Ernst & Young released its bi-annual oil and gas Global Capital Confidence Barometer on May 7. It highlights that nearly half (44%) of the 152 oil and gas company executives surveyed believe the global economic situation is improving, up from 27% in October 2012.
Notably, oil and gas companies are generally more optimistic than the broader global sample of 1,600 respondents in 50 countries. However, only 27% of the respondents expect to undertake any M&A activity in the next six months, a decline from six months ago.
Andy Brogan, Ernst & Young’s Global Oil & Gas Transactions Advisory Leader, explains this confidence paradox: "While general confidence in the state and outlook of the economy is improving, this is accompanied by increasing levels of uncertainty about the direction of travel of commodity prices in general and oil and gas prices in particular. This is leading to a valuation disconnect which is delaying many transactions."
Appetite for M&A declines slightly
The oil and gas sector has been one of the most resilient for M&A over the last five years. However, this survey sees a slight decrease in sentiment with 27% of respondents now expecting to pursue acquisitions over the next 12 months, down from 28% in October 2012 and 31% a year ago. It is not just a lack of confidence in the business environment that is holding companies back — many are also concerned about the gap between their valuation of potential acquisitions and the prices sought by sellers.
For many companies, the appetite for M&A has declined. Five years after the financial crisis, many executives are still waiting for more price visibility before taking action. That conservatism aside, oil and gas respondents expect that global M&A deal volumes will increase over the next 12 months, with 72% expecting volumes to at least modestly improve. Expectations of the larger global sample were broadly similar.
Growth focus returns
Prioritization of growth had broadly declined as companies in general became more focused on the fundamentals, but that decline has seemingly ended. Oil and gas companies’ focus on growth had similarly been declining, but increased sharply in this survey. Notably, our oil and gas respondents continue to be more focused on growth than the global sample of companies. Compared with six months ago, our respondents, both in the broader global sample as well as the oil and gas respondents, report a decreased focus on reducing costs, improving efficiency, and optimizing capital.
Growth remains the number one objective for a majority of our oil and gas companies, with 61% reporting that growth is their primary focus, as compared to 20% whose primary focus was on cost reduction and operational efficiency, and 17% whose focus was on maintaining stability. This is the highest percentage of respondents citing growth as their top priority since April 2011.
Credit conditions improving globally
While credit has remained broadly available, particularly to large-cap enterprises, the global respondents report a substantial increase in credit availability. Compared with two years ago, banks are on a stronger footing and better capitalized. Yet this healthier picture has not always translated into increased lending, as many banks tightened their lending standards, particularly for small to-medium enterprise (SME) borrowers. Banks also face higher capital requirements under impending Basel III regulations, which could restrict their ability to increase the flow of credit into the economy.
Eighty-five percent of oil and gas respondents now view credit availability as stable or improving. Within this, the percentage of oil and gas companies seeing credit conditions loosening has increased substantially.
Mixed global deleveraging trends
The oil and gas sector has tended towards conservatism with respect to leverage. The improving credit conditions have prompted many of them to review and adjust their capital structure. Some took advantage of better credit conditions to take on debt and reduce their overall cost of capital. However, reflecting the industry’s traditional conservatism in this area (and the buoyant oil price), over the last two years, more oil and gas companies have been looking to deleverage their balance sheets.
The proportion of companies expecting to finance to further expand their operations — and increase their debt-to-capital ratios — grew to 28%, up from 21% in October 2012. However the proportion of oil and gas companies looking to take the opportunity to decrease their debt-to-capital ratios increased even more sharply to 45%, up from 31% in October 2012.
In the recent survey, more than 74% of the oil and gas respondents reported debt-to-capital ratios below 50%, with 40% reporting ratios of less than 25%. Both of these percentages declined, however, from the firm’s October 2012 survey. Clearly, some oil and gas companies, as well as companies in general, are choosing to shed some of their caution.
Debt decreases as a source of deal financing
Only 30% of the oil and gas respondents were expecting to refinance loans or other debt obligations in the next 12 months, up from 21% from the October 2012 survey, but still down from 49% in the April 2012 survey. With large-scale changes to their capital structures now completed, oil and gas companies are focused on refinements — reducing interest costs, extending debt maturities and removing restrictive covenants. Declining in importance for refinancing has been the optimization of the corporate structure and retiring of maturing debt.
Brogan concluded, "Throughout the crisis and recovery period the oil and gas sector has proved remarkably resilient. Many companies have already taken advantage of improving credit conditions to restructure their balance sheets but overall the industry remains conservative in this area. Going forward we expect the sector to remain resilient both from an operational and an M&A perspective. However, with expectations on forward price curves for oil and gas subject to increasing uncertainty we can see that pricing is going to be a key issue in the transaction markets over the next six months."
Evidence of steady growth
As this is written, stock market indexes are at a record high, and so are better-than-expected corporate earnings, says Ron D’Vari, CEO and co-founder of NewOak Capital, a New York-based financial services and risk advisory firm. He says this is driven by monetary stimulus and supporting evidence for improving housing and steady economic growth.
"The US economy ahead is less subject to derailment from its slow recovery than at any time in the last five years," says D’Vari. "A key issue remains unemployment, which must be corrected to support a robust fundamental growth. The US housing sector continues to be the bright spot."
When analyzed in light of earnings and steady expected growth, the stock market valuation is not out of line with the historical norm, he adds.
"Another reason for a lower probability of market crash is there are still plenty of investors with cash waiting in the wings for a potential dip to add to their equity exposures," D’Vari concludes. "It is hard to short US consumer and housing sectors. Barring another global crisis, many expect the economy, and hence the markets, to do generally well. While risks remain high in both the equities and debt markets, we recommend overweighting normal exposures to the equity markets and underweighting fixed income allocations or at least keeping the duration short."
