HOW should investors think about oil companies?
They aren’t the most environmentally friendly companies in an increasingly green world. And they haven’t attracted many investor friends recently with activist shareholders aggressively challenging boards.
Not that the activists have necessarily been wrong.
Banks in the US — the home of ExxonMobil, Chevron and ConocoPhillips — have formed the Net-Zero Banking Alliance, which wants virtually zero lending to carbon producing companies by 2030.
A recent court decision in the Netherlands effectively said Royal Dutch Shell — Europe’s biggest oil company — needs to reduce carbon emissions by 45 per cent by 2030. And in the middle of last month, the European Commission released its Fit for ’55 roadmap to zero carbon emissions in Europe, as a continent, by 2055.
But oil companies comprise more than 6 per cent of the market capitalisation of companies around the globe. Their output, literally, makes the world move around and will be in demand for decades to come.
It’s an investors dilemma, says Ashley Pittard, Pendal’s head of global equities.
“Oil companies will have to limit their capital expenditure which means production growth will be slower and prices will remain strong,” Pittard says.
“And that means oil companies will have significant free cash flow so we should expect buybacks, dividends and investing in greener technology like wind, hydrogen and batteries.”
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Valuations on the companies are compelling, Pittard says, trading around six to eight times earnings.
“They are trading below, or significantly below, their replacement value, and they’re on a dividend yield of 6 per cent. And while much of the rest of the market is at near record levels, oil company prices are flat.”
So, there’s clearly opportunity. But what about the green question?
“It’s better to be in the tent, buying businesses and enacting change via proxy voting then saying we’re just not going to fund these businesses,” Pittard explains.
But that doesn’t mean its okay to buy any oil company.
“We will screen out stocks that structurally that can never change,” Pittard says, giving the example of tobacco companies.
“But some oil companies can change and the best example is TotalEnergies. Over the last five years that have spent a significant amount of their free capital on battery farms, wind farms and gas. They have used their free cash flow to reinvent themselves.”
“Total is already at the front end of being green among the integrated oil companies. They are investing in renewable technology. But other companies are being dragged to the table.”
In essence, investing in oil companies that benefit from the current market conditions, and are using cash flow to shift into renewables is a way of having your cake, and eating it too?
“In the short term, tailwinds of limited capital expenditure and higher oil prices are attractive. But in the long term, automobiles are becoming electric, notwithstanding there will be a long tail of vehicles,” Pittard says.
“What you will see over time is the best oil companies becoming more like wind generation companies, or battery technology companies.
“Ironically that will reduce cyclicality among the integrated oil companies and they will end up with a business model which is more like a utility companies.
“You can invest in oil companies so long as they are doing a good job reinventing themselves, increasing their focus on wind technology, battery technology, solar and the rest.
“That way you can get the upside of them being an oil company today.”
Ashley Pittard leads Pendal’s Global Equities investment boutique. He is responsible for setting the strategy, processes and risk management for the boutique and its funds including Pendal Concentrated Global Share (COGS) Fund.
Ashley has more than 24 years of finance experience, including roles in petroleum economics, global energy investment analysis and 20 years as a global equities fund manager.
Pendal COGS Fund is an actively managed, concentrated portfolio of global shares diversified across a broad range of global sharemarkets.
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