eni to deliver mild returns amongst low oil price ... · pdf fileresults are weak, as...

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Equity Analyst

Gabriel Jablon

[email protected]

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ENI to deliver mild returns amongst low oil

price, expected to underperform the market

Results are weak, as expected, but also highlight holes in production process that should be of a

concern

I. A bit of history

Introduction

ENI was founded on the ruins of Mussolini’s fascist Italy in 1953. Enrico

Mattei, a notable industrialist, was in charge of dismantling the company.

Instead, he transformed the company into the Ente Nazionale Idrocarburi

– ENI. The company has built its fame on the discovery and exploitation

of the gas field of the Pô valley, which is still working today (and

represent 11% of the group’s hydrocarbon production) in 20141.

As of today, ENI is the fourth largest European oil and gas producer (in

terms of volumes2) and is exploiting every European sites (North sea: UK

and Norway, where the goliath well was only recently exploited, after a

huge USD 6.0 Bn expense), in the Middle-East (Egypt), in Sub-saharan

Africa (Mozambique, Angola), in Myanmar and in Mexico. The company

produces around 1700 kboe3/d including 100 kboe/d in Italy (mainly oil

and gas from the Pô valley). The company is public, but the Italian state

still owns 30% of it.

03-Apr-15

ENI Oil and gas

Current price LT price

MT long/short strategy : - Buy TOTAL - Sell ENI

Dividends

12.79 9.00

Cur. : EUR

1 See chart 5

2 See chart 1

3 Thousands of barrels of oil

equivalent per day

Beta 1,10 Stock Price 12,79

BBG ENI IM Market cap 46,5 Bn

Reuters ENI.MI PER -

Country Italy EPS -2,16

Currency EUR P/B ratio 0,91

Results are weak, as expected, but also highlight holes in production process that should be of a concern

2

ENI

Oil and gas Cur. : EUR

03-Apr-15

whiteoak-research.com

Production profile

ENI is an integrated oil and gas company, which means it controls the three steps of producing, transforming and trading oil, gas and their derivatives: the upstream (also called exploration and production), the downstream (also called refining) and the Marketing and Services (roughly: services stations).

If the large size of its upstream division put ENI at the fourth place amongst

European peers, the refining division is notably unprofitable, due to out-of-age

infrastructure. Despite the fact that the drop in oil price should bolster the

profitability of downstream (and hurt the upstream’s), ENI only undergoes low oil

prices4. The poor results of ENI during the fiscal year 2015 are only explained by the

weakness of its refining division, and is at the exact opposite of its French

counterpart (and our best pick in the sector), Total, that faced a very solid year

considering the sharp drop in oil price (Total SA 2015 profit: -20% versus 2014, oil

price: -60%).

A series of problems

Its historical exposure to gas and the strong dependence of Italy to this resource

oriented the infrastructure web to the importation and storage of gas. The gas

division faced numerous problems due to large investments that did not produce

the expected returns. In effect, ENI is exposed to the gas sector through its

subsidiary Saipem, a company that has been in agony and under state perfusion for

ages. The most recent drawback for the firm in the cancellation of the Southstream

B.V. project (which was a joint-venture between ENI and Gazprom), that will cost

ENI around EUR 2.0 Bn.

Moreover, the drilling of Goliat oil field in the Barents Sea (in artic, off the coasts of

Norway) will have cost ENI around USD 6bn and has just started, while the

4 See chart 2


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ENI


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breakeven price is expected to be at USD 100 per barrel (ENI estimates the

breakeven at USD 50.05). Let’s remember has been stating since the publication of

its 2015-2018 strategic plan that the breakeven price for newly started projects

would be at around USD 63.0 /b. This price is already far from the average barrel

price in 2015 (USD 52.4) and we hardly doubt that the company will be able to

reach their target breakeven on Goliat.

