Category: Commodities

A commodity market is a physical or virtual marketplace for buying, selling, and trading raw or primary products. There are currently about 50 major commodity markets worldwide that facilitate trade in approximately 100 primary commodities. commodities can be invested in numerous ways. An investor can purchase stock in corporations whose business relies on commodities prices or purchase mutual funds, index funds, or exchange-traded funds (ETFs) that have a focus on commodities related companies.

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Commodities

Mineral Sands Prices Continue to Rise on Strong Demand, Raising Iluka FVE to AUD 9.70

Business Strategy and Outlook

Iluka is a leading global mineral sands miner. Major mines are its Jacinth-Ambrosia mine in the Eucla Basin in South Australia, Cataby in Western Australia and Sierra Rutile in Sierra Leone.Iluka’s main focus is on managing volumes and the resulting impact on prices. Efforts to maintain margins and prices means sales volumes can fall in periods of weak demand as Iluka shoulders part of the responsibility for balancing industry supply, but Iluka can also flex production to increase its market share, or liquidate excess inventories, as prices rise. Maintenance capital expenditure is relatively modest, but expansions and reinvestment to prolong life are generally pursued when Iluka sees a need for new demand and potential for reasonable returns on investment. Conversion of resources to reserves is an obvious path to life extensions, but resources are likely lower-grade and higher-cost.

The balance sheet is relatively strong with net cash of around AUD 300 million at end-December 2021. Iluka intends to maintain a conservative balance sheet with no net debt on average through the cycle. This should provide the appropriate capacity to finance inventory build when necessary and invest through the cycle.Management values cash returns to shareholders, primarily through dividends, but will flex depending on investment needs.

Mineral Sands Prices Continue to Rise on Strong Demand, Raising Iluka FVE to AUD 9.70

Iluka Resources continues to benefit from booming mineral sands markets, with both the zircon and titanium dioxide feedstock markets continuing to bounce back after the COVID-19-induced weakness in 2020. Zircon sales of 355kt were up 48% in 2021, reflecting demand strength across all of the company’s markets. High-grade titanium dioxide feedstocks also showed strong demand, supported by production issues at Rio Tinto’s Richards Bay Minerals in South Africa. Rutile sales were up 27.8%, to 207.2kt, while synthetic rutile sales rose 164% to 305.9kt. The company’s synthetic rutile kiln 2 (SR2) at Capel operated at full capacity, producing 60kt during the quarter. Given the strength in global titanium dioxide feedstock markets, restarting synthetic rutile kiln 1, due in the fourth quarter of 2022, seems reasonable. Thus, Morningstar analysts raise the fair value estimate to AUD 9.70 from AUD 9.10 on higher mineral sands prices and a lower AUD/USD exchange rate.

Financial Strength

Iluka’s balance sheet is strong with net cash of around AUD 300 million at December 2021. Modest net cash at end 2015 turned to a relatively small net debt position with the acquisition of Sierra Rutile for AUD 455 million in late 2016. The subsequent improvement in prices meant debt was repaid by the end 2018. Iluka intends to maintain a conservative balance sheet and targets no net debt on average through the cycle. The company’s strategy is to build inventory during periods of weak sales demand. Excess inventories at the end of 2016 were about AUD 400 to 500 million. The excess inventories were largely liquidated through 2017 and 2018 as external conditions improved and sales volumes exceeded production. Iluka is expected to use cash flow for incremental organic growth projects, the potential expansion of Sierra Rutile, debt repayment and cash returns to shareholders (primarily dividends). In the medium to long term, cash flows will either be reinvested or returned to shareholders. Iluka’s total debt facilities stood at AUD 500 million at end-June 2021, maturing in July 2024. The debt profile gives significant financial flexibility to hold inventory or make opportunistic and/or countercyclical investments.

 Bulls Say  

  • Iluka is an industry leader with relatively high grade zircon and rutile deposits. Supply can be withheld to defend prices and margins in times of weak demand. 
  • Management has improved company fortunes with a strong focus on returns on capital. Demand for zircon is likely to be bolstered by new applications such as chemicals and digitally printed tiles. 
  • Iluka has some diversification. The revenue mix is approximately half from zircon and half from high grade titanium products. Geographically, revenue is split between North America, Europe, China and the rest of Asia.

