Morgan Stanley analyst Devin McDermott began coverage of the U.S. Integrated Oil space with an In-Line industry view, and initiated Chevron (CVX) with an Overweight rating and Exxon Mobil (XOM) with an Equal Weight. The analyst believes Chevron stands out within his global energy coverage as a free cash flow leader with low risk, while Exxon Mobil's "ambitious growth plan" will take time to show results.
LAUNCHING COVERAGE OF U.S. INTEGRATED OIL: In a research note to investors on Monday, Morgan Stanley's McDermott began coverage of the U.S. Integrated Oil space with an In-Line industry view. The analyst pointed out that 2018 was a year plagued by volatility, and the value of the integrated business model "shone through." U.S. Oil Majors Exxon Mobil and Chevron generated a combined $35B in organic free cash flow, a level exceeded only once in the past decade, he noted. However, he believes that the cash flow profile should diverge from here for those two companies.
TWO STOCKS, TWO 'DIFFERENT STRATEGIES': Morgan Stanley's McDermott initiated coverage of Chevron with an Overweight rating and $146 price target and started Exxon Mobil with an Equal Weight rating and $84 price target. The analyst believes Chevron is focused on measured spending and strong free cash flow, while Exxon Mobil is embarking on an aggressive countercyclical growth strategy. While he acknowledged that "both have merit," McDermott argued that cash flow drives stock performance in Big Oil, and reinvestment for long-term growth typically does not get fully valued by the market. His quantitative back-testing across the U.S. and EU Majors shows that expectations for growth in free cash flow and improving dividend coverage drives outperformance, "and a strategy of pairing the leaders against the laggards on these metrics would have outperformed the Energy sector by 60% 2014-present." Additionally, the analyst highlighted that both companies have emerged as leaders in shale, and while lofty production goals are achievable, they will require "some productivity gains." Opportunistic consolidation over time could be accretive to valuation while improving core inventory depth and supporting a long production plateau, he contended. Based on stated strategic objectives and an analysis of acreage footprints, McDermott has looked at hypothetical combinations, and Anadarko Petroleum (APC), Concho Resources (CXO), Pioneer Natural Resources (PXD), and Cimarex Energy (XEC) "screen best." Lastly, the analyst believes near-term downstream and chemicals headwinds should subside into 2020. While Chevron has relatively small exposure to these businesses, Exxon Mobil is the world's largest refiner and polyethylene producer, he noted. Overall, McDermott sees Chevron positioned for outperformance, while it might be "too early" to play Exxon Mobil’s growth strategy.
PRICE ACTION: In morning trading, shares of Chevron have gained over 1% to $124.79, while Exxon Mobil's stock has advanced about 1% to $81.34.
Exxon Mobil
+0.5 (+0.62%)
Chevron
+1.84 (+1.49%)
Bought by OXY
+0.84 (+1.85%)
Bought by COP
+2.47 (+2.23%)
Pioneer Natural
+2.77 (+1.82%)
Cimarex Energy
+1.04 (+1.49%)