Hear My Train A Comin': A Look At The Investment Case for the US Majors

5 March 2018Integrated OilUS Integrated OilsIndustrialsIntegrated OilIndustry UpdateNorth AmericaUnited StatesIndustryUS Integrated OilsDate5 March 2018Deutsche BankMarkets ResearchHear My Train A Comin': A Look At TheInvestment Case for the US MajorsGrowth, Returns, Free Cash Flow In Focus But Are Improving Near-TermFundamentals Sustainable?As Chevron ( CVX) and ExxonMobil (XOM) get set to hold their annual analyst daymeetings this week (please see our detailed expectation tracker in this report'sCorporate Notes), we see the Majors in a relative sweet spot, with a multi-yearoutlook of above average volume/cash flow growth, rising FCF, improving returns,and relatively impressive resource depth. Looking beyond the 3-year outlook, wesee evidence for a sustainably improved outlook for returns and free cash flowover the long-term anchored by a 1) Growth via low-risk, low-cost and returnsaccretive US shale resource 2) A relatively deeper and lower-cost upstreamproject backlog relative to global peers 3) Increased levels of transparency (e.g.COP, CVX) are here to stay as competitors (global IOCs and US E&Ps) continueto progress along the discussion on sustainable value creation with investorsand analysts. Admittedly the improving fundamental backdrop has not goneunnoticed by the market (with trading multiples for the group close to historicalpeaks (~25%-30% premium to 10-yr NTM EV/EBITDA), we believe there is moreto chop particularly for COP and CVX where we see FY19 FCF yields for COPand CVX (~8%, 7.5% resp at $62/bbl Brent) at 10-year highs and competitivelypositioned vs. global peers (~ FY19 FCF yield 7-8%).Massive reduction in capital intensity drives inflection in growth, FCF andreturns to 2020After over a decade of returns compression and negligible (or negative) growth,market expectations are for 3% annual volume growth from 2017-2020 with DBegrowth of 4.8%/1.3% for CVX/XOM. Importantly, the incremental volumes, ledby US shale, LNG and deepwater, are largely accretive to cash margins withDBe growth in margins of 3.5%/2% annually at CVX/XOM respectively. Andwith budding US shale growth, little need for costly exploration driven reservedepletion mitigation, and decreasing F&D costs across the broader portfolio allpointing to sustainably lower capital intensity over the medium-term, the outlookfor FCF is compelling (particularly for CVX). By 2020, we estimate total CFO atDB's base LT commodity deck ($65/bbl Brent) as $82Bn for the US majors, vs.$44Bn in capex (gross C&E) and $24Bn of dividend requirement, or a net $14Bnof FCF in excess of the dividend. With a swing of $10Bn in CFO from a $10/bbldownward move in oil prices, we see the US majors at nearly break-even cashflow (including the dividend) at $50/bbl Brent.US shale is transformative - even for the US MajorsRyan ToddResearch Analyst+1-212-250-8342David FernandezResearch Analyst+1-212-250-3191Joe McKayResearch Associate+1-212-250-5717Cheryl KniattResearch Associate+1-212-250-4461Top picksChevron (CVX.N),USD111.64BuyConocoPhillips (COP.N),USD54.06BuySource: Deutsche BankCompanies featuredChevron (CVX.N),USD111.64Buy2017A2018E2019EEPS (USD)3.876.05–P/E (x)28.818.5–EV/EBITDA (x)10.07.4–ExxonMobil (XOM.N),USD75.55Hold2017A2018E2019EEPS (USD)3.544.39–P/E (x)23.117.2–EV/EBITDA (x)11.39.0–Source: Deutsche BankDeutsche Bank Securities Inc.Deutsche Bank does and seeks to do business with companies covered in its research reports. Thus, investors should beaware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should considerthis report as only a single factor in making their investment decision. DISCLOSURES AND ANALYST CERTIFICATIONSARE LOCATED IN APPENDIX 1. MCI (P) 083/04/2017.Distributed on: 05/03/2018 10:57:10 GMT7T2se3r0Ot6kwoPa 5 March 2018Integrated OilUS Integrated OilsKey to understanding the shift in the long-term outlook for the US integrateds,is the transformative nature of the rise of US shale. It's not just the level ofcapital flexibility or repeatable, lower-risk reserve and volume growth, but alsothat the sheer size and depth of the high quality, returns-accretive resourcesupports underappreciated sustainability and high-grading across the rest of theconventional/major project portfolio. We estimate that CVX's Permian positioncan offset declines elsewhere in the portfolio for nearly 60 years! And 15-20years for COP and XOM. Through 2020, we see ~40%/50% growth volumesat CVX/XOM driven by growth in their respective liquids-weighted resources(Permian, Permian/Bakken resp). And while we recognize the concern related toa growing share of high-decline onshore resource within the portfolio, we alsorecognize that one of the greatest concerns for large oil companies is the riskassociated with both replacing reserves and reinvesting (ie. recycling) cash flowin a returns-accretive manner. In our view, few