Company Profile

Iluka Resources is a leading global mineral sands miner. It is the largest global producer of zircon, and the third-largest producer of titanium dioxide feedstock (rutile, synthetic rutile) behind Rio Tinto and Tronox. Low zircon costs are underpinned by the high-grade Jacinth-Ambrosia mine in South Australia but reserve life is less than 10 years. The Sierra Rutile operations in Sierra Leone lack a cost advantage but expansions could bring some scale economies if they can be effectively executed. A 20% shareholding in Deterra Royalties brings exposure to the high-quality Mining Area C iron ore royalty. Iluka’s nascent rare earths operation at Eneabba is a low-cost source of rare earth oxides neodymium and praseodymium, albeit with a reserve life of only around 10 years.

(Source: Morningstar)

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

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AGL Energy Ltd. gains strengthened by its low-cost coal-fired generation fleet.

Business Strategy and Outlook

AGL is one of Australia’s largest integrated energy companies. We believe it has a narrow economic moat, underpinned by its low-cost generation fleet, concentrated markets, and cost-advantages from vertical integration. Key attractions for shareholders include relatively defensive earnings, solid dividends, and relatively conservative gearing. Earnings are dominated by energy generation (wholesale markets), with energy retailing about half the size. Strategy is heavily influenced by government energy policy, such as the renewable energy target. 

AGL has proposed a structural separation into two businesses; a multi-product energy retailer focusing on carbon neutrality and an electricity generator that will own AGL’s large fleet of coal fired power stations among other assets. It is expected to be completed in mid-2022. 

AGL’s consumer market division services over 4 million electricity and gas customers in the eastern and southern Australian states, representing roughly a third of available customers. Retail electricity consumption has barely increased since 2008, reflecting the maturity of the Australian retail energy market and declining electricity consumption from the grid. Despite deregulation and increased competition, the market is still dominated by AGL Energy, Origin Energy, and Energy Australia, which collectively control three fourths of the retail market. 

AGL’s wholesale markets division generates, procures, and manages risk for the energy requirements of its retail business. The acquisition of Loy Yang A and Macquarie Generation means electricity production significantly outweighs consumption by its retail customers. Exposure to energy-price risks is mitigated by vertical integration, peaking generation plants and hedging. More than 85% of AGL’s electricity output is from coal-fired power stations. AGL Energy has the largest privately owned generation portfolio in the National Electricity Market, or NEM.

Financial Strength

AGL Energy is in reasonable financial health though banks are increasingly reluctant to lend to coal power stations. From 1.4 times in 2020, we forecast net debt/EBITDA rises to 2.1 times in fiscal 2022. Funds from operations interest cover was comfortable at 12.8 times in fiscal 2021, comfortably above the 2.5 times covenant limit. AGL Energy aims to maintain an investment-grade credit rating. To bolster the balance sheet amid falling earnings and one-off demerger costs, the dividend reinvestment plan will be underwritten until mid-2022. This should raise more than AUD 500 million in equity. Dividend pay-out ratio is 75% of EPS

Bulls Say’s

  • As AGL Energy is a provider of an essential product, earnings should prove somewhat defensive. 
  • Its balance sheet is in relatively good shape, positioning it well to cope with industry headwinds. 
  • Longer term, its low-cost coal-fired electricity generation fleet is likely to benefit from rising wholesale electricity prices.

Key Investment Considerations:

  • Fiscal 2022 will be tough but high wholesale gas and electricity prices bode well for earnings recovery from 2023. 
  • The proposed separation of AGL’s retail and generation businesses will likely be somewhat value destructive due to potential duplication of resources and loss of scale benefits. 
  • The Australian energy sector is heavily influenced by government energy policy, particularly over emissions and utility bill affordability.

Company Profile 

AGL Energy is one of Australia’s largest retailers of electricity and gas. It services 3.7 million retail electricity and gas accounts in the eastern and southern Australian states, or about one third of the market. Profit is dominated by energy generation, underpinned by its low-cost coal-fired generation fleet. Founded in 1837, it is the oldest company on the ASX. Generation capacity comprises a portfolio of peaking, intermediate, and base-load electricity generation plants, with a combined capacity of 10,500 megawatts.