As another poisonous gift, we can give the example of the lead on Kashagan project

(Kazakhstan) that was granted to ENI. The project, that turned into a white elephant

for integrated oil and gas, will have cost USD 50 Bn o the exploiting consortium

(Exxon, Shell, Total and ENI) without producing any barrel, as of today. Worse, the

production was halted for a year due to defective pipes that were destroyed by the

hydrogen sulfide, and were provided by Saipem…6

Last but not least, the strong presence of ENI in Egypt (champ de Zohr, champ de

Melehia, etc.) despite geopolitical tensions since the end of Mubarak era must

remind us the risks of producing in a politically instable country. And let us not

forget that ENI has a strong presence in Libya, were its fields produce 300kboe/d or

around 40% of Lybia’s oil production.

Positive aspects

There are however some reasons to hope an improvement of ENI’s situation. One

of the strong points is the discovery of a mega-field at the large of Egypt (Zohr’ gas

field) which is considered as the discovery of the century. The Italian group will

have to convince investors of its capability to generate enough CAPEX for this

project (entrance fees for ENI, alone on this project : USD 5.0 Bn7) while

investments are frozen and in sharp decline for the last few years.

5 Source : WSJ

6 Source : capital.fr 7 Source : FY15 results


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Moreover, Saipem is currently suing Southstream B.V. in order to get some money

back from what it already paid in the project, and against the prejudice of the

cancellation of the contract and demands USD 760m (plus interests) to Gazprom8.

Even if it is highly improbable that Gazprom pays anything to Saipem, there is a

little hope the total bill for Saipem could be sweetened.

Conclusion on ENI productive and geographical situation

ENI’s problem (and of the oil and gas sector in general) is that a potential investor

would theoretically be exposed to the advantages and drawbacks of the health and

dynamism of ENI, while he would actually be exposed to the random walk of oil

price, and in a lesser extent to the disequilibrium of Upstream/Downstream of the

company. For well-integrated companies, the impact of oil price fluctuations is

limited to the Downstream’s weaknesses. In perfectly well-integrated companies,

for which Total S.A. is the closets example, this impact is low. ENI however faces

numerous weaknesses and thus cannot structurally be considered as a profitable

business model.

Moreover, while looking at the numerous setbacks face by the exploration and

production during the last years, we can see that ENI has been involved in every

rickety projects (arctic oil, Kashagan, Southstream B.V.,…), being whether exposed

in direct or through its subsidiaries. We can also add that in contrary of these

projects, ENI is the sole operator on the Zohr field…and thus will be fully exposed to

costs overruns and other risks in case the project turns sour.

The sale of Saipem was expected for years. On the 22nd of January 2016, ENI sold to

the Italian strategic fund (thus Italian taxpayers) 12.5% of Saipem share in exchange

of EUR 463m, which valuates the company to EUR 3.7 Bn…except that beside the

Italian state, no investor would ever take the risk to buy Saipem, or only to keep

8 Source : Interfax


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family jewels and liquidate what remains. Moreover, consolidation in the oil and

gas sector (Shell buying BG Group, and building an alliance with Gazprom to

operate the Sakhalin island, Total and Novatek producing gas in Siberia, etc.) make

Saipem a strategic asset for ENI…

The lack of visibility on the Zohr project, the numerous operational setbacks that

ENI suffered and the much deteriorated state of its infrastructures, greatly justify

our valuation of ENI’s stock. Sell.


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ENI


03-Apr-15


II. Comments on 2015 FY results

Data

As expected, with oil prices at a 7-year low, ENI 12105 FY results have been

particularly weak. They heavily suffered from low oil price and low refining

efficiency.

From an upstream point-of-view, we noted a strong 10% increase of oil and gas

production from the FY2014, and the fourth quarter was the highest producing

quarter since 2010. This increase was driven by a global increase of production in

projects started in 2014 (Angola, Venezuela, the United States and the United

Kingdom), and higher production in Iraq, Libya and the recovery of trade

receivables from Iran. The gross increase production was 139kboe/d and was partly

offset by dry up of older projects.

