Category Archives: English

English

ENI and its alleged break-up value

Energy, English, On the cover, Sin categoría
Over recent weeks,Knight Vinke has suggested that splitting the company into utility gas and traditional oil businesses would unlock significant value.
They value ENI between €27.8 and €32.
My biggest discrepancy with them is a) that the issue is not the Gas & Power business but the E&P, and b) I find it hard to believe that both parts would trade at top-of-subsector multiples if separate.
First in the Snam and Gas & Power business… They take the assumption of Snam trading at a 20% premium to RAB, which is crazy compared to other utility stocks. They also use the rest of the gas & power division at a 30% premium to Enel, Edison, Hera, Acea (which all trade at 5.6-6x EBITDA 1yr fwd). They totally disregard the constant process of de-rating of the Italian utilities in the past six years and the impact on power prices of stalled demand and excessive capacity from gas oversupply.
The refining business is put at Neste multiples, which is OK to me
Chemicals are valued at much higher than anyone can imagine (7.5x EBITDA)
Corporate charges are drastically reduced (probably as part o the assumption that, as separate entities, cost savings and job cuts would happen). This is difficult to believe in Italy, but can be acceptable as a thesis.
Then Knight Vinke value the E&P business at the multiples of a BG, which is too radical given the poor growth, high capex and returns.
In essence they use consensus Sum of the Parts, reduce the traditional Megacap oil discount (21% to 15%) to zero by cutting corporate charges and others, pumping up the valuation of the Italian G&P to multiples of non-Italian (and therefore more attractive) utilities and applying a premium to the Snam RAB that it has never enjoyed in the past (Snam is a mature asset and growth RAB is very limited versus maintenance RAB, something that KV seem to value in the same way).
The key, as some analysts (e.g Nomura) point out is that where Eni trades (a 40% discount to its invested capital) is no different to that of other large-cap oils (BP, RDS, FP and STL). I think the value argument can be applied equally to all these companies, but unlocking it is not about addressing a small part (Gas & Power is only 15% of Eni’s invested capital base) but about turning around the core E&P businesses where returns have fallen a staggering 400-500 basis points in four years (while oil prices rose).
That is why, even if separated, it is an illusion to believe that oil investors would see ENI as a high multiple E&P and see it trade at the same multiples as Tullow, Dana, etc… First, because it would still be a State owned entity and its resource base would still be heavily impacted by resource nationalism, low returns and OPEC quotas.
In the meantime, the bet on the stock from here is a full break up not only of the utility assets (which as Scaroni has said, would be regulaywise impossible) but also the disposal (at current market price, no discount) of the Saipem stake.

US Natural Gas Dynamics

Energy, English, gas, On the cover, US

US natural gas is set to continue rising but fundamentals keep it capped at $6.5/MMBTU mid-term. The conclusion is that US gas is likely to be in a tight range of plus/minus 15% of the marginal cost of production (downside to $3.5/MMBTU and upside to a c$6/MMBTU short-term) as the contango flattens.

I would highlight three data points:

  1. Current 55-60% decrease in gas directed drilling activity in the US has not been sufficient to balance 2009 supply and demand. These rigs will gladly come back any time gas reaches $5-$5.5/MMBTU. Additionally, onshore rigs are being moved to Russia and West Africa, where there are stronger conomics. On the support side, coal-to-gas switching tends to kick off at $4/MMBTU
  2. Estimated base decline with current drilling activity (33%) can be misleading as production will still be c54BCF/day in the US in a worst case scenario and there is plenty of resources (if demand stays weak as predicted) in unconventional gas plus ample new reserves in the US (Marcellus, Barnett) .
  3. I do however believe the LNG “threat” is less than what market anticipates (although I am happy to assume 2-2.5BCF/d LNG into the US in 2010). Case in point is that all of consensus expects Chevron-Exxon’s Gorgon and BG’s Queenland Curtis to supply at sub-target ROCE levels (DB expects them to make 13% versus a target of 20%). This (in my view) is unlikely to happen as these are companies that ruthlessly monitor and manage ROCE, and have proven, to everyone’s surprise, that delays in LNG happen. The LNG overcapacity disappears in 2012 (no more LNG projects commissioned post 2011) so waiting and monitoring is not an issue.

Why the market can’t go up… and one positive

Energy, English, Markets, On the cover
In a letter to investors last week, Warren Buffett admitted having made some serious mistakes last October when he bought a  large stake in Conoco (purchased at $7bn worth $4bn now) and other stocks. His famous letter “buy equities, I am”, was full of confident messages about deep value and the possibilities of the American economy to recover.
All these messages were hit by harsh reality… If we distort the market dynamics through bank bail-outs, short-selling bans, rescue plans for declining industries and false messages of speedy recovery, confidence plummets further. That is what has happened.
Now for the positive. Two words: Corporate bonds.
I have seen and participated in very attractive corporate issues of three to five year bonds that yield 6% to 6.5%, with very high quality rating (single 
A) and low risk. When the bonds yield more than the equity, and the balance sheet is strong, you get 3% risk premium for free.
So far the CDS of most single A companies have stabilized, and the healthy appetite for bonds and the good quality of their balance sheets show that when the crisis is over these companies will have survived. This is not a signal to  buy their equities yet, as multiples keep expanding while EPS is downgraded, creating a fake view that the stocks are “cheap”. It’s a signal to keep investing in corporate bonds and avoid the equity market problems for a while.
Meanwhile, the VIX keeps going crazy, so if you want to be in equities, stick to the golden rule of my previous posts… 2008 outperformers with solid balance sheets will repeat their performance this year.