Energy Sector SUMMER 2015 ANALYSTS: DANIEL J. ERIN & JONATHAN CREMEANS Agenda Overview Chevron Conoco Phillips Recommendation 2 Overview 3 Business Cycle Energy 4 Industries Energy Equipment & Services ($349.38B) Oil, Gas, and Consumable Fuels ($3.07T) Down 35.91% over the past year Down 23.30% over the past year 5 Sector Performance Brent Crude PPB Increase from prior week: $4.57 Brent Crude PPB decrease from prior week: $5 Brent Crude PPB Increase from prior month: $10.86 Brent Crude PPB decrease from prior week: $5 Brent Crude PPB decrease from prior month: $5.50 6 Energy Sector Operating Margin 7 US EIA Projections: Price Per Barrel of Brent Crude 7/24: $54.62 2015: $55.62 2016: $67.04 2017: $76.35 8 Recommendation Add at least 40 bps of exposure to match S&P Industry is highly dependent on the price per barrel of oil equivalent The price of Brent Crude is expected to increase; however this is based on the relationship between global GDP (demand proxy) and global supply. A divergence between the 2 in either direction will significantly impact the price per barrel of oil and the valuation of the companies in the sector. 9 Chevron 10 Business Analysis: Competitive Advantage Value creation and capture: by the efficient deployment of cash in the world’s key hydrocarbon basins, the transportation of crude products, and the effective differentiation of hydrocarbon products. Upstream: drilling success rate in 2014 was 66% beating the industry average of 59%. When the price per barrel of oil is high, Chevron is able to leverage their production capacity and industry leading earnings per barrel of oil Downstream: Chevron has a strong position in gasoline, diesel and other fuels, as well as in additives, petrochemicals and lubricants. Chevron has effectively differentiated many of its premium base fuel and petrochemical products to capture an industry leading earnings BOE Industry leader in earnings per BOE in 2014 11 Business Analysis: Future Positioning The current Oil and Gas market is terrible; however, Chevron has taken the following steps to position itself for success if the price per BOE increases: Reducing capital spend; with a renewed focus on less-risky fields Lowering costs - leveraging purchasing power, negotiating supplier reductions, and rebidding contracts Improving efficiency Divesting low performing assets 12 Business Analysis: Key Economic Drivers and Recent Performance • The price of per barrel of Brent Crude • The S&P 500 • Global GDP Growth 140 120 100 CVX regressed against the S&P 500 and the price per barrel of Brent Crude (10YR) 80 60 Regression Statistics Multiple R R Square 40 20 Adjusted R Square Standard Error Observations 0 Brent Crude CVX 90% 81% 80% 9.17 113.00 Predicted Y (CVX Stock Price) = -2.4567 + (0.4917 * Brent Crude Spot Price) + (0.037 * S&P500 Price) 13 Financial Analysis: 3 yr. Projections Table1: Forecasted Segment Revenues Decrease in revenue is consistent with other companies projections (000$) Gradual increase in revenue is expected from a rebound in the price per BOE Income and EPS are expected to increase as a result of the Cash Flow improvement initiatives discussed above Net Income Basic Diluted Consensus - GAAP FY 2017E $13,303 7.06 7.05 7.90 FY 2016E $10,468 5.56 5.54 5.72 FY 2015E $7,781 4.13 4.12 4.10 Net Revenue: Upstream Downstream Other Total Segments Elimination of intersegment sales Total Core Business Revenue Income from equity affiliates Other income Total net revenue Consensus FY 2017E FY 2016E FY 2015E 56,483 143,863 1,500 201,846 52,788 134,452 1,500 188,739 43,990 112,043 1,500 157,533 -39,505 -37,269 -31,318 162,341 151,470 126,214 6,000 6,000 2,000 2,000 170,341 159,470 174,916 159,000 6,000 2,000 134,214 130,146 Expected improvement due to better margins and price per BOE rebound 14 Financial Analysis: History and Comps Sector Valuation: Absolute Basis P/E P/B P/S P/EBITDA High 19.51080 3.2370 1.5546 8.1340 Low 5.8400 1.4863 .5128 2.8922 Median 12.7610 2.2172 1.0109 5.7870 Current 16.8320 1.8514 1.5288 7.8828 Stock Valuation: Ticker Average CVX XOM US RDSA LN BP/ LN HES US FP FP IMO CN P/E TTM P/S TTM 31.02 11.41 13.11 13.08 46.06 94.54 33.46 15.52 P/B 0.92 1.13 1.12 0.51 0.41 2.12 0.61 1.34 P/CF TTM 1.21 1.27 2.11 1.14 1.17 0.92 1.31 1.86 5.80 7.77 9.69 5.23 4.92 5.60 4.83 11.74 EV/ EBITDA TTM 6.74 6.90 8.64 4.79 4.45 4.89 5.15 10.67 Chevron’s P/E is below the industry average and the low when compared to peers 15 Financial Analysis: DCF High discount rate to appropriately account for the risk in the global oil market Strong projected upside Revenue and EPS estimates are in-line with analyst consensus opinion 16 Financial Analysis: Predictive Regression 10 year 2 variable regression model: S&P 500 Brent Crude Monthly Spot Price Bret Crude Spot Price 7/24 S&P 500 7/24 Predicted Price of CVX (as of 7/24): Actual Price Potential Upside Predicted Y (CVX Stock Price) = -2.4567 + (0.4917 * Brent Crude Spot Price) + (0.037 * S&P500 Price). Multiple R R Square Strong potential upside; consistent with the DCF model Adjusted R Square Standard Error Observations 54.62 2,079.65 101.62 90.60 12% Regression Statistics 90% 81% 80% 9.17 113.00 17 Recommendation: Target Price $105.0, representing 13.7% upside over 7/28 close CVX currently accounts for 3.58% of the SIM portfolio Increase 40BPS to the 3.98% bringing the energy sector to market neutral Why CVX: Risks: Positioned well for future growth Global geo-political peace Industry leader in profitability per BOE in both the upstream and downstream segments 80% of CVX earnings are directly related to the price of a commodity CVX is unable to implement their Cash Flow improvement initiatives and margins are worse than expected Improvements to the attractiveness of oil& gas alternatives Environmental disaster Appears to be cheaper than comparable based on P/E ratio (in spite of poor earnings) Strong DCF and predictive historical regression upsides 18 ConocoPhillips 19 Overview • Formed in 2002 from merger between Conoco, Inc. and Phillips Petroleum • Largest independent oil & gas exploration and production company • Conventional and unconventional assets in North America, Europe, Asia, Australia and Africa • Currently 3.79% of SIM Portfolio 1,610 MBOED Production - 1Q'15 8.9 BBOE Reserves - YE 2014 Liquids 18% 24% 16% 58% OECD North American Gas LNG + International Gas Non-OECD 84% Source: COP Q1 Investor Update 20 Key Investment Considerations • Commitment to steady, compelling dividend • • Annualized 4.7% dividend in 2Q’15 Diversification/Portfolio management capabilities • • • Robust geographic and product diversification Hand in nearly every significant production play throughout the world Capital Flexibility • • Recently freed $5bn+ in capital Strong position to capitalize on upcoming opportunities in industry changes 21 Business Analysis - Diversification • • Unique cost structures, regulatory environments and risk profiles across locations No more than 33% production from one geographic segment Production (MMBOED) 2.0 1.5 1.0 Europe Alaska Europe Alaska AP&ME AP&ME Canada Canada Lower 48 Lower 48 2014 2017 0.5 - Income/(loss) by Business Segment ($mm) 4,000 3,000 2,000 1,000 (1,000) (2,000) Alaska Lower 48 Canada Europe 2014 Asia Pacific and Middle East Other International Corporate and Other 2013 22 Business Analysis – Capital Flexibility 2015-2017 Avg. Capital ~11.5bn • Recently freed ~ $5bn in capital • Excess creates enhanced ability to quickly shuffle invested capital to highest-returning geographic segment, products, etc. • Ability to quickly close acquisitions • $12.0bn $10.0bn Europe $8.0bn Alaska $6.0bn AP&ME $4.0bn $2.0bn Canada Lower 48 $- Key for distressed assets 23 Financial Projections Forecast Methodology Summary • Management production targets • Sharp decline in revenue in ’15 • WTI/Brent Crude & HH futures through 2017 • • Expenses projected as Cost/BOE where applicable, otherwise % sales Strong top-line growth after ‘15 from increased production & appreciation in oil & gas prices • Significant EPS growth from cost savings FY 2017E Total Revenue FY 2016E FY 2015E MRQ 1Q15 FY 2014A FY 2013A FY 2012A FY 2011A FY 2010A $44,294,312 $41,797,656 $36,364,169 $8,002,000 $55,517,000 $58,248,000 $62,004,000 $66,069,000 $63,335,000 37,605,871 36,949,128 33,964,133 8,358,000 46,127,000 43,802,000 46,581,000 50,673,000 45,460,000 Income Taxes 2,541,608 1,842,441 912,013 (642,000) 3,583,000 6,409,000 7,942,000 8,208,000 7,570,000 Net Income 4,146,833 3,006,087 1,488,022 286,000 5,807,000 8,037,000 7,481,000 7,188,000 10,305,000 Diluted EPS $3.27 $2.36 $1.14 $0.22 $5.51 $7.39 $6.73 $8.97 $7.62 Costs and Expenses 24 Trading Comps Price Market Enterprise EBITDAX ROIC% ROE% Dividend 6/30/15 Cap Value Margin 2014 2014 Yield Exxon Mobil Corp (XOM) $83.20 $347,868.2 $378,215.8 14.6% 9.4% 16.3% 3.3% Chevron Corp (CVX) $96.47 $181,409.7 $206,248.5 20.0% 5.4% 11.3% 4.4% ConocoPhillips (COP) $61.41 $75,715.3 $96,511.3 33.2% 3.8% 9.9% 4.7% Imperial Oil Ltd (IMO) $38.66 $32,761.9 $40,038.7 15.7% 8.7% 15.1% 1.1% Hess Corp (HES) $66.88 $19,220.1 $23,872.4 64.7% 4.0% 6.7% 1.5% Husky Energy Inc (HSE) $19.14 $18,828.8 $28,784.2 25.6% 2.8% 3.8% 5.0% Murphy Oil Corp (MUR) $41.57 $7,398.2 $8,768.0 ($ in millions except per share data) 69.8% 8.5% 8.9% 4.1% Median 25.6% 5.4% 9.9% 4.1% Average 34.8% 6.1% 10.3% 3.5% EV/EBITDAX EV/Reserves P/E Exxon Mobil Corp (XOM) Chevron Corp (CVX) ConocoPhillips (COP) Imperial Oil Ltd (IMO) P/CF EV/EBITDA TTM 2015E 2016E 2015E 2016E 2014A 1Q'15 19.4 x 9.9 x 8.3 x 8.1 x 6.9 x 45.0 x 15.1 x 23.4 x 7.9 x 5.9 x 6.5 x 5.4 x 35.9 x 18.3 x 140.8 x 7.7 x 5.8 x 8.5 x 5.9 x 43.4 x 10.8 x 22.2 x 11.9 x 9.6 x 11.6 x 9.3 x 55.9 x 10.1 x N/A 6.7 x 5.0 x 7.9 x 6.1 x 41.5 x 16.6 x Husky Energy Inc (HSE) 63.7 x 6.7 x 5.6 x 7.8 x 5.9 x 33.6 x 21.6 x Murphy Oil Corp (MUR) N/A 5.1 x 4.0 x 5.8 x 4.7 x 16.2 x 11.4 x Median 23.4 x 7.7 x 5.8 x 7.9 x 5.9 x 41.5 x 15.1 x Average 53.9 x 8.0 x 6.3 x 8.0 x 6.3 x 38.8 x 14.8 x Hess Corp (HES) 25 DCF Analysis 61 9.0% 10.0% 11.0% Terminal Growth Rate 2.0% 2.5% 3.0% $57.7 $60.7 $64.2 $49.2 $51.3 $53.7 $42.6 $44.1 $45.8 44 9.0% 10.0% 11.0% Avg. Crude Price $70.0 $75.0 $80.0 $62.6 $64.2 $65.9 $52.8 $54.2 $55.7 $45.5 $46.7 $47.9 Weight 40% 60% Cost of Equity $60.2 15.7% Cost of Equity DCF-Implied Share Price Implied Return Cost of Equity $51.3 $66.2 EBITDA Exit Multiple 82 7.0x 8.0x 9.0x 9.0% $64.9 $73.4 $81.8 10.0% $58.5 $66.2 $74.0 11.0% $52.7 $59.8 $66.8 Cost of Equity Price GG-Implied Share Price EMM-Implied Share Price 44 9.0% 10.0% 11.0% Avg. Nat. Gas Price $4.0 $5.0 $6.0 $62.1 $64.2 $66.2 $52.5 $54.2 $55.9 $45.2 $46.7 $48.1 26 COP Recommendation • Target price: $61.0, representing 16% upside over 7/28 close • No change to current position • Uncertainty over the next 3-6 months for the industry outweighs positive valuation & growth potential 27 Conclusion • Increase position in CVX 40BPS to 3.98% to bring the energy sector to market neutral • No change to current COP position 28 Appendix 29 COP Production Profile $000s Production Profile FY 2017E FY 2016E FY 2015E MRQ 1Q15 FY 2014A FY 2013A FY 2012A FY 2011A FY 2010A Crude Oil Average net production (MBD) % Growth Average price per barrel Average Daily Revenue Annual Revenue 667 5.0% 64.41 42,945 15,674,830 635 5.0% 62.42 39,638 14,507,655 605 5.0% 54.51 32,965 12,032,088 622 8.0% 48.05 29,887 2,727,198 576 2.5% 89.72 51,679 18,862,733 562 -0.9% 100.11 56,262 20,535,564 567 N/A 102.69 58,225 21,310,434 747 -12.9% 97.12 72,549 26,480,254 858 N/A 72.63 62,317 22,745,537 Natural Gas Liquids Average net production (MBD) % Growth Average price per barrel Average Daily Revenue Annual Revenue 160 1.5% 20.0 3,192 1,165,143 157 1.5% 20.0 3,145 1,151,069 155 2.6% 19.0 2,944 1,074,412 155 2.6% 19.60 3,038 277,218 151 1.3% 37.45 5,655 2,064,057 149 0.7% 39.60 5,900 2,153,646 148 N/A 44.62 6,604 2,416,976 N/A - N/A - Bitumen Average net production (MBD) % Growth Average price per barrel Average Daily Revenue Annual Revenue 156 0.0% 20.0 3,120 1,138,800 156 0.0% 20.0 3,120 1,141,920 156 1200.0% 20.0 3,120 1,138,800 156 1200.0% 17.22 2,686 245,127 12 -7.7% 60.03 720 262,931 13 8.3% 55.25 718 262,161 12 N/A 57.58 691 252,891 10 N/A 55.16 552 201,334 10 N/A 51.10 511 186,515 4,060 0.0% 4,060 0.0% 4,060 18.1% 4,059 18.1% 3,438 -0.6% 3,458 -4.2% 3,611 -10.3% 4,024 -9.3% 4,437 N/A 3.30 13,404 4,892,510 3.08 12,505 4,576,699 3.25 13,205 4,819,654 4.72 19,158 1,748,211 6.01 20,652 7,538,004 5.68 19,641 7,169,126 5.05 18,236 6,674,211 5.64 22,695 8,283,806 5.07 22,496 8,210,890 Total COP Production Revenue % Growth 22,871,283 7.0% 21,377,343 12.1% 19,064,954 -33.6% 4,997,753 N/A 28,727,725 -4.6% 30,120,497 -1.7% 30,654,513 -12.3% 34,965,394 12.3% 31,142,942 Revenue from Operating Subsidiaries % Growth 17,989,984 5.0% 17,133,318 20.0% 14,277,765 -40.0% 2,718,247 N/A 23,796,275 -2.0% 24,292,503 -11.1% 27,312,487 -6.6% 29,230,606 16.6% 25,072,058 3,067,045 366,000 3,433,045 2,920,995 366,000 3,286,995 2,655,450 366,000 3,021,450 205,000 52,000 29,000 286,000 2,529,000 98,000 366,000 2,993,000 2,219,000 1,242,000 374,000 3,835,000 1,911,000 1,657,000 469,000 4,037,000 1,239,000 370,000 264,000 1,873,000 1,376,000 5,563,000 181,000 7,120,000 44,294,312 45,689,000 41,797,656 41,990,000 36,364,169 33,756,000 8,002,000 55,517,000 58,248,000 62,004,000 66,069,000 63,335,000 Natural Gas Average net production (MMCFD) % Growth Average price per thousand cubic ft. Average Daily Revenue Annual Revenue Income Statement Equity in earnings of affiliates Gain on dispositions Other income Total Other Revenue Total Revenue Consensus 30 COP Free Cash Flow ConocoPhillips (NYSE:COP) Discounted Cash Flow Analysis Analyst: Jon Cremeans 6/10/15 $000s Terminal Discount Rate = 9.0% Terminal FCF Growth = 2.5% EBITDA Exit Multiple= 9.0 x 2015E 2016E 2017E 2018E 2019E 2020E 2021E 2022E 2023E 2024E 36,364,169 -33.6% 41,797,656 14.9% 44,294,312 6.0% 46,951,970 6.0% 49,299,569 5.0% 51,764,547 5.0% 54,352,775 5.0% 57,070,413 5.0% 59,923,934 5.0% 62,920,131 5.0% 1,309,110 3.6% 4,848,528 11.6% 7,574,327 17.1% 7,981,835 17.0% 9,120,420 18.5% 9,835,264 19.0% 10,870,555 20.0% 11,414,083 20.0% 11,984,787 20.0% 12,584,026 20.0% Interest (Income)/Expense % Sales 363,642 1.0% 417,977 1.0% 442,943 1.0% 469,520 1.0% 492,996 1.0% 517,645 1.0% 543,528 1.0% 570,704 1.0% 599,239 1.0% 629,201 1.0% Taxes Rate 359,278 38.0% 1,683,610 38.0% 2,709,926 38.0% 2,854,680 38.0% 3,278,421 38.0% 3,540,695 38.0% 3,924,270 38.0% 4,120,484 38.0% 4,326,508 38.0% 4,542,833 38.0% Net Income % Sales 586,190 1.6% 2,746,942 6.6% 4,421,458 10.0% 4,657,635 9.9% 5,349,003 10.9% 5,776,923 11.2% 6,402,757 11.8% 6,722,895 11.8% 7,059,039 11.8% 7,411,991 11.8% 7,272,834 20.0% (24,000) -0.1% 9,091,042 25.0% 8,359,531 20.0% 167,191 0.4% 9,404,473 22.5% 8,858,862 20.0% 9,987 0.0% 8,858,862 20.0% 9,390,394 20.0% 10,586 0.0% 9,390,394 20.0% 9,859,914 20.0% 11,115 0.0% 9,859,914 20.0% 10,352,909 20.0% 11,671 0.0% 10,352,909 20.0% 10,870,555 20.0% 12,254 0.0% 10,870,555 20.0% 11,414,083 20.0% 12,867 0.0% 11,414,083 20.0% 11,984,787 20.0% 13,510 0.0% 11,984,787 20.0% 12,584,026 20.0% 14,186 0.0% 12,584,026 20.0% Free Cash Flow Discount Factor (1,208,018) 0.92 1,534,810 0.84 4,411,472 0.77 4,647,050 0.71 5,337,888 0.65 5,765,253 0.60 6,390,502 0.55 6,710,028 0.50 7,045,529 0.46 7,397,805 0.42 PV of FCF (1,108,273) 1,291,819 3,406,465 3,292,087 3,469,261 3,437,632 3,495,824 3,367,537 3,243,957 3,124,913 Revenue % Growth Operating Income Margin Plus: Depreciation, Depletion and Amortization % Sales Less: Δ NWC % Sales Less: Capital Expenditures % Sales 31 COP DCF Calc Implied Equity Value (Gordon Growth) Terminal Value (EMM) Terminal Value (Gordon Growth) Cumulative PV of Cash Flows 27,021,221 35.4% 2024E EBITDA 25,168,052 PV of Terminal Value Implied Equity Value 49,277,473 76,298,695 64.6% 100.0% EBITDA Exit Multiple 9.0x Terminal Value 226,512,471 FCF Yield 3.3% PV of Terminal Value 95,681,315 Terminal FCF Terminal Growth Rate Discount Rate Implied Multiples (GG) Market P/E 136.1x 29.0x 18.0x Projected P/E Market EV/EBITDA Projected EV/EBITDA 130.2x 11.9x 11.5x 27.8x 7.7x 7.5x 17.3x 6.2x 6.0x Implied Share Price (GG) Shares Outstanding 1,245,531 Terminal P/E 30.6x Implied Share Price 82.73 DCF-Implied Return 29.2% 7,397,805 2.5% 9.0% Terminal Value FCF Yield 116,657,700 6.3% PV of Terminal Value 49,277,473 Terminal P/E 15.7x Terminal EV/EBITDA 4.6x Implied Equity Value/Share Debt Cash Cash/Share $64.06 $61.26 -4.4% 22,318,000 2,664,000 2.14 Calculated Share Price Price GG Implied Share Price $61.3 EMM Implied Share Price 82.7 DCF-Implied Share Price Implied Return Cost of Equity Current Price Implied Equity Value/Share GG-Implied Return 61 8.0% 9.0% 10.0% 11.0% 12.0% 2.00% $69.8 $58.3 $49.7 $43.0 $37.7 2.25% $72.0 $59.7 $50.7 $43.7 $38.3 Terminal Growth Rate 2.50% $74.3 $61.3 $51.8 $44.5 $38.9 2.75% $76.9 $62.9 $52.9 $45.4 $39.5 3.00% $79.7 $64.8 $54.1 $46.2 $40.1 Weight 60.0% 40.0% $69.8 9% 32