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Commodities Trading Ideas & Charts

Marathon Petroleum’s Strong Performance Leads to Greater Shareholder Returns, Increased FVE

Business Strategy and Outlook

The combination of Marathon and Andeavor created the U.S.’ largest refiner with facilities in the Midcontinent, Gulf Coast, and West Coast. Through the combination, Marathon planned to leverage this geographically diverse footprint to optimize its crude supply from North America to reduce feedstock cost, while also improving its operating cost structure. It delivered $1.1 billion of a planned $1.4 billion in synergies by year-end 2019, but its focus shifted to capital and cost reductions in 2020 when the pandemic hit. These efforts proved successful with the company delivering over $1 billion in operating expense reductions. In the near term, its focus remains on delivering more cost and capital improvements.

Financial Strength

Cash flow has been sufficient to cover capital spending while allowing for share repurchases and dividend increases in recent years. Based on our current forecast, however, we expect operating cash flow to sufficiently cover capital spending and the dividend. Marathon received $17.2 billion in after-tax proceeds from sale of its Speedway segment in second-quarter 2021. As of the year 2021, it has retired $3.75 billion in debt and repurchased $4.5 billion shares. It plans to repurchase another $5.5 billion shares by year-end 2022 at the latest and repurchase another $5 billion of shares beyond then. 

The large amount of repurchases have reduced the dividend burden, and as such it is expected that  management to return to dividend growth at some point given the company’s strong cash flow. It’s possible management returns to its previous shareholder return target of 50% of discretionary free cash flow including dividend growth and share repurchases. Our fair value estimate to $79 from $68 per share after updating our near-term margin forecast with the latest market crack spreads and incorporating management’s guidance, and the latest financial results.

Bulls Say’s 

  • Marathon Petroleum’s high-complexity facilities in the midcontinent and Gulf Coast leave it well-positioned to capitalize on a variety of discount crude streams, endowing it with a feedstock cost advantage. 
  • Closure of lower-quality refineries and investment in renewable diesel leaves Marathon in a better competitive position in the long term. 
  • Current repurchase plans amount to 20% of the current market cap, with potentially more coming if market conditions remain strong.

Company Profile 

Marathon Petroleum is an independent refiner with 13 refineries in the midcontinent, West Coast, and Gulf Coast of the United States with total throughput capacity of 2.9 million barrels per day. The firm also owns and operates midstream assets primarily through its listed MLP, MPLX.

(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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Currencies Trading Ideas & Charts

India to Launch its own digital currency in 2022-23

The Reserve Bank of India (RBI) intimated in October 2021 that it had got approval for a modification to the Reserve Bank of India Act 1934 that would broaden the definition of bank note to include CBDCs. The central government has emphasised the potential benefits of CBDCs, claiming that they will lessen reliance on fiat currencies.

In another major announcement, Sitharaman said that all income from the transfer of virtual digital assets will be taxed at 30%. This will impact gains from cryptocurrencies and NFTs.

She further highlighted that no deduction will be allowed for expenditure undertaken on its acquisition. The loss from transfer of virtual digital assets cannot be set off against any other income.

The Finance Minister also proposed to provide for TDS on payment made in relation to transfer of virtual digital assets at the rate of 1 percent of such consideration above a monetary threshold. Gift of virtual digital assets has also been proposed to be taxed in the hands of the recipient.

India’s crypto industry had several demands, including that the government classify cryptocurrencies, provide clarity on taxation and establish a self-regulatory framework shaped by the crypto industry.

Many countries have rolled out their CBDCs recently. Nigeria launched eNaira in October last year. The Bahamas and five other islands in the East Caribbean have also rolled out their digital currencies.

(Source: The Financial Express)

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

Soaring Steel Spreads Expected to Normalise, Maintaining BlueScope’s FVE at AUD 15.50

Business Strategy and Outlook

BlueScope’s strategy appropriately plays to its strengths and attempts to neutralise its weaknesses within its portfolio of legacy assets. Steel manufacturers produce largely undifferentiated products and have limited pricing power. Sustainable competitive advantage is typically generated by being the lowest cost provider. BlueScope’s Australian business operates at a relatively high cost and struggles to compete in highly competitive export markets. North Star is significantly more entrenched and operates toward the low end of the cost curve.