The downstream segment returned a profit of EUR 282m (adj.) versus a EUR 41m

loss last year. This turnaround was highlighted by the company as a result of their

efficiency policy, we however think that it was a mechanical benefit from low oil

price and should the oil price increase, the segment would go back to being

unprofitable.

Standard ENI refining margin was up by 2.6 times versus FY14 (at 8.32 $/b) that

highlights a general increase of refining segment, driven by low oil prices.

Global refining throughputs were also up by 5.5% (from 25 mmtonnes to 26.4

mmtonnes).


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It is important to note that European sales have decreased, due to asset sales in

Eastern Europe (Czech Republic, Slovakia and Romania).

Results

For the FY15, upstream adjusted operating profit was down 64.4%, while adjusted

net profit was down 83% (from EUR 4.42 Bn to EUR 756m), reflecting lower oil price

(down 48% y-o-y). Those poor results were, as expected, on impairments on

upstream assets, that were triggered on lower oil price and thus lower recoverable

amounts, and especially were production costs are high (USA, UK, Norway and

Angola).

Downstream was at last profitable, with the breakeven of EBIT being reached two

years earlier than expected (2015 vs 2017 expected), which illustrates our doubt

over ENI’s downstream production facilities (since the downstream division’s

profitability should have been 1) profitable and 2) the profitability should not have

come as a surprise).

As usual, it is very difficult to find non-adjusted figures for ENI’s results. They

disclosed an overall net loss of EUR 7.8 Bn versus a net profit of EUR 101m a year

earlier (which is already very poor) driven by lower sales (-27%), higher

depreciations and amortization (+42%), offset by a decrease of 26% in operating

expenses. The loss before tax, at EUR 4.2 Bn is increased by a EUR 3.2 Bn tax loss,

driven by decrease of deferred tax assets due to lower-than-expected taxable profit

at Italian activities.


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03-Apr-15


Cash flows statement Net cash provided by operating activities is EUR 3.2 Bn lower than in FY14 (from EUR 15.1 to 11.9 Bn) on a EUR 7.4 Bn loss versus a EUR 200m profit last year. This was partly offset by higher change in working capital and higher depreciation and amortization. Gross CAPEX are down by 5.6% (to EUR 11.6 Bn) but that hides a 27% increase on net CAPEX9 (computed from group cash flow statement) that has the overall impact of lowering the FCF by EUR 5.6 Bn from 6.6 to EUR 1.0 Bn, and that represents a decrease of 84%.

Divestments are down by 39% versus FY14, which is a bad sign since disposals are a

good way to offset troubled times of low oil prices. It can show the poor quality of

divested assets of even the lack of them. Divesting must be performed in a smart

manner since divested assets are, by definition, not in the portfolio of assets and

thus their lack harm the producing capacities on the longer run (when oil prices

recover).

Cash provided by financing is up by EUR 2.9 Bn (from a negative 5.4 Bn to a negative

2.4 Bn) and that shows that ENI increased its short term and long term debt to

increase its cash position (by EUR 2.7 Bn). It benefitted by the low cost of

borrowings but we believe that this debt increase was used to pay the cash

dividend it promised to its shareholders (EUR 0.8 per share, a total of EUR 3.46 Bn

for the FY14 and 15), while its generated cash flows from operations are at EUR 1.0

Bn). The amount of generated cash flows (EUR 1.0 Bn) and the increase in debt

(EUR 2.7 Bn) corresponds to almost the amount of cash dividend ENI paid (EUR 3.46

Bn).

No significant share buybacks have been stated in 2015.

9 This is that kind of tricks ENI uses to

show investors a better picture than it really is.