(Source: Morningstar)

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

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Activity in Guyana provides Hess Corp. geographic diversification and shields it from domestic issues

Business Strategy and Outlook

Hess’ track record for efficiently allocating capital and generating value has been steadily improving for several
years. This had been a source of frustration for shareholders in the past. Before 2012, the firm was struggling
with persistent budget overruns and costly exploration failures, and the eventual collapse in its share price led
to a heated proxy fight with an activist investor (which it lost). Subsequently, the board was reshuffled, and
management began streamlining the company, selling midstream and downstream assets and rationalizing its
upstream portfolio. The current portfolio is more competitive, but the development cost requirements are
heavily front-loaded.
Currently, Hess is one of the largest producers in the Bakken Shale, with about 1,700 producing wells and about
530,000 net acres of leasehold. This includes a large portion in the highly productive area near the Mountrail-
McKenzie County line in North Dakota. Even with four rigs, it would take more than 10 years to develop this
position, and to conserve capital in the wake of the COVID-19 pandemic management is only running two rigs
(with a third to be added late 2021). Like peers, Hess has made huge strides with enhanced completions. It is
expected 180-day cumulative oil production to average 150 mbbls going forward (consistent with break-evens
of about $40/bbl. for West Texas Intermediate).
Hess also holds a 30% stake in the Exxon-operated Stabroek block in Guyana, which will be the firm’s core
growth engine going forward and is a game-changer for the company, due to its large scale and exceptional
economics. The block contains numerous confirmed discoveries already, including Liza, which came online in
late 2019. Economically, these projects appear around on par with the Bakken. But the up-front capital
demands are onerous–Hess’ share of the first development phase was over $1 billion. Six phases are currently
planned, culminating in gross volumes of about 1 mmb/d and management has suggested there is scope for as
many as 10 phases in the ultimate development. Total gross recoverable resources are a moving target, but the
latest estimate is over 9 billion barrels of oil equivalent.

Financial Strength

Hess’ Guyana assets are capital-intensive (it must pay 30% of the development costs, which run to $1 billion-$2
billion for each sanctioned phase of development; a total of six are currently planned and more than that are
likely eventually). And these commitments are heavily front-loaded. As a result, capital spending has
significantly exceeded cash flows in the last few years, leaving the firm with leverage ratios that are elevated
from the historical norm. At the end of the last reporting period, debt/capital was 57%, while net debt/EBITDA
was 1.8 times. The good news is that the firm’s liquidity backstop is very strong, as it prefunded a portion of its
Guyana commitment with noncore divestitures. The firm has a $2.4 billion cash war chest, and there is more
than $3 billion available on its credit facility as well. In addition, the term structure of the firm’s debt is fairly
well spread out, and there are no maturities before 2024 (other than a $1 billion term loan due 2023 and likely
to be paid in full with operating cash flows by the end of 2022).The firm does have a covenant requiring it to

Commodities – Energy
28 January 2022

Website: www.lavernefunds.com.au Email: info@laverne.com.au
1300 528 376 (1300LAVERNE) 1
keep debt/capital above 0.65, though it isn’t expected to get close to that level (and if it does a violation would
still be unlikely because in the associated debt agreement capital is defined to exclude impairments).
Bulls Say’s
 The Stabroek block (Guyana), in which Hess has a 30% stake, is a huge resource, with at least 9
billion barrels of oil equivalent recoverable.
 The first phase of the Liza development is profitable at $35/bbl (Brent), making it competitive with
the best shale. Management expects similar economics from subsequent projects in Guyana.
 Hess’ activity in Guyana provides geographic diversification and insulates it from domestic issues
(like antifracking regulations).

Company Profile
Hess is an independent oil and gas producer with key assets in the Bakken Shale, Guyana, the Gulf of Mexico,
and Southeast Asia. At the end of 2020, the company reported net proved reserves of 1.2 billion barrels of oil
equivalent. Net production averaged 323 thousand barrels of oil equivalent per day in 2020, at a ratio of 70%
oil and natural gas liquids and 30% natural gas.
(Source: Morningstar)
General Advice Warning
Any advice/ information provided is general in nature only and does not take into account the personal
financial situation, objectives or needs of any particular person.

