Analyst Note| Stephen Ellis |
Given the vaporization of tens, if not hundreds, of billions in investor capital over the last decade, it's understandable that U.S. exploration and production companies are shunned by investors. Our U.S. E&P playbook better aligns executive compensation with investor interests by de-emphasizing production targets in favor of ROICs, embraces carbon legislation to reduce uncertainty, targets manageable leverage between 1 and 2 times, and promotes living within cash flows no matter what. The big shift, though, is massively boosting capital returns so that shareholders will get back 75%-100% of the firm's enterprise value in a decade. This will significantly reduce investor uncertainty, as the present value of most E&Ps' assets cannot cover their long-term obligations if the asset lives are greatly curtailed from our standard 40-year assumption. This compares with what Big Tobacco, another "sin" industry, did in the early 2000s after that industry's Master Settlement Agreement in 1998. Based on the multiple expansion that resulted, the valuation uplift for E&Ps successfully executing our playbook could be as high as 60%. Our top picks, based on a combination of discount to fair value and progress on our action plan, are Pioneer, Cabot, EOG, and Diamondback.