MoneyTalks: Decarbonisation is trending but Monash Investors’ Simon Shields says don’t discount ‘old world’ energy stocks
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MoneyTalks is Stockhead’s regular drill down into what stocks investors are looking at right now. We’ll tap our extensive list of experts to hear what’s hot, their top picks, and what they’re looking out for.
Today, Monash Investors portfolio manager Simon Shields talks about his favourite stock picks for 2022.
Monash Investors is currently paying close attention to the Energy sector, where the world is investing enormous sums into renewables while dis-incentivising hydro-carbon investment.
“Stock prices of companies in transitionary periods are volatile which can offer mispricing opportunities to investors,” Shields said.
“For example, the S&P 500 Energy sector is up 63% over the last 12 months.
“Despite this, the entire Energy sector’s weighting in S&P 500 is about 4%, down from 13% in 2011.
“For some context, Apple and Microsoft sit around 5-7% each in the S&P 500.”
Shields says that decarbonisation is a key macro trend going forward and Monash is keen to back sensible opportunities in this area, however he did flag oil’s ongoing role as a fuel is often underappreciated, while on the supply side, production capacity has remained strained given a chronic underinvestment in new oil projects.
“As we re-enter a world where money is not free and the Federal Reserve is withdrawing liquidity from the market, the Energy sector has attractive attributes,” Shields said.
“Notably, strong cash flow generation, earnings resilience and management teams prioritising returns to shareholders.
“We expect these returns to shareholders will increasingly come in the form of share buy-backs and dividends.”
Within the decarbonisation megatrend, Shield sees many interesting developments including carbon capture programs, wider adoption of regulated carbon credits and emergent low-emission replacement technologies like Calix (ASX:CXL).
“However, let’s take a look at the ‘old world’ energy sector for a moment,” he said.
“With the current macroeconomic backdrop, one might be surprised that the oil price remains well above its pre-COVID levels.
“Elevated concerns of a global recession, rising costs of living and ongoing lockdowns in China are strong downward pressures on oil demand.”
On the supply side, the US Government has released on average 0.7 million barrels of oil per day into the market from its Strategic Petroleum Reserve (SPR) since April 2022.
For context, the IEA estimates that the yearly growth in global oil demand for 2022 is 2.1 million barrels per day – which means that the SPR has been releasing about one-third of that additional demand per day.
The SPR releases have reduced the finite SPR oil reserves by 40% (levels not seen since 1984) which Shields said are unsustainable but have had a meaningful impact on the oil price.
“In commodities, the rule of thumb is that ‘the cure for high prices, is higher prices’ because producers respond to higher prices with more supply, thereby reducing prices,” he said.
“Yet, the oil price remains surprisingly stubbornly above pre-COVID levels due to a subdued response from oil majors to ramp up supply, and we expect it to remain so.”
Sheilds added that structural underinvestment in the oil and gas industry is here to stay, and that’s positive for the price of oil, “because supply growth will not otherwise keep up with the growth in demand.”
“Between environmental activism/restrictions, ‘lawfare’, reluctance of lenders, the ESG focus of institutions, the threat of super taxes on profits, subsidies for renewables and social opprobrium for directors, the disincentives are overwhelming.”
Shields’ top pick in the sector is Santos (ASX:STO), the giant Aussie oil and gas producer that completed its merger with Oil Search in late 2021.
His reasoning includes the experienced and well-regarded management team which is using the company’s strong cash flow generation – US$2.7 billion this year to the end of September – to invest in building out their core assets and other growth opportunities including offshore oil production in Western Australia.
“The company is also conducting partial sales of some of its assets (Alaska and Papua New Guinea) and using the funds generated to return capital to shareholders,” Shields said.
“It’s on track to complete a $350m buy-back by year-end expectations for another buy-back program in 2023.”
In September, Santos announced Kumul Petroleum Holdings Limited (Kumul) will acquire a 5% interest in PNG LNG for asset value of US$1.4 billion.
Production in 2023 is expected to be in the range of 91-98 mmboe, influenced by the end-of-field life at Bayu-Undan, timing of completion of the expected sell-down of a five per cent stake in PNG LNG and lower Western Australia domestic gas production.
“[The company is also] targeting carbon neutral status by 2040 with significant reductions in emissions and carbon offsets planned for 2030,” Shields added.
Another pick is Woodside (ASX:WDS) which Shields says has improving fundamentals and production volumes and recently beat analysts’ expectations on both production volumes from Australian assets and better LNG prices realised.
“Management is also undertaking a strategic review of the company’s portfolio of assets to streamline production and prioritise exploration endeavours,” he said.
“The company remains committed to returning capital to shareholders through dividends with a payout ratio of 50-80% of net profits.”
In the September quarter, the producer delivered record production of 51.2 MMboe (557 Mboe/day), up 52% from Q2 2022 – and record revenue of $5,858 million, up 70% from Q2 2022.
Woodside also upgraded its full-year 2022 production guidance to 153–157 MMboe.
Karoon (ASX:KAR) is Shields’ final pick, an Aussie oil exploration company that has graduated from a choppy past into a pure oil producer with the purchase of its Brazilian projects.
Oil production in the 2022 September quarter was 1.29 million barrels (MMbbl), 19% higher than in the prior quarter, and oil sales revenue from the cargoes lifted was US$140.2 million.
“The company however retains some single asset risk,” Shields said.
“[They’re] generating strong cash flows with potential to increase production from some existing oil wells and on-ramp of two wells currently in development.
“Its net cash balance sheet position is growing strongly and provides management with optionality to purchase another asset.”
Karoon is also targeting net zero emissions by 2035 through carbon offset purchases and notably, made it into the ASX200 club in the September quarter.
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