We’re starting to witness an evolution in the upstream space. After years of habitually outspending cash flow and relying on capital market access to fund development programs, the industry appears to be focusing on cash flow neutrality—or said another way, simply matching capex to internally generated cash flow.
Anadarko Petroleum, a large-cap producer, has been at the forefront of this movement with its CEO, Al Walker, making waves when he called out Wall Street for its unhealthy focus on growth. Since that time, the movement has gained traction and it’s even included an emphasis on returning capital to shareholders. In conjunction with Q4 earnings, Anadarko, Pioneer, and Diamondback increased dividend payments. In addition, Anadarko, Pioneer, and Encana increased stock buybacks. Overall, we view this movement as very positive for the industry as it will lead to a more stable and sustainable business model. After being inflated for parts of 2016 and 2017, forward EV/EBITDA multiples are now 5–10% below the five-year average.
While trading at a discount, E&P companies seem stronger, more efficient, and appear to be becoming better stewards of capital than they have in the past. The industry is also somewhat unique in that some studies have shown that higher multiple names often outperform. In our opinion, the reason for this is that the multiple is often reflective of the quality of a company’s acreage. Top-tier acreage is a win-win for companies and investors, as it is more economic in low commodity price environments and enables an accelerated development profile in high commodity price environments. In keeping with this idea, Miller/Howard Investments looks to invest in companies viewed by us as having the best rock, lowest break-even costs, extensive drilling inventories, experienced management teams, solid balance sheets, and attractive valuations.
Note: As of March 21, 2018, Miller/Howard Investments held Anadarko Petroleum, Encana, Pioneer and Diamondback in its portfolios.