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Marathon Focusing on Capital Returns After Strengthening Balance Sheet

Business Strategy and Outlook

Marathon has comprehensively reshuffled its portfolio in the past five to 10 years, discarding most the conventional projects it historically focused on and doubling down on U.S. shale. The international assets it has retained, in Equatorial Guinea, will be harvested for cash flows that can be redeployed in the U.S. Elsewhere, the firm is still just getting started. It entered the Permian Basin in 2017, and is ramping quickly from a very low base of production. The position is fairly fragmented, limiting the scope for long-lateral development (though management is attempting to address this with acreage trades, bolt-on acquisitions, and acreage swaps). 

Well results thus far have been reasonably impressive, and are consistent with a West Texas Intermediate break-even level under $40 per barrel (comparable to, but not significantly better than, what other Permian producers typically achieve). The Oklahoma portion of the portfolio could have similar potential, but this is more speculative–the firm’s drilling results to date have been middling, and the natural gas weighting and high cost of development have been weighing on its potential returns there. Activity in both of these areas has been dialed back to a minimum since the 2020 downturn in crude prices.

Financial Strength

Marathon holds about $4.0 billion of debt, resulting fairy strong leverage ratios. At the end of the last reporting period debt/capital was 27%, and net debt/EBITDA was about 1 times. These metrics are likely to improve further. The firm can generate free cash flows under a wide range of commodity scenarios. Management’s benchmark five-year plan is based on $1 billion capital expenditures annually, and that should generate $1 billion annually in free cash (which can comfortably fund its base dividend, leaving it with plenty left over for debt reduction). So it’s pretty unlikely that the firm will need to tap its liquidity reserves, but if it does there’s $500 million cash on the balance sheet, and it has an undrawn $3 billion revolver.

Bulls Say’s 

  • Marathon’s acreage in the Bakken and Eagle Ford plays overlaps the juiciest “sweet spots” and enables the firm to deliver initial production rates far above the respective averages. 
  • Holding acreage in the top four liquids-rich shale plays enables management to sidestep transport bottlenecks and avoid overpaying for equipment and services in areas experiencing temporary demand surges. 
  • Marathon was one of the first U.S. shale companies to establish a track record for free cash flow generation.

Company Profile 

Marathon is an independent exploration and production company primarily focusing on unconventional resources in the United States. At the end of 2020, the company reported net proved reserves of 972 million barrels of oil equivalent. Net production averaged 383 thousand barrels of oil equivalent per day in 2020 at a ratio of 67% oil and NGLs and 33% natural gas.

(Source: Morningstar)

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

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APA Corp. Widened its Focus to Include Suriname

Business Strategy and Outlook

APA Corp. is an upstream oil and natural gas producer with assets in the U.S. and overseas. The vast majority of its domestic production is derived from the Permian Basin. This was a key growth engine for the company until 2020, when the coronavirus-related collapse in crude prices forced the company to dial back on drilling capital. After a hiatus, development operations have restarted, albeit at a slower pace–Permian volumes are likely to decline slightly during 2021. Drilling is currently focused on the same reservoirs that APA’s competitors are targeting (the Spraberry and Wolfcamp intervals in the Midland Basin and the Bone Spring and Wolfcamp formations in the Delaware). But in the past the firm also focused on its own discovery in the Permian region, the Alpine High play. Alpine High wells are characterized by very strong initial production rates but with a much higher gas and natural gas liquids content than it is probable elsewhere in the Permian. More recently, it has also been testing its East Texas Austin Chalk acreage. 

APA also holds a large acreage position in Egypt, where it has operated for nearly a quarter of a century. It is now harvesting cash flows there, and will probably keep volumes more or less flat in the next few years (drilling new wells to offset declines from older ones). But reported volumes could fluctuate as APA’s revenue and profits in Egypt are governed by production-sharing contracts (due to cost recovery provisions in these contracts, lower crude prices translate to higher volumes, creating a natural hedge, helping the company to cope with this very weak commodity environment). Meanwhile, it is awaited modest production declines from APA’s mature assets in the North Sea. 

Further, the company’s focus has now widened to include Suriname, following a string of exploration successes in Block 58 (which APA is appraising with its 50/50 partner, Total). The evidence to date suggests a very large petroleum system, which could be potentially transformative for the company. At this point, it is alleged that it is very likely that one or more of the discoveries will progress to the development stage, though none have been officially sanctioned yet.

