Morningstar | Integrated Oils' Free Cash Flow Set to Improve; Increasing FVEs
Integrated oils are set to reverse years of little or no free cash flow despite significantly lower oil and gas prices as high levels of investment give way to growth and capital restraint. We expect increased free cash flow from both upstream and downstream segments. In upstream segments, improved cost structures and the addition of higher-margin production will increase cash margins, offsetting much of the impact of lower oil prices. Meanwhile, service cost deflation, standardization, and simplification combine to reduce the capital intensity of key project areas such as deep-water, shelf, and onshore, creating the opportunity to do more with less. In downstream segments, continued strong market conditions combined with earnings growth lead to strong free cash flow generation. This results in financially stronger and healthier companies that can increase dividends and repurchase shares. Importantly, this improvement can occur at our midcycle oil price of $60/barrel, well below current levels, and in many cases, the market is underpricing the improvement.We have revisited our moat ratings in light of upstream cost improvements and are upgrading Shell and BP to narrow moats on the ability of their integrated portfolios to deliver excess returns at our midcycle oil price of $60/bbl.
We are also increasing our fair value estimates to reflect our positive outlook, leaving the group trading at an average 15% discount, despite our bearish outlook for oil prices. With non-E&P segments typically comprising nearly a third of earnings, and natural gas 50% of production on average, valuations are less leveraged to oil prices. More importantly, in many cases, current market values do not reflect the improvement in free cash flow we expect, even at $60/bbl oil, with Best Ideas Shell and Total trading at the greatest discounts.
Please see our latest report “Integrated Oils: A Free Cash Flow Story,†published Sept. 4, for more.
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