Over the past decade, BlueScope sensibly restructured Australian operations away from commodity export markets where the relatively high cost of production places it at a competitive disadvantage. The Australian operations are now tailored to the domestic market with a focus on shifting its sales mix to its value-add metal coated and painted product brands.

BlueScope is taking appropriate actions to manage its environmental, social, and governance risks. BlueScope is proactively investing in technologies to limit the carbon intensity of its steelmaking operations and has committed to a net zero emissions target by 2050.

Expecting a Normalisation in Steel Spreads at BlueScope; Maintaining FVE at AUD 15.50

A combination of supply side disruptions and large fiscal and monetary stimulus programs enacted in major economies in response to the pandemic have pushed steel prices and steelmaking spreads to unsustainably high levels. Indicative steelmaking spreads exceeded USD 1,000 at North Star and USD 500 at Port Kembla during 2021, well above long-term averages. Morningstar analysts expect BlueScope will benefit handsomely from these conditions over the next couple of years, particularly during fiscal 2022. However, Morningstar analyst longer-term view for steelmaking spreads is more subdued and expects a gradual return to historical spread levels largely beginning in fiscal 2023. 

Morningstar analysts maintain a fair value estimate for BlueScope Steel at AUD 15.50 per share following transition to a new covering analyst. While Morningstar analysts have maintained its fair value estimate, but have adjusted its near-term earnings estimates for the latest steelmaking futures curve. As a result, the prediction for fiscal 2023, 2024 and 2025 EBIT forecasts have increased 30%, 122%, and 32% to AUD 1.8, AUD 1.3 and AUD 0.9 billion, respectively. Offsetting a positive outlook for earnings is a slight reduction in implied underlying EV/EBITDA terminal multiple to 5.0 times from 5.6 times, aligning with recent historical levels.  Morningstar analysts maintain very high uncertainty, Standard capital allocation, and stable no-moat ratings. BlueScope currently screens at an 18% premium to Morningstar analyst fair value estimate

Financial Strength 

BlueScope has a strong balance sheet. As at the end of fiscal 2021, BlueScope’s net cash position was AUD 798 million (including operating leases) and had approximately AUD 3 billion in undrawn debt facilities. BlueScope’s balance sheet will be put to work over the next few years to fund a range of initiatives across Port Kembla, North Star, and the U.S. buildings segment. BlueScope is also strategically investing in sustainability programs associated with its commitment to net zero emissions by 2050. Longer term, BlueScope is targeting a relatively conservative net debt position of around AUD 400 million with at least 50% of free cash flows distributed to shareholders in the form of dividends and share buybacks.

Bulls Say

  • Incremental electric arc furnace capacity expansion within the U.S. will dampen North Star’s margins.
  • Investors may apply a risk premium to BlueScope’s relatively emissions intensive business. 
  • The removal of import tariffs on steel from the European Union has the potential to reduce U.S. domestic steel prices and lower North Star’s margins. The removal of tariffs on other countries’ steel has the potential to have a similar effect.

Company Profile

BlueScope is an Australian-based steelmaking firm with five steel related business units. The Australian Steel Products segment predominantly specialises in a range of high-value coated and painted flat steel products for the Australian domestic market. North Star is the group’s U.S. mini-mill specialising in the production of hot rolled coil for the U.S. construction and automotive sectors. Building Products Asia and North America comprise operations across Southeast Asia, China, India, and the U.S. West Coast involved in metal-coating, painting, and roll-forming. New Zealand Steel and the Pacific Islands business has steel operations across New Zealand, Fiji, New Caledonia, and Vanuatu. The Buildings North America segment specialises in non-residential building solutions.

 (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

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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Commodities Trading Ideas & Charts

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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Commodities Trading Ideas & Charts

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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Commodities Trading Ideas & Charts

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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Commodities Trading Ideas & Charts

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.