Financial Strength

APA Corp has started to turn the corner after several years of above-average indebtedness. The firm has now strung together several quarters of substantial free cash flows, and while very high commodity prices have played a part, it is alleged the firm can maintain its current course at midcycle prices (reinvesting only a moderate portion of its operating cash while keeping production flat slightly growing). The deconsolidation of its Altus Midstream subsidiary won’t directly impact the firm’s financial health, though its leverage ratios will improve as reported debt will no longer include the Altus revolver, which has no recourse to APA. The Altus transaction will make it easier for APA to monetize that investment though, which potentially paves the way for further balance sheet strengthening. At the end of the last reporting period, consolidated debt was $7.4 billion. On an annualized basis net debt/EBITDA was 2.5 times, and debt/capital was over 100%. However, both metrics will improve after the deconsolidation. Anyway, there is little chance of a liquidity crisis anytime soon. The term structure of the firm’s debt is extremely spread out. Only about $500 million comes due before 2025, and only $3.2 billion matures in the five years after that. That means APA can forget about the principal on over half of its debt until at least 2030. Additionally, the firm has a liquidity reserve composed of $400 million cash and well over $3 billion in committed bank credit. The revolver does include a covenant ceiling of 60% for debt/capital, but capital is defined to exclude impairments since mid-2015. On that basis, APA is unlikely to come close.

 Bulls Say’s

  • APA’s international operations in Egypt and the North Sea generate high rates of free cash flow under midcycle conditions, given exposure to Brent crude pricing, low operating costs, and minimal maintenance capital requirements. 
  • APA has a long runway of drilling opportunities in the high-growth, low-cost Permian basin. 
  • The recent discovery in Suriname could open the door to large-scale developments there, and the partnership with Total means APA’s capital commitment will be greatly reduced.

Company Profile 

Based in Houston, APA Corp. is an independent exploration and production company. It operates primarily in the U.S., Egypt, the North Sea, and Suriname. At year-end 2020, proved reserves totaled 874 million barrels of oil equivalent, with net reported production of 440 mboe/d (66% of which was oil and natural gas liquids, with the remainder comprising natural gas).

(Source: MorningStar)

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

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Commodities Trading Ideas & Charts

Diamondback’s Operation Remain Lean and Efficient, Despite Recent Expansions

Business Strategy and Outlook

Diamondback Energy was a modest-size oil and gas producer when it went public in 2012, but it has rapidly become one of the largest Permian-focused oil firms through a combination of organic growth and corporate acquisitions, most notably Energen in 2018 and QEP Resources in 2021. The firm consistently ranks among the lowest-cost independent producers in the entire industry, supporting a sustainable margin advantage. 

Keeping costs low is baked into the culture at Diamondback, and it is alleged, operations to remain lean and efficient, despite the recent expansions. From the outset, the company has enjoyed a competitive advantage that enables it to systematically undercut its upstream peers. This was initially based on the ideal location of its acreage in the core of the basin, and helped by the early adoption of innovations like high-intensity completions (resulting in more production for each dollar spent). More recently, the firm has started seeing significant economies of scale as well. 

Management has fiercely protected the balance sheet over the years and has been willing to tap equity markets when necessary, as it did several times during the 2015-16 downturn in global crude prices. But that’s ancient history now. Diamondback’s financial health is excellent, and the firm can maintain or grow its production while generating substantial free cash flows under a wide range of commodity scenarios. It is viewed little to no chance that the firm will choose to allocate more capital for new drilling than appropriate, which means production will probably stay flat or grow at low-single-digit rates for the foreseeable future. Excess cash will be used for debt reduction or returned to shareholders. To preserve flexibility for management, the firm has not committed to a specific reinvestment rate or vehicle for capital returns, like certain peers have, but it does intend to distribute at least half of its free cash somehow. 

Finally, it is emphasized that, the firm’s stake in its mineral rights subsidiary, Viper Energy Partners. This vehicle owns the mineral rights relating to some of Diamondback’s most attractive acreage, further juicing returns on drilling for the parent

Financial Strength

Diamondback has historically maintained excellent financial health, with one of the strongest balance sheets in the upstream coverage. The Energen acquisition pushed up its leverage ratios for a brief spell in 2019, COVID-19 kept them elevated in 2020, and the Guidon and QEP deals extended these period of above average leverage into 2021. But borrowing never reached an unsustainable level, even in these periods, and the firm’s leverage has already recovered. At the end of the last reporting period, debt to capital was 36% and annualized debt/EBITDA was 1.1 times. And as the firm is capable of generating substantial free cash under a wide range of commodity price scenarios, it could be held that, these ratios to continue improving. The firm has targeted debt reduction of at least $1.2 billion in 2021 using its free cash flows plus the over $800 million in asset sale proceeds from its sale of noncore assets. Consolidated liquidity stands at roughly $2 billion with no material debt maturities until 2023.

