Share repurchase announcements are commonplace throughout the market and are usually met with mildly-positive investor reception, as Wall Street typically views them as a proactive and opportunistic use of a company’s free cash flow. However, for energy today, the topic is much more significant. This was illustrated by yesterday’s 8% jump in Anadarko Petroleum’s (APC) stock price, after its announcement that it will use cash on hand to repurchase up to $2.5B of its shares (10% of its market cap) with $1B to be repurchased by year-end 2017. Most importantly, we believe the announcement could be followed by other exploration and production companies (E&Ps) and could mark a significant change in the mindset and strategy regarding production growth for the sector in general.
We highlight the following potentially positive implications from APC’s share repurchase announcement for the energy sector:
- Newly-Found Capital Discipline by Select E&Ps. A wide-spread criticism of E&P companies has become their lack of free cash flow generation. While producers have touted their reduced breakevens and profitability at the wellhead (i.e., single-well economics), the reality is that few E&Ps generate free cash flow after considering corporate costs and capital expenditures for future development. Thus, a cash allocation away from what the Street commonly views as endless E&P cap ex requirements and back to investors signals enhanced capital discipline and focus on corporate-level returns.
- A Willingness to Listen to Investors. Wall Street has been vocal in calling for greater capital discipline from E&Ps. Possibly most notable has been David Einhorn’s well-publicized short position in Pioneer Natural Resources (PXD) and general criticism of producers’ lack of free cash flow. Even APC’s CEO Al Walker recently told investors at a conference that they should be more selective in providing companies capital to reward growth. Thus, we believe an industry trend toward greater capital discipline – indicated by cash allocated to buybacks, dividends, or even less outspend overall – would show an attentiveness of energy companies to the demands of their investors.
- A Slower Growth Rate for US Supply. One of the largest overhangs for oil prices today is the anticipated production growth stemming from US shale. Producer comments of dramatically increased operational efficiencies and growth by access to multiple pay zones, as well as more wells per drilling pad, has led analysts to expect dramatic production growth from US shale formations in upcoming years. Therefore, indications of greater capital discipline by E&Ps would likely imply some reduction in future US production growth, providing support for oil prices.
- A Potential Sentiment Shift for Energy. Energy has been the worst performing sector in the market in 2017 and today comprises only 6% of the S&P 500, a level not seen since the tech boom of the late 1990s/early 2000s. The factors mentioned above can be attributed to much of this underperformance. As such, with sentiment at such a low level, we believe similar announcements to APC’s planned buyback would be well received by Wall Street and could mark an inflection point for energy equities.
Disclaimer: This material is for informational purposes only and does not constitute an offer or a solicitation to buy, hold, or sell an interest in any investment or any other security, including any investment with BP Capital Fund Advisors, LLC (“BPCFA”) or any of its affiliates or any other related investment advisory services. This material does not constitute legal, tax, or investment advice, nor is it a substitute for such professional advice or services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should consult a qualified professional adviser. In preparing this material BPCFA has relied upon data supplied by third parties. BPCFA does not undertake any obligation to update the information contained herein in light of later circumstances or events. BPCFA does not represent the information herein is accurate, true or complete, makes no warranty, express or implied, regarding the information herein, and shall not be liable for any losses, damages, costs or expenses relating to its adequacy, accuracy, truth, completeness or use. This material is subject to a more complete description and does not contain all of the information necessary to make any investment decision, including, but not limited to, the risks, fees and investment strategies of an investment.