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Indebtness (balance sheet)

From 2014 to 2015, debt has increased by EUR 3.3 Bn from EUR 19.3 Bn to EUR 22.6

Bn, partly because ENI needs to finance its cash dividend. Cash balance decreased

by EUR 1.4 Bn. While the dividend represented 53% of the total cash balance for

the year 2014, it now represents 67%. Mechanically, net leverage (including cash

balance) increased by 36% from 31% to 42%.

Conclusion and outlook

As stated above, lackluster results were partly due to the low oil price, that severely

harmed the upstream division, and partly due to the poor state of ENI

infrastructure and governance. We expect the situation to stay the same while the

oil price does not recover. And potentially become better as new projects become

profitable and source of sustainable growth.

Dividend comment

The FY2015 saw ENI being unable to cover its cash dividend with its FCF (dividend

cover FY2015: 29%, dividend cover FY2014: 189%). While other companies have

started paying scrips amid oil slump, ENI kept its dividend guidance at EUR 0.8 per

share, in cash.


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III. Valuation hypothesis

On production data

Highly optimistic hypothesis on increase of production beyond Y+5 at 0,5% per year

(versus -3% on le last five years)

On the DCF model

Hypothesis of price increase until USD 80$/barrel beyond Y+5. That puts the FCF at

around the same level as the last five years FCF

Conservative valuation hypothesis with CAPEX increase as soon as 2016 at the

average of 2008-2015 and then a decrease to reach an average level of EUR 12.5Bn.

We added the CAPEX add-on of EUR 1Bn per year to highlight the increase of costs

of new Zohr-type projects (which correspond to the 5-y estimations and

conservative hypothesis on infinite CAPEX).

On actualization rates

5-Y CAPM: beta at 1.1 (=beta 3-Y)

Beyond 5-Y CAPM at 1.5 (=beta 5-Y)

Risk-free rate and market premium are at respectively 1.5% and 5.4%10.

10 Source : IESE Business School


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Chart 1 : production of the four European super-majors Chart 2 : upstream/downstream mix in ENI adj. profit

Chart 3 : net CAPEX, for each super-major Chart 4 : Cash flows from operation, for each super- major

Chart 5 : geographical repartition

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Equity Analyst

Gabriel Jablon

[email protected]

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Table 1 : DCF valuation model (data)

2011 2012 2013 2014 2015 2016e 2017e 2018e 2019e 2020e 2021e

Net Income 7 512 4 395 982 2 043 8 245 - 7 768 - 6 674 - 5 580 - 4 487 - 3 393 - 2 299 -

DAP 9 096 11 349 9 578 10 919 15 519 15 208 14 737 14 267 13 797 13 326 12 856

Change in WC 2 214 - 3 373 - 409 2 148 4 629 4 857 4 312 3 767 3 222 2 677 2 132

TOTAL CFO 14 394 12 371 10 969 15 110 11 903 12 297 12 375 12 454 12 532 12 610 12 689

Gross CAPEX 13 798 - 13 517 - 12 570 - 12 648 - 11 784 - 13 058 - 12 889 - 12 685 - 12 446 - 12 172 - 12 540 -

El Zohr add-on 1 000 - 1 000 - 1 000 - 1 000 - 1 000 -

Disposal 2 539 5 309 5 790 4 119 907 2 986 2 986 2 986 2 986 2 986 2 986

FCF 3 135 4 163 4 189 6 581 1 026 2 225 1 472 1 754 2 072 2 425 3 135

Divisor 1,074 1,154 1,240 1,332 1,432 1,538

DCF 2 071 1 275 1 414 1 555 1 694 2 038

Table 2 : DCF valuation model (actualization hypothesis)

rf 1,50% rf 1,50%

M prem. 5,40% M prem. 5,40%

beta 1,1 beta 1,5

CAPM 7,44% CAPM 9,60%

beta computation LT beta computation

Infinte growth rate 0,50%

Table 3 : DCF valuation model (price per share)

Value Y+5 8 009

Value infinity 24 545

Number of shares 3601

Price per share 9,0

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Equity Analyst

Gabriel Jablon

[email protected]

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