European Integrated Oil:From scrip to buy-back.Upgrading the deck.
As the cash flows build we expect the buy backs to feature into H218
Following upgrades to our price deck in this note we present revised estimatesfor the Euro IOCs across the 2018-21period together with a mark-to-market ofour expectations for Q4'17. With most companies set to balance cash cycles atc$50/bbl oil and little, if any, chance in our view of cost and capex elevationour use of $62/bbl oil in 2018(was $54.5/bbl) and 2019($56/bbl) sees FCFexpand meaningfully with cash cover of dividends rising to over 1.3x in 2018from under 1.1x previously. Tactically an implied view that oil will retrace from$69/bbl spot argues for some caution. Fundamentally, however, as we movefrom scrip to buy-back an FCFY of a rising 7% suggests value upside.Upgrading the deck to $62/bbl in 2018(was $54.5) and $65/bbl LT (was $60)Set against an improved supply-demand balance, Deutsche Bank’scommodities team has revised upwards its expectations for Brent oil.Significantly, we move to $62/bbl Brent in both 2018and 2019(from $54.5/bbland $56/bbl respectively) whilst also raising our long term forecast to $65/bblfrom $60/bbl. We assume that WTI will trade at towards a $6/bbl discountacross the forecast period.
A $10/bbl move adds $15bn to sector CFFO. FCFY for 2018rises to 7%.
Allowing for some modest offset from changed FX expectations the revisionsto our commodity deck impact forward estimates for cash flow materially.With little likelihood in our view of an upwards shift in capex guidance andoperating efficiencies continuing to emerge, the sector’s 2018FCFY movestowards 7% in 2018(a 15% uplift) and 8% in 2019. Cash cover of the sector’s2018dividend rises to 1.3x (1.5x 2019). We expect this improvement toencourage the greater use of buy-backs as we move into the H22018therebyoffsetting part of the dilution introduced by scrip in recent years, upliftingprospective shareholder cash returns to 6-7% and helping to reinforceshareholder perception of discipline on capital allocation.
Price targets rise by an average 6%. Continue to prefer the UK majors.
With expectations for cash flow rising we have revised upwards our pricetargets by an average 6%. Modest perhaps given the much improved outlookfor cash flows but equally allowing sensible caution in our view for an oil priceoutlook that remains very sensitive to the behavior of OPEC and US shale. Wecontinue to prefer the super-majors most particularly the UK names Shell (Buy2800p from 2700p) and BP (Buy 565p from 545p) which in our view continueto offer both an attractive 5% plus income yield and are, we believe, mostlikely to offset absolute share counts through the use of buy-backs.
We are constructive the sector. Yet oil at $69/bbl calls for tactical addition.
Clearly we remain constructive the oils into 2018believing that with their cashcycles rebalanced for a $50/bbl world and material project driven cash flow yetto come, the sector’s cash jaws are set to open. However, with Brent tradingsome 10% above our revised $62/bbl expectation and our first cut of Q4’17earnings (detailed herein) suggesting typical seasonal weakness, we would notchase the names at current levels but rather see weakness as an opportunityto add. As detailed on p15we value the oils using a mix of dividend, DCFtechniques and FCFY multiples. Risks include project slippage and geopolitics.This note changes TP for few stocks, see Fig 10for details.