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Private Client Research 18 March 2020

Energy Sector

Implications of lower oil prices

To reflect the current global environment, Ord Minnett has materially lowered its oil price forecasts, which has had a significant impact on earnings, free cash flow and valuation. Spot oil prices suggest potentially further downside risk, but we do not believe a US$30/bbl Brent oil price level is sustainable.

Overall, we see the sector as attractive for investors looking for long-term returns, although we note potential for further downside in the near term.

With value everywhere, we believe companies with strong balance sheets and limited growth should be the priority.

Please see the table below for a full list of our energy sector ratings and target prices.

• Lowering oil price forecasts – Brent oil prices reached a 16-year low of US$30/bbl, with global demand likely to be materially affected by economic turmoil and OPEC+ failing to extend production cuts. With exploration and production (E&P) companies signaling growth capital expenditure will be curtailed, it is clear current prices are unsustainable. Using our normal methodology and noting the forward curve is now in contango*, we have lowered our price forecasts to US$42/bbl in CY20 and US$45/bbl in CY21. We have also increased our weighted average cost of caital (WACC) estimates for our coverage universe to account for increased balance sheet, free cash flow and earnings risk.

• Valuation – On average, the sector is trading on a price to net present value (P/NPV) multiple of only 0.57x using our base-case price forecasts and new WACC estimates. However, running spot to perpetuity challenges value entirely, and so the longer prices remain weak the further stocks could derate near-term. We believe there could be significant returns to investors taking a long-term view of the sector and we recommend a broad stock exposure rather than necessarily being specific.

• Balance sheet strength – Our stock preferences are based on those with strong balance sheets. In the big caps, our key preferences are: 1) Santos (STO); 2)Beach Energy (BPT); 3) Origin Energy (ORG); 4) Oil Search (OSH); and 5)Woodside Petroleum (WPL). With the smaller caps, our key preferences are: 1) Senex Energy (SXY); 2) Cooper Energy (COE); and 3) Carnarvon Petroleum (CVN). We note that we have a Hold rating on Woodside, Oil Search and Carnarvon, only because of our preferences elsewhere. Meanwhile, Worley’s (WOR) investment case has been challenged: Our previous positive disposition on the stock was that global E&P capex was improving. The current situation has materially challenged that view and is likely to have a material impact on earnings forecasts and valuation.

* Contango is where the futures price of oil is higher than the expected future spot price – that is, traders will pay a premium to lock in a shipment at a given price several months away – according to supply.

Equity Ratings and Price Targets

Company

Mkt Cap Ticker ($m)

Price ($)

Rating
Cur Prev Cur

Price Target
End Prev End

Date Date

Dec-20 2.45 n/c Dec-20 0.47 n/c Dec-20 0.64 n/c Dec-20 7.20 n/c Dec-20 9.25 n/c Dec-20 9.20 n/c Dec-20 0.38 n/c Dec-20 40.20 n/c Dec-20 17.60 n/c

Beach Energy
Carnarvon Petroleum
Cooper Energy
Oil Search
Origin Energy
Santos
Senex Energy
WoodsidePetroleum
WorleySource: Company data, Bloomberg, Ord Minnett estimates. n/c = no change. All prices as of 17 Mar 20.

Hold Accum
Hold Buy 8.30

BPT 2,725.57 CVN 214.58 COE 707.59 OSH 4,040.58 ORG 8,989.86 STO 7,436.66 SXY 254.92 WPL 17,809.22 WOR 3,741.58

1.20 0.15 0.44 2.65 5.14 3.57 0.18

18.90 7.19

Accum Hold Accum Hold Accum Accum Accum

Hold Buy Buy Accum n/c n/c Bu