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Oil & Gas - International Integrated Outlook: Prospects Bleak

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The global benchmark Brent crude oil has resumed trading above the $70-a-barrel psychological mark, reflecting a massive improvement of more than 181% since the historical low of $26.01 hit in January 2016.

Since refiners buy raw oil for making finished petroleum products like gasoline, the massive recovery in crude has been consistently hurting refining businesses of leading international integrated energy players.

Moreover, the prospects for the industry’s upstream operations are gloomy as uncertainty regarding future demand and supply makes it difficult to issue projections for the commodity’s price.

Going by the law of demand, the current high price of oil might dent demand for the commodity. The supply picture is obscure as well considering uncertainty about the expected production hike by OPEC players and anticipated sanctions on Iranian crude export by the United States. 

At a contentious meeting in June, OPEC members decided to pump out more oil to address global supply concerns stemming from declining Venezuela output and Iran sanction. However, Saudi Arabia — the biggest crude producing member of the cartel — slashed July output, per media reports.

Also, the United States’ sanction on crude export from Iran — one of the largest oil producers — is slated to take effect in November.  

Industry Lagging in Terms of Returns

The Zacks Oil & Gas-International Integrated Industry, part of the broader Zacks Oil and Energy Sector, has underperformed the S&P 500 and its sector over the past year. 

We can see that stocks in this industry have collectively gained 14.5% over the past year, while the Zacks S&P 500 Composite and Zacks Oil and Energy Sector have rallied a respective 15.6% and 17.1%.

One-Year Price Performance

International Integrated Energy Stocks Look Expensive

In order to determine the value of the oil sector, we have used the trailing 12-month Enterprise Multiple. This is because oil energy players typically shoulder significant debt pertaining to investments in growth projects and EV (Enterprise Value) includes debt for valuing company or industry.

Enterprise Multiple = EV/EBITDA

The industry currently has a trailing 12-month EV/EBITDA ratio of 6.34, higher than the five-year median multiple of 5.40. Although the space looks cheap when compared with the market — depicting trailing 12-month EV/EBITDA ratio of 11.57 — there is apparently less room for upside considering the industry is close to its highest level of 9.85 over that period.

Enterprise Value/EBITDA Ratio (TTM)

 

Comparing the group’s current EV/EBITDA ratio with that of its broader sector shows that the industry is overvalued.

Enterprise Value/EBITDA Ratio (TTM)

 

Earnings Outlook Glum

Although the price of the Brent crude has made a significant recovery, the industry is lagging in terms of capitalizing the higher oil price.

Per the U.S. Energy Information Administration (EIA), the average monthly prices of Brent for the month of April, May and June of 2018 was recorded at $72.11 per barrel, $76.98 and $74.41 respectively, considerably higher than the year-ago months of $52.31, $50.33 and $46.37. Despite the favorable business scenario following the massive crude price recovery, the industry’s free cashflow fell from $5.3 billion in April to June quarter of 2017 to $3.9 billion in second-quarter 2018, according to our proprietary model.

But what really matters to investors is whether this group has the potential to perform better than the broader market in the quarters ahead. While the ratio analysis shows that there is a solid value-oriented path ahead, one should not really consider the current price levels as good entry points unless there are convincing reasons to predict a rebound in the near term.

One reliable measure that can help investors understand the industry’s prospects for a solid price performance is the earnings outlook for its member companies. Empirical research shows that a company’s earnings outlook significantly influences its stock performance.

The Price & Consensus chart for the industry shows the market's evolving bottom-up earnings expectations for it as well as the industry's aggregate stock market performance. The red line in the chart represents the Zacks measure of consensus earnings expectations for 2019 while the light blue line represents the same for 2018.

Price and Consensus: Zacks International Integrated Industry

 

This becomes clearer by focusing on the aggregate bottom-up EPS revision trend. The chart below shows the evolution of aggregate consensus expectations for 2018.

Please note that the $4.98 EPS estimate for the industry for 2018 is not the actual bottom-up dollar estimate for every company within the Zacks Oil & Gas-International Integrated Industry but rather an illustrative aggregate number created by our proprietary analytics model. The key factor to keep in mind is not the industry’s earnings per share for 2018 but how this estimate has evolved recently.

Current Fiscal Year EPS Estimate Revisions

As you can see here that although the $4.98 EPS estimate for 2018 is up from $3.50 at the end of Aug 31, 2017, there have been steady downward revisions of the estimate since Jun 30, 2018 — reflecting analysts’ cautious stance for this group’s earnings potential.

Zacks Industry Rank Indicates Bleak Prospects

The group’s Zacks Industry Rank is basically the average of the Zacks Rank of all member stocks.

The Zacks Oil & Gas-International Integrated Industry currently carries a Zacks Industry Rank #197, placing it in the bottom 23% of more than 250 Zacks industries. Our research shows that the top 50% of the Zacks-ranked industries outperforms the bottom 50% by a factor of more than 2 to 1.

Moreover, our proprietary Heat Map shows the massive deterioration of the industry’s rank in four of the last eight weeks. 

 

Overall the improvement in top and bottom lines that the international integrated energy firms have been showing since the start of 2017 could not offset the dismal near-term prospects.

Revenues: Zacks International Integrated Industry

Net Income: Zacks International Integrated Industry

 

Bottom Line

Since the near-term prospect of the industry does not appear encouraging, it would be prudent to stay away from some weak international integrated stocks that are likely to underperform.

Below are four stocks which have witnessed downward or no earnings estimate revision in the last 60 days. Two of the stocks carry a Zacks Rank #4 (Sell) or 5 (Strong Sell).

Sasol Limited (SSL - Free Report) : The stock of this Johannesburg, South Africa-based energy player has declined 1.5% in the past three months against the S&P 500’s rally of 4.9%. The Zacks Consensus Estimate for current-year EPS has been revised downward in the past 60 days. Currently, it has a Zacks Rank #4.

Three-Months Price Performance: SSL

Premier Oil plc (PMOIY - Free Report) : This London-based energy firm has shed 3.2% in the past three months. The Zacks Consensus Estimate for current-year EPS moved down 40% in the past 60 days. Currently, the stock has a Zacks Rank #4.

Three-Months Price Performance: PMOIY

PetroChina Company Limited (PTR - Free Report) : The integrated oil company in China slipped 6% in the past three months. The Zacks Consensus Estimate for current-year EPS has been stable in the past 60 days. Currently, it has a Zacks Rank #3 (Hold). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Three-Months Price Performance: PTR

 

Eni SpA (E - Free Report) : In the past three months, this Rome, Italy-based energy player lost 8.8%. Also, the Zacks Consensus Estimate for current-year EPS has been revised 12.5% downward over the past 60 days. Currently, the stock has a Zacks Rank #3.

Three-Months Price Performance: E

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