Energy Sector Presentation

1
Energy Sector Presentation

• Presented by
• Waquar Ahmad
• Farzan Bharucha
• John Dotson
• Rachel Eddy
• Erik Gast
• Ken Gill

2
Outline

• Sector Overview
• Business Analysis
• Financial Analysis
• Valuation Analysis
• Recommendations

3
OverviewSize Composition

• Size
• Energy sector is 5.8 of SP 500 (498.7 billion
  market cap)
• 7.42 current energy portfolio weight in SIM
• 1.62 overweight (second largest bet)
• Composition
• 23 companies listed in SP 500 classified into
  two sub-industries
• Oil and gas (87 - 15 listings)
• Energy equipment and services (13 - 8 listings)

4
Overview Size Composition

• Three companies represent 68 of the energy
  sectors market capitalization
• Exxon (47)
• Chevron (14)
• Conoco-Phillips (7)
• SIM Companies 55 share of the energy sectors
  market capitalization
• Exxon (47)
• Conoco-Phillips (7)
• Marathon (1)

5
Business Analysis External Factors

• Life Cycle Mature
• Business Cycle Cyclical
• Technology Deep off-shore drilling
  technology enhanced
• Government Uncertainlikely HIGH (War
  in Iraq, The US Strategic Petroleum Reserve,
  political relations with OPEC-member
  countries)

6
Business Analysis External Factors

• Social Travel habit changes (auto vs.
  plane)but demand still remains
• Demographics Minimal changes
• Foreign Influence HIGH (OPEC supply
  changes, Venezuela strike, Iraq production
  concerns)

7
Business Analysis Demand Analysis

• Demand analysis would suggest earnings are
  counter-cyclical with GDP but...

8
Business Analysis Demand Analysis

• Market valuation is not highly correlated with
  GDP.

9
Business Analysis Supply Analysis

• Supply Growth Mature companies. Expect 2
  supply growth in 2003 (to meet expected demand
  growth of 2).
• Capacity Utilization OPEC has 68 of worlds
  reserves and should provide about 38 of world
  supply in 2003. Existing oil reserves expected
  to last until 2020, thus expansion is needed in
  future.
• Time to Build Extensive.
• Cost to Build High .
• Expansion Plans Consolidation is vogue. Sector
  upstream investment of 32 billion near
  all-time high of 39 billion (1980).
• - upstream is defined as exploration
  production of oil and natural gas.

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Business Analysis Supply Analysis
OPEC can drastically influence the worlds supply
of crude oil
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Supply and Demand Analysis
P
P
1
S
S
P1
P1
D
D
Q
Q
Q1
Q1

• During fluctuations in demand (for example,
  during an economic boom), there is no drastic
  change in oil prices because OPEC and other
  oil-producing countries can increase their supply
  to ensure stability. Therefore, energy stock
  valuation does not seem to be highly correlated
  to changes in energy demand.

12
Supply and Demand Analysis
P
S
P1
D
Q
Q1

• However, during supply shocks, since the worlds
  demand for energy doesnt decrease, the price of
  crude oil increases dramatically. Hence, energy
  stocks do very well in these times of supply
  uncertainty.

13
Business Analysis Five Forces Analysis

• Ease of Entry (Strength of Entrants)
• Low threat high fixed costs - costly to exit
• New capacity takes extensive time to impact
  market
• Exploration drilling, Refining, Marketing
  distribution
• Industry Concentration (Rivalry)
• High rivalry mostly mature companies
• Domestic and international competitors
• Consolidation

14
Business Analysis Five Forces Analysis

• Strength of Customers
• High threat commodity - customers monitor
  prices closely
• Prices of Supply Inputs (Strength of Suppliers)
• Mixed although OPEC controls 38 of supply.
• Issues do exist with OPEC countries following own
  quotas thus full power not exerted.
• Greater output expected from Non-OPEC countries
  such as Russia but significant equipment upgrades
  are needed.
• Product Segmentation (Substitutes)
• Low threat - little to none

15
Financial AnalysisGrowth and Margin Check
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Financial AnalysisRatios
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Financial Analysis Ratios
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Financial AnalysisROE

• ROE is highly dependent on crude oil prices. But
  seem to follow a 6-month lag.

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DuPont Analysis
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Financial Analysis Cash Flow Statement
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Valuation AnalysisRatios

• SP 500
• P/E 16.7
• P/S 1.34
• P/B 2.90
• P/CF 10.5

• Energy Sector
• P/E 14.9
• P/S 0.91
• P/B 2.50
• P/CF 8.1

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Valuation Analysis Ratios
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Valuation Analysis P/B to ROE
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Valuation Analysis P/S to Net Profit Margin
25
Technical AnalysisPrice Momentum Index
38.77
35.86
26
Technical AnalysisCrossover Index
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Components of DDM
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Three Components of Return

• r (E/Po) payout g
• Po Eo payout (1g) / (r-g)
• Dividend Yield
• Always higher than SP average
• Growth
• Mature industry, stable growth expected
• Valuation
• P/B, P/CF and P/S close to 15-year averages
• Technical analysis suggests close to resistance
  levels

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Valuation Cycle
HIGH
RISING
FALLING
Energy stock prices rise with the price of oil
Winter SIM class recommends energy overweight
LOW
30
Rationale Behind our Recommendation

• The uncertainty surrounding energy has been
  mitigated with the end of the Gulf War. Future
  supply shocks seem unlikely
• Oil prices are falling from their peak 3 months
  ago
• Oil futures have dropped
• The energy sector is starting to reinvest in
  capital expenditure at the wrong time
• In a recovery phase, the counter-cyclical nature
  of energy stocks indicates under-performance
  compared to the SP
• Valuation analysis indicates energy stock prices
  should revert back to the mean

31
Wall Street Opinion

• Industry Analyst recommendations seem to support
  our analysis
• Bear Stearns - Market Under-weight
• Merrill Lynch - Market Perform
• Prudential - Market Perform

32
Recommendation

• SIM is currently overweight in the energy sector
  compared to the benchmark
• We recommend market equal-weight for the energy
  sector
• We believe SIM should sell off a portion of its
  energy holdings to bring it to an overall
  weighting of 5.8 in the SIM portfolio

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Questions?
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Supplemental Information
35
Overall Energy Sector Profile
36
Energy Sector Overview Industry Performance

• Oil and Gas companies are performing better than
  energy equipment and service companies.

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Sales and EarningsEnergy Equipment and Services
38
Sales and EarningsOil and Gas