Extreme makeovers by exploration and production companies over the past five years have resulted in higher crude oil and natural gas production, lower costs and more money for shareholders in the form of dividends and share buy-backs. Despite all this, investors have continued to abandon the E&P sector, with the S&P E&P index sliding to a series of record lows: down 75% from its 2014 peak, down 51% from a year ago, and down 5% from this time last month. Why the major disconnect? Today, we examine the improving financial health of most of the 48 E&Ps we track in this analysis and the reasons why investors remain wary of E&P equities.
Any investors who’ve held onto E&P shares since the valuation apex in 2014 have been punished by a more than 20% negative annual return over those five years — a period in which the much broader S&P 500 Index generated a healthy 8.75% annualized gain. Similarly, over the last 52 weeks, S&P’s E&P index recorded a staggering 51% loss, while the overall market was up nearly 2%. But as we pointed out in our recent Don’t Stop Believin' blog, the major U.S. oil and gas producers we monitor recorded a sixth consecutive quarter of solid profitability for the three-month period ending June 30, 2019, generating $10.2 billion in pre-tax operating profits and $26.1 billion in operating cash flow. All but two of the companies were profitable, with the remaining two reporting net losses on one-time asset impairment charges. Over the last six quarters, the E&Ps reported $68 billion in pre-tax operating profits, a remarkable recovery after $128 billion in losses in 2015-16. Cash flows over the last six quarters totaled $162 billion, far exceeding the $110 billion in capital investment.
Of course, these are relatively short-term results. Investors may be retreating from energy equities for reasons that include longer-term concerns about the future viability of the U.S. E&P sector. So, in this blog, we will examine five-year trends in key fundamental areas, such as capital costs, operating costs, leverage, and profitability, to see if they justify the current negative sentiment about the energy industry.
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