Merger mania has gripped the oil patch this year. Oil giant ExxonMobil kicked things off by agreeing to acquire Pioneer Natural Resources for more than $60 billion. Fellow oil behemoth Chevron followed that up by agreeing to buy Hess for $60 billion.
More deals are likely. This consolidation wave has a few Fool.com contributors growing more cautious about the sector. They have their eyes on three oil stocks in particular -- Valaris(NYSE: VAL), ConocoPhillips(NYSE: COP), and Equinor (NYSE: EQNR) -- as the current merger wave washes over the oil patch.
Buying oil being around for a while; not so sure about buying Big Oil right now
Jason Hall(Valaris): Count me with those who hope to see the end of fossil fuels as a major source of global energy sooner rather than later. Sadly, I don't expect it to happen as quickly as many expect. Big Oil will remain relevant for years, largely because of its ability to acquire and integrate new assets with existing operations.
But I'm not buying Big Oil right now, at least not at these prices in such a cyclical industry. They may look cheap based on trailing earnings multiples, but Chevron and ExxonMobil trade for low-teens forward estimates, and with big acquisitions to now swallow and digest, the math may not be favorable. I also expect high interest rates to weigh on multiples for these big, dividend-driven investments in the years ahead.
Instead, investors should consider looking offshore, where there's growth again. This segment of the oil and gas industry was the hardest hit by the pandemic, sending most of the public companies into bankruptcy. Today, it looks much healthier; more oil companies are spending to explore and develop offshore, and the industry is no longer oversupplied with old vessels and the companies have much healthier balance sheets.
My favorite right now is Valaris. Not only does it have one of the best advanced drilling fleets on water, but it also has a very strong balance sheet -- more cash than debt at the end of the second quarter -- and is pumping out cash. At recent prices, it trades for about 14 times operating cash flow, and I expect its cash flows to grow a lot in the years to come.
Hoping it remains disciplined
Matt DiLallo (ConocoPhillips): Exxon kicked off the oil industry's megamerger mania with its more than $60 billion deal for Pioneer Natural Resources. Chevron quickly responded by agreeing to acquire Hess for around $60 billion. With the two largest U.S. producers striking deals, it will probably force No. 3 player ConocoPhillips to act. The company was already looking at potential deals before Exxon sealed its Pioneer purchase.
As a longtime ConocoPhillips shareholder, I'm interested to see what company it might acquire. Some believe it will follow Exxon by bulking up on its position in the Permian. Analysts have speculated it could acquire a company like Diamondback Energy or Matador Resources, while Reuters recently reported it was considering making a bid for privately held CrownRock. It could also go bigger and buy a multibasin producer like Occidental Petroleum or EOG Resources.
I just hope that the company doesn't overpay for an acquisition. It has historically been very disciplined because large corporate mergers in the oil patch often require a high premium and, therefore, don't yield the returns that other investments can generate. Its last notable corporate merger came in late 2020, when it bought Concho Resources for $9.7 billion. It was opportunistic; it took advantage of a turbulent period in the oil market to make a meaningful deal at an attractive valuation.
That's not the case this time around. While oil prices are off their peak from last year, they're in the mid-$80s, and that means oil company valuations are higher. For example, Chevron is paying 35 times earnings for Hess, which is a lot considering the oil giant trades at 12 times earnings. Meanwhile, Exxon is paying a meaningful 18% premium to acquire Pioneer.
The pressure to do a deal to compete with its rivals could cause ConocoPhillips to overpay. That would dilute existing shareholders and undo a lot of the impact of the company's share repurchase program, which has retired 10.5% of its outstanding shares since acquiring Concho.
While I'm not opposed to ConocoPhillips' making an acquisition, it needs to be the right deal at the right price. If it vastly overpays to one-up its rivals, I might consider selling my shares.
This oil giant is making big buys... of its own stock
Tyler Crowe (Equinor): I'm of two minds on a lot of these big merger-and-acquisition deals. I can see the strategic rationale behind ExxonMobil and Chevron's respective moves, but I'm slightly concerned they are both buying now because they are flush with cash that was burning a hole in their pockets. Equinor, on the other hand, is an oil giant that's taking all that excess cash and giving it back to shareholders through regular dividends, special dividends, and share repurchases.
Over the past 12 months, the company has returned about $16 billion to shareholders through dividends and repurchases. Since Equinor is a $98 billion market cap company, that means it has returned about 16% of its market cap to shareholders in the past 12 months alone. Even the American integrated oil companies, well known for returning cash to shareholders, can't match that kind of shareholder return.
What's even more encouraging is that the company appears to be financially strong enough to keep generously rewarding its shareholders. It has $18 billion more in cash and short-term investments on the books than it does total debt outstanding. Also, even with lower oil prices, the company is still bringing in loads of free cash flow thanks to low-cost oil production and disciplined capital spending.
It may not make headlines like these splashy acquisitions, but these are the kind of moves investors should want to see. With shares trading at a reasonable price -- a price-to-free cash flow ratio of 6.1 -- Equinor is the kind of big oil stock I want to invest in today.
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Jason Hall has positions in Equinor and Valaris. Matthew DiLallo has positions in ConocoPhillips. Tyler Crowe has positions in Equinor and ExxonMobil. The Motley Fool has positions in and recommends EOG Resources. The Motley Fool recommends Chevron, Equinor, Occidental Petroleum, and Pioneer Natural Resources. The Motley Fool has a disclosure policy.
