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Energy Q1 Earnings Ahead: Can Higher Prices Quell Winter Woes?

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Halliburton (HAL - Free Report) kicks off Oils-Energy earnings season with its first-quarter results tomorrow. Kinder Morgan (KMI - Free Report) and Schlumberger (SLB - Free Report) will report later in the week.

Following vaccine progress and the ongoing macroeconomic recovery, commodity prices have rebounded sharply, returning to their pre-pandemic levels. Agreed, demand is yet to come back fully but the sector seems to have found its footing following a brutal 2020. While the returns improved in the third and fourth quarters on gradually tightening fundamentals, the January-March period should further reinforce the sector’s stability. Amid proof of rising fuel consumption, investors will also be looking for more constructive signs of recovery through 2021.

Over the next month or so, as we make our way through the earnings deluge, here are some important things to look for:

Revenue & Earnings Comparison Relative to Q1 ’20

According to the U.S. Energy Information Administration, in January, February and March of 2020, the average monthly WTI crude price was $57.52, $50.54 and $29.21 per barrel, respectively. In 2021, average prices were $52 in January, $59.04 in February and $62.33 in March, i.e., mostly stronger year over year.

The news is even better on the natural gas front. In Q1 of 2020, U.S. Henry Hub average natural gas prices were $2.02 per MMBtu in January and fell to $1.91 in February before tumbling further to $1.79 in March. Coming to 2021, the fuel was trading at $2.71, $5.35 and $2.62 per MMBtu, in January, February and March, respectively. In other words, natural gas traded higher in all the three months.

Despite taking into account the year-over-year improvement in commodity prices, the picture looks a little downbeat for the Q1 earnings season. Per the latest Earnings Preview, Energy is likely to have experienced a decline in earnings from a year earlier. Per our expectations, the sector’s earnings are likely to have decreased 16.1% from first-quarter 2020 on 8.6% lower revenues. The reason was mid-February’s Texas freeze which was a week-long spell of severe cold blast that forced many companies to temporarily suspend production and refinery plants, causing lost revenues and rising costs.

How Will the Sub-Industries Perform?

From upstream (exploration and production) to midstream (pipelines) to downstream (refining and distribution), let’s see how the different subsets of energy might have performed in the March quarter.

While the price boost will buoy the results of E&P companies for obvious reasons, some of that positive effect might have been offset by the weather downtime. On the other hand, the refiners’ numbers will be dragged down by surging expenses to comply with cleaner gasoline production rules (or RIN costs), continued macro hurdles, plus volume and cost impacts from the winter storms.

Meanwhile, the E&P capital discipline is likely to continue through 2021, which automatically translates into lesser work for the oilfield service firms — companies that make it possible for upstream players to drill for oil and gas. Agreed, rig count has recovered considerably, costs have been slashed and completion activity is looking up too but overcapacity and pricing pressure would restrict the positive impact.

Finally, the pipeline companies are also likely to have faced the repercussions from upstream shut-ins due to the severe winter weather in February. Some midstream operators like Western Midstream Partners (WES - Free Report) and DCP Midstream (DCP - Free Report) have clearly outlined the adverse impacts to earnings as a result of lower volumes. At the same time, the deep freeze sent natural gas prices skyrocketing in February, which benefited the marketers of the commodity. Overall, the macro environment for energy infrastructure providers remained favorable during the first quarter with production stabilizing and energy demand rebounding.

What’s the Outlook for Dividends/Distributions?

As exploration activity takes off amid WTI crude’s new-found stability of $60 per barrel, companies might look to allocate rising cash flows to dividends. While the likes of Diamondback Energy (FANG - Free Report) and EOG Resources (EOG - Free Report) — both carrying a Zacks Rank #1 (Strong Buy) — have already raised their payout this year, it should come as no surprise if more oil producers decide to dish out dividend hikes to pacify the long-suffering shareholders.

You can see the complete list of today’s Zacks #1 Rank stocks here.

The major midstream players — being largely insulated to fluctuations in commodity prices — managed to maintain their distribution levels through the crisis-stricken 2020. Further, their relatively steady coverage and improving commodity price visibility should represent a more predictable midstream payout scenario in the first quarter.

Shale Producers in the Spotlight

Most indicators show that energy could be on a steady recovery path. Of late, crude has found strong support at around $60-a-barrel, with the U.S. benchmark hitting a nearly two-year high above $66 in March. With this firmed-up price and some previously shut-in production coming back online, shale operators could surprise on the upside.

As output from the unconventional plays look set for an uptick, all eyes will be on the companies working in the Permian Basin — America’s hottest and lowest-cost shale region, and by far the primary driver of crude production in the United States. The improvement in oil prices has prompted these firms to shore up drilling activity, leading to improved cash flows and increased chances of an earnings beat.

Keep an Eye on Positive Financial Guidance for the Year Ahead

Since the coronavirus-induced depths of the April-June period, the sector has been staging a recovery over the past two quarters on rebalancing supply/demand fundamentals. We expect the positive momentum to have carried into the first quarter based on the improving outlook for the global economy and oil demand.  

The quarterly announcements will also present an opportunity for the companies to highlight their plans of using the substantial free cash flows — whether to strengthen the balance sheets or pay cash back to shareholders. With the most encouraging macro backdrop in months and optimism around the vaccines, investors will be looking ahead to company-level improvements in the outlook.

An effective way to gauge a firm’s strength and resilience is to look out for improved guidance. Of particular interest will be the cost-reduction initiatives, updates on free cash flow, and upward revision in estimated production.

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