Big Oil, a name coined for the group of large-cap super majors like Exxon Mobil Corp (XOM) , British Petroleum (BP) and Royal Dutch Shell (RDS.B) , has been in perennial decline despite oil price cycles as they tend to underperform on the way up and down. Being the victims of their own success, they have become so big, that to move the needle and to grow is so much harder. These behemoths pump in excess of 3.5 million barrels per day (mbpd), which is more than some OPEC nations combined.
Last week, Chevron Corp (CVX) agreed to buy Anadarko Petroleum Corp (APC) for $33 billion in stock and cash, with an aim to take it a notch higher into the Super Majors league, expanding into shale, putting it right behind Exxon. This acquisition will allow Chevron to become one of the leading operators in the U.S. shale region (West Texas and New Mexico) at a time when the U.S. is overtaking Saudi Arabian and Russian daily production. Strategically, the deal makes a lot of sense as mid- to small-cap oil companies have been badly mismanaged due to overspending, trying to boost growth but with less capital discipline. Shareholders have grown wary of their bad performance, asking for more shareholder return than just pure growth.
Many of the U.S. shale operators have seen massive decline rates, costing them more to just maintain production, let alone grow it. Big oil has been much more capital disciplined relatively; they have scalability and more resources to really take advantage of the acreage area. Finding conventional resources of oil are harder to come by, so the growth in this last cycle has been about blasting sand and water into formations to extract oil -- fracking. U.S. exports about 12 mbpd, and the new combined company will produce more than 1.6 mbpd in the U.S.
Over the last two years, Chevron's stock has gained 25% and Anadarko's stock has fallen 23%, with Chevron trading on about 7.9x EV/EBITDA multiple, while Anadarko traded at 5.7x EV/EBITDA. So one can say it was a fair deal and quite opportunistic. This deal is not only about shale, it is also about liquefied natural gas. Anadarko has a Mozambique project, which is one of the industry's largest. LNG is the way forward, as countries look for cheaper ways to replace fuel and coal generation.
Based on the deal metrics, Anadarko will receive 0.3869 shares of Chevron plus $16.25 in cash for each share, about a 39% premium from the previous day's close. The deal terms values Chevron at $62.5/shares vs. its closing price of $61.78/shares, implying a discount of just 1.3%. Such a low discount means that shareholders pretty much expect the deal to go through and shareholders to vote for it, perhaps even less room for other bidders to counterbid Chevron's offer. Chevron plans to dispose of about $15 billion-$20 billion in assets post the deal closing to reduce debt and return cash back to shareholders. It expects the deal to be free cash flow and earnings positive a year from the purchase date and will boost its buyback by $1 billion.
This deal will boost the values of other shale operators. But one cannot be mechanical about extrapolating the same multiple across the board, as each E&P operator has its own unique cost structure and cash position, combined with the right acreage. This deal makes a lot of sense for Chevron and its strategy; one that shareholders will look to reward over time as they start seeing it being executed properly.
Whether it made the purchase at top of the cycle, it is hard to tell. At least oil is not trading in excess of $100/bbl. it is more fairly valued here, even if quite boring given the excess supply in the market for the time being. It is well managed by OPEC+ nations to provide a floor around $45/bbl. Given modest demand growth, one can assume oil price (excluding Chinese growth collapse and/or U.S. recession) is closer to $65-$70/bbl, for now. But these big oil companies do not focus on quarter-on-quarter oil prices, instead they focus on the next 10 years.
Their job is to keep growing production at the lowest price possible, extracting as much revenue and paying back to shareholders and reinvesting in the company. It is a delicate task to manage, hence when an investor invests in oil companies, they are dismayed by the low nominal returns -- especially vs. the likes of FAANG stocks that keep growing in excess of 20%-40% year over year.
It all depends on the type of investor you are. Income investors love investing in Big Oil, as it gives them some dividend income. For more active total return Hedge Funds, this sector continues to be a source of shorts unless one can say oil market is in an ultra-bull market? Hardly so.
