Matti Teittinen, senior principal energy equity analyst and author of the IHS report.
Teittinen noted that, prior to the downturn in oil prices, share price performance and valuation multiples favored smaller E&P companies with assets in quality plays as investors focused on production growth over returns on capital.
Teittinen commented that, in contrast with 2014, approximately 30% of companies assessed in the IHS study achieved a positive return in the first quarter of 2015, vs. only 10% last year. The decline in market capitalization has also been less pronounced, IHS said, with the group losing 3% of the beginning year total compared with a 17% loss in 2014.
“While the drop in shareholder returns has been steep, it has been outpaced by the decline in oil prices,” Teittinen said. “We at IHS believe this indicates that the market is factoring in a recovery in oil prices, as well as the ability for companies to capture cost-savings resulting from lower global spending levels. This is further supported by our valuation analysis, which shows that many companies in our IHS coverage universe currently trade at a higher oil-price assumption, with the exception being those that are highly leveraged.”
In response to lower oil prices, the IHS report noted, companies have been sharply cutting 2015 spending plans. Despite these cuts, IHS forecasts that the industry will fall short of funding capital expenditures and dividends in 2015. Large amounts of cash on hand will help to cover some of the shortfall, and many companies have been issuing new debt to further boost cash reserves.
Uncertainty over the path of oil prices has led to differing expectations between buyers and sellers and a sharp drop in merger and acquisition (M&A) activity. With cash infusions from asset sales largely off the table, those looking to preserve the balance sheet have turned to the equity markets choosing to issue shares rather than increase debt. During the first quarter, proceeds from share issuances by the E&P companies reached $11.9 billion, nearly half of the total for all of 2014.
Teittinen commented that, among the North American E&P companies, the large companies have fared the best over the past year as investors shifted their focus to balance sheet strength over volume growth. The share prices of smaller companies with highly leveraged balance sheets continued to drop, and several are facing financial difficulties due to the persistent low oil prices.
“Sustained low oil prices have caused financial difficulties for many small and mid-sized operators.” Teittinen said. “This will provide an opportunity for the well-capitalized companies to acquire distressed assets and companies well below historical M&A prices. This is particularly true for buyers that have equity pricing power on a relative valuation and share-price performance basis.”