Equinor: A Great Company To Bet Against The Investor Sentiment (EQNR)

avstraliavasin Introduction Equinor ASA (NYSE:EQNR) is known as the partly Norwegian state-owned oil company. They are known for their low carbon footprint and lately important role in energy security in the Europe. My thesis is based on the belief that oil demand will peak later than 2030, because of lower EV adoption rate in the transportation industry. If this happens to be true, then investors holding oil companies will end up with a great return, with a bet against the current investor sentiment and I believe Equinor could be a great company to invest in, based on its current price. Additionally, Equinor has really cheap multiples compared to competitors and great capital allocation, which long-term investors can benefit from. For simplicity purposes, this analysis will focus more on Equinor’s oil sector. What is the revenue mix? Equinor’s revenue mix is separated into five different areas: Exploration and production, Norway Exploration and production, International Exploration and production, USA Marketing, Midstream, and Processing Renewables Approx. Adjusted Operating income (Authors calculations) E&P, Norway, is the main contributor to Equinor’s operating profitability, with slightly more than 76% of the operating income, which is the main source of income for Equinor ASA. At the current moment, Equinor is losing money on its Renewables division, with lower prices in Europe and inflation impacting its profitability. Still, Equinor has an opportunistic view on this sector and believes in long-term profitability for this sector in the long term based on how much they are investing into renewables lately. Revenue by commodity (Equinor Q2) Crude oil is the heavy lifter, with slightly more than 60% of the revenue, and oil will be the main focus of this article. The production numbers Equinor delivered a total equity production of 2 mboe per day. The difference between Equity production and Entitlement production is that equity is gross production, but entitlements are after deducting contractual and fiscal obligations such as royalties, production sharing agreements (PSAs), and taxes. Operational information (Equinor Q1 2024) Norway reached an average price of Brent oil of $83 per barrel, with an average of 648 mboe per day in production. The gas production from Norway is equal to 814 more per day, with an average price of 9.41 USD/MMBtu. The last 188 mboe per day was produced internationally, achieving a gas price of 2.33 USD/MMbtu. Growth According to Equnior, their plans are to grow their oil and gas division by 5% until 2026 and then sustain their 2 million barrels per day production through 2030. How will they do this? Key projects are the Linnorm discovery in the Norwegian Sea, the Breidablikk field, and the Sparta field in the Gulf of Mexico. Their future plans are to grow their renewable division to more than 80 TWh within 2035. That is an increase of more than 10.000% from today’s 774 GWh of renewable production. How much will this cost? Well, according to Equinor, its plan is to use 50% of its capital expenditures on its renewable division by 2030. Equinor has from 2021 to 2026 plans to invest around $23 billion in renewable energy projects. Focusing on offshore wind, solar, and other low-carbon solutions. IEA oil demand and supply outlook IEA demand outlook suggests that peak oil demand will be in 2029. Impacted by high EV sales, renewables and gas changing the demand for energy production and improvement in vehicle efficiency will drive down the demand for oil. IEA suggests that EV sales could reach 40 million by 2030, and that will displace around 6 mb/d. This will resolve to a peak oil demand of 106.5 mb/d by 2029 as their base case. IEA believes that supply will increase by 6 mb/d until 2030 and end at 113 mb/d significantly above their predicted demand peak. