The last few months have been tough for oil producers as persistent weakness and volatility in oil prices have clouded their future. But Noble Energy (NBL) is a rare exploration and production company whose outlook is looking better than ever. The company is getting closer to bringing a major project located in offshore Israel online which will fuel significant production, earnings, and cash flow growth. The Houston, Texas-based company will also start generating tons of free cash flows from next year which it will use to reward investors with dividends and buybacks. Noble Energy stock has delivered a blowout performance this year and I believe it will likely continue doing well.
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Noble Energy is an independent oil and gas producer that currently operates primarily in three US shale oil plays – the DJ Basin in Colorado and the Eagle Ford and Permian Basin in Texas. Noble Energy also has international operations but a vast majority of its production (75.4% in Q2-2019) comes from the three US onshore shale oil plays. In the second quarter, Noble Energy’s US onshore volumes clocked in at 263,000 boe per day, of which 55% came from the DJ Basin, 24% from the Delaware Basin which is located within the Permian Basin and 21% from Eagle Ford.
Noble Energy, however, has been struggling with losses and weak levels of cash flows. The company has reported an adjusted loss of $0.19 per share for the first six months of 2019, down from a profit of $0.52 per share a year earlier. Noble also delivered weak levels of operating cash flows of $972 million in the first half of the year. The company spent $1.4 billion as cash capital expenditure. The total capital expenditure for the exploration and production business on an accrual basis was $1.3 billion. The operating cash flows couldn’t cover the capital expenditures on cash as well as accrual basis. As a result, the company faced a cash flow deficit.
However, Noble Energy is on the verge of turning around. Remember, the company’s losses and weak cash flows have been driven partly by the fact that it has been spending heavily to develop one of its biggest projects – the Leviathan gas field located in offshore Israel – which hasn’t come online yet. Noble Energy holds a 39.66% stake in Leviathan which holds 33 Tcf of natural gas reserves which makes it one of the biggest gas finds of the last decade. Noble is the field’s operator while its other major partner is Israel’s Delek Drilling which holds a 45.34% stake in the project. Noble and its partners will invest a total of $3.75 billion in the project which will produce up to 1.2 billion cf per day of natural gas and will more than double Israel’s total gas production. In terms of size and scale, this is the largest energy project in Israel’s history.
Noble and its partners have finished 90% of the development work at Leviathan and will bring the project online by the end of this year. Its gas sales will surge in 2020, averaging almost 800 million cf per day in the year of which Noble’s shares will be roughly 317 million cf per day. That’s going to make a meaningful impact on Noble which produced 893 million cf per day of gas in H1-2019. Leviathan’s output will continue climbing in the future and may average above a billion cf per day in 2021. The fuel will be consumed by utilities in Israel, including the country’s primary utility Israel Electric Corporation. Noble will also export a large chunk of Leviathan’s output to Egypt and Jordan at attractive prices through the East Mediterranean Gas (EMG) pipeline in which Noble and Delek hold a minority stake. The sale to Egypt, which will be the main international buyer, will be made under an agreement signed last year for the supply a total of 64 billion cm of Israeli gas to Egypt’s Dolphinus Holdings over 10 years.
The start-up of Leviathan will reduce Noble’s capital expenditure requirements and will meaningfully push the company’s production and earnings higher. Additionally, Noble will also witness a surge in cash flow from operations while its cash outflows as capital expenditure could decline. I believe this could push Noble to free cash flows from next year. That’s going to mark Noble’s turnaround. The free cash flows will likely expand as Leviathan ramps up to full capacity in the subsequent years without any additional investment.
In my view, Noble’s US onshore business will also start delivering better results. The company has been working on increasing volumes by more than 5% while cutting capital expenditure by around 20% from last year. The company’s Eagle Ford assets have been generating free cash flows and have provided crucial support to the rest of the US exploration and production operations. Noble’s DJ and Delaware Basin properties, however, have been burning cash but this will likely change in the future as the company grows production while bringing down costs. The company’s output from DJ and Delaware Basins increased to record levels in the second quarter and is on track to climb further in the third quarter.
Meanwhile, well costs at DJ and Delaware Basins have fallen by more than 15% from Q4-2018 due in large part to the ongoing efficiency improvements coming from lower drilling and completion times. The company initially planned to cut well costs by $500,000 to $1 million per well in the DJ Basin and $1 million to $1.5 million per well in the Delaware Basin. But Noble has done a commendable job of exceeding the high-end of cost reduction guidance for both regions. Moreover, the company’s Delaware operations will benefit from the start-up of the EPIC pipeline which will give Noble access to the lucrative Gulf Coast market where oil trades at a premium over WTI. I believe the better-than-expected cost reductions, growing levels of output, and greater access to the Gulf Coast prices have put the company in a good position to improve profit margins and deliver free cash flows from the US oil business.
For these reasons, I believe Noble Energy is firmly on track to significantly grow its earnings and cash flows from 2020 as Leviathan comes online and the company’s US onshore operations turn around. Shares of Noble Energy have risen by 9% in the last six months, easily outperforming the broader exploration and production space (XOP), which has tumbled by 13% in the same period. I think the company’s shares will likely continue moving higher as it starts reporting strong levels of profits and free cash flows from next year. Noble, however, is an expensive stock. The company’s shares are priced 8.21x EV/EBITDA (fwd) multiple, higher than the peer median of 6.87x, as per data from Seeking Alpha Essential. At this price, I would rate Noble as a hold. Investors should consider buying on weakness.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.