Bulls Say’s

  • Diamondback is one of the lowest-cost oil producers operating in the United States. 
  • Stacked pay in the Permian Basin multiplies the value of acreage, and further value can be unlocked as additional plays are proved up over time. 
  • Diamondback has been an early adopter of enhanced completion techniques and is expected to remain at the leading edge.

Company Profile 

Diamondback Energy is an independent oil and gas producer in the United States. The company operates exclusively in the Permian Basin. At the end of 2020, the company reported net proven reserves of 1.3 billion barrels of oil equivalent. Net production averaged about 300,000 barrels per day in 2020, at a ratio of 60% oil, 20% natural gas liquids,  20% natural gas. 

(Source: MorningStar)

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

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CSX Corp. Automotive and Intermodal Volumes Under Pressure

Business Strategy and Outlook

Railroad turnaround legend Hunter Harrison led Eastern Class I railroad CSX from early 2017 until his death in December that same year. Before joining CSX, he turned around three railroads. Most impressively, his leadership improved Canadian Pacific’s reported OR from 81.3% in 2011 to 58.6% in 2016. While his time was cut short at CSX, Harrison laid the foundation for rapid improvement. As his replacement, the rail installed James Foote, who is quite familiar with Harrison’s precision railroading model from years working at Canadian National. 

This has been Foote’s first opportunity to lead a Class I railroad and, on top of that, CSX operates a complicated spiderweb network in a densely populated area. This differs from the railroads Harrison and Foote ran in Canada, which are mostly linear and run through remote locations. Even so, considering CSX’s impressive operating ratio improvement over the past four years, we think Foote has executed admirably carrying the precision railroading, or PSR, baton–the rail posted an impressive 58.4% OR in 2019 and kept it near 58.8% in 2020 despite lower volume for the year. Previously, CSX’s OR had been range-bound between 69.4% and 71.5% for seven years, even as other rails progressed. In fairness, CSX lost almost half of its highly profitable coal franchise during that time and still maintained a respectable OR. 

Foote has overseen the implementation of Harrison’s PSR playbook at CSX, particularly in terms of rightsizing all assets, including human resources, real estate, sorting yards, motive power, and rolling stock. Fewer assets and longer trains drive up network fluidity, resulting in labor productivity gains, better service levels, and higher potential incremental operating margins. Better service also creates greater intermodal opportunities. Intermodal saw first-half 2020 volume headwinds from COVID-19 disruption, but has since rebounded on robust retailer restocking and tight truckload market capacity (rising truck-to-rail conversions). CSX’s domestic intermodal volume may face congestion-related constraints lingering into early 2022, but we still see intermodal as a key long-term growth opportunity for CSX.

Financial Strength

CSX’s balance sheet is in good shape. The firm held more than $2.2 billion of cash and short-term investments compared with $16.3 billion of total debt at year-end 2021. Debt increased slightly in 2020 as the firm took measures to shore up liquidity amid the pandemic–as most transports did. Net debt/EBITDA was about 2.0 times and EBITDA/interest coverage stood at a comfortable 10 times in 2021. It is expected that net-debt/EBITDA to remain near 2 times in 2022. Overall, we consider these levels secure, given CSX’s reliable cash generation. CSX employs a straightforward capital structure composed of mostly long-term unsecured debt to fund its business, although it uses a small amount of secured debt to finance equipment.

Bulls Say’s

  • Thanks to PSR, CSX has posted impressive operating ratio gains in recent years despite losing half of its highly profitable coal business over the past eight years. 
  • Rooted in heavy service corridor investment over the past decade, CSX’s intermodal franchise has posted solid mid-single-digit container growth on average over the cycle. 
  • Compared with trucking, shipping by rail is less expensive for long distances, is 4 times more fuel efficient per ton-mile, and does not contribute to freeway congestion. These factors should support incremental intermodal growth over the long run.

Company Profile 

Operating in the Eastern United States, Class I railroad CSX generated revenue near $12.5 billion in 2021. On its more than 21,000 miles of track, CSX hauls shipments of coal (13% of consolidated revenue), chemicals (22%), intermodal containers (16%), automotive cargo (9%), and a diverse mix of other bulk and industrial merchandise

(Source: Morningstar)

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

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Commodities Trading Ideas & Charts

Murphy Shares Starting to Look Expensive After Rally

Business Strategy and Outlook

Murphy Oil repositioned itself as a pure-play exploration and production company in 2013, spinning off its retail gas and refinery businesses.The firm is a top-five producer in the Gulf of Mexico, and the region accounts for almost half of its production. Murphy has a number of expansion projects lined up there that should offset legacy declines and enable it to hold production flat in the next few years. There is regulatory risk, though: after entering office, U.S. President Joe Biden has pledged to halt offshore oil and gas permitting activity (to demonstrate his climate credentials). Murphy already holds valid leases for its upcoming projects and is ahead of schedule on permitting but will eventually require further approvals if it wants to continue its development plans. Thus far, the Biden administration has taken little action, leaving Murphy unencumbered. But we would not rule out a more comprehensive ban.

The firm has made considerable progress cutting costs and boosting productivity since the post-2014 downturn. However, while the firm still has over 1,400 drillable locations in inventory.When this portion is exhausted, well performance, and thus returns, could deteriorate. And in Canada, the firm is currently prioritizing the Tupper Montney gas play while natural gas prices in the region are more stable after a period of steep discounts caused by takeaway constraints that have now cleared.

Murphy Shares Starting to Look Pricey After Rally

Morningstar analyst nudged fair value for Murphy Oil to $26 from $25, after incorporating the firm’s third-quarter financial and operating results. That’s about 25% higher than where shares were trading as recently as September, but since then the stock has surged higher along with near-term oil prices. Morningstar analyst think the market has gotten carried away and is mistakenly extrapolating spot prices and midcycle forecast is unchanged at $60 Brent.

Financial Strength 

The COVID-19-related collapse in crude prices during 2020 impacted the balance sheets of most upstream oil firms, and Murphy saw its leverage ratios tick higher as well. But management has engineered a rapid recovery, aided by strengthening commodity prices. At the end of the last reporting period, debt/capital was 39% and net debt / EBITDA was 1.4 times. That’s about average for the peer group.The firm currently holds about $2.6 billion of debt, and has roughly $2 billion in liquidity ($500 million cash and about $1.5 billion undrawn bank credit). The term structure of the firm’s debt is reasonably well spread out, and only about 20% of the outstanding notes come due before 2024 (the firm has maturities totaling $500 million in 2022). At strip prices, the firm should have no issues covering the 2022 notes with cash, but if the operating environment deteriorates, management could always refinance a portion of this obligation or lean on the revolver.

Bulls Say

  • The joint venture with Petrobras is accretive to Murphy’s production and generates cash flows that can be redeployed in the Eagle Ford and offshore. 
  • The Karnes County portion of Murphy’s Eagle Ford acreage offers economics that are as good as or better than any other U.S. shale. 
  • Murphy’s diversified portfolio gives it access to oil and natural gas markets in several regions, insulating it to a degree from commodity price fluctuations or regulatory risks.

Company Profile

Murphy Oil is an independent exploration and production company developing unconventional resources in the United States and Canada. At the end of 2020, the company reported net proven reserves of 715 million barrels of oil equivalent. Consolidated production averaged 174.5 thousand barrels of oil equivalent per day in 2020, at a ratio of 66% oil and natural gas liquids and 34% natural gas.

(Source: Morningstar)

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

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Woodside’s Fourth-Quarter Revenue Swells on High LNG Prices

Business Strategy and Outlook:

The BHP Petroleum merger will result in a highly strategic lock-up of gas resources and infrastructure around the North West Shelf, with flexibility to mix and match gas with infrastructure to maximise returns. This includes construction completion of the Pluto to Karratha Gas Plant interconnector pipeline with commissioning underway. Woodside completed the sale of a 49% non-operating participation interest in Pluto Train 2 just after quarter’s close. This was as expected and the first LNG cargo from Pluto Train 2 remains targeted for 2026. 

Final investment decisions have already been taken on the Scarborough and Pluto Train 2 developments, including new domestic gas facilities and modifications to Pluto Train 1. The project signoff essentially unlocks 11.1 trillion cubic feet, or Tcf, (100% basis) of the world-class Scarborough gas resource. To put that into perspective, one Tcf of gas is equivalent to 20 million tonnes of LNG, and 11.1Tcf will underpin two standard 4.8Mtpa-5.0Mtpa LNG trains for over 20 years.

Financial Strength:

The fair value of Woodside is AUD 40 which equates to a 2030 EV/EBITDA of 7.6, excluding the USD 3.7 billion lump sum we credit for undeveloped prospects.

Woodside has a healthy balance sheet with which to fund development of Scarborough and Pluto T2. We estimate stand-alone net debt stands at just USD 2.6 billion, leverage (ND/(ND+E)) of just 17% and net debt/EBITDA just 0.6. And BHP Petroleum’s assets will be coming unencumbered, which will effectively halve these already favourably low debt metrics.

Company Profile:

Incorporated in 1954 and named after the small Victorian town of Woodside, Woodside’s early exploration focus moved from Victoria’s Gippsland Basin to Western Australia’s Carnarvon Basin. First LNG production from the North West Shelf came in 1984. BHP Billiton and Shell each had 40% shareholdings before BHP sold out in 1994 and Shell sold down to 34%. In 2010, Shell further decreased its shareholding to 24%. Woodside has the potential to become the most LNG-leveraged company globally.

(Source: Morningstar)

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

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Commodities Trading Ideas & Charts

Raising U.S. upstream oil and gas fair values would drive Pioneer’s growth

Business Strategy and Outlook:

Pioneer Natural Resources is one of the largest Permian Basin oil and gas producers overall, and is the largest pure play. It has about 800,000 net acres in the play, all of which is located on the Midland Basin side where it believes it can get the best returns. The firm acquired the bulk of its acreage well before the shale revolution began, with an average acquisition cost of around $500 per acre. That’s a fraction of what most of its peers shelled out during the land grab at the beginning of the Permian boom, giving the firm a unique advantage. And the vast majority of this acreage is located in the core of the play, where well performance is typically strongest. That gives Pioneer an extensive runway of low-cost drilling opportunities primarily targeting the Wolfcamp A, Wolfcamp B, and Spraberry reservoirs.

Pioneer has expanded fairly rapidly, with annual production growth averaging 10%-15% over the last eight years. Management still has grand plans for future growth, although it has long since abandoned its earlier goal of increasing production to a million barrels of oil equivalent per day by 2026. The current plan calls for up to 5% growth while reinvesting much less than 100% of its operating cash flows (a remarkable achievement for a company in the oft-demonized shale industry, which historically relied on capital markets to support its profligacy and is commonly expected to keep destroying value). The remaining surplus will be used to preserve Pioneer’s very impressive balance sheet, and to return cash to shareholders via a part-variable dividend.

Financial Strength:

The fair value of the Pioneer is USD 239.00. The primary valuation tool is net asset value forecast. This bottom-up model projects cash flows from future drilling on a single-well basis and aggregates across the company’s inventory, discounting at the corporate weighted average cost of capital.

Pioneer’s leverage ratios have already recovered after rising slightly in the wake of two substantial acquisitions (Parsley and DoublePoint). The subsequent divestiture of the Delaware Basin assets that were bundled with these acquisitions improved the firm’s balance sheet even further, with proceeds exceeding $3 billion. After the last reporting period, net debt/EBITDA was around 0.8 times and debt/capital is 22%. These metrics should decline further because the firm is generating surplus cash, even after its generous variable dividend payout.

Bulls Say:

  • Pioneer’s low-cost Permian Basin activities are likely to generate substantial free cash flows in the years to come, assuming midcycle prices ($55/bbl for WTI). 
  • The firm intends to target a 10% total return for shareholders via its base dividend, a variable dividend with a payout of up to 75% of free cash flows, and 5% annual production growth. 
  • Pioneer has a rock-solid balance sheet and is able to generate free cash flows even during periods of very weak commodity prices.

Company Profile:

Headquartered in Irving, Texas, Pioneer Natural Resources is an independent oil and gas exploration and production company focusing on the Permian Basin in Texas. At year-end 2020, Pioneer’s proven reserves were 1.3 billion barrels of oil equivalent with net production for the year of 367 mboe per day. Oil and natural gas liquids represented 81% of production.

(Source: Morningstar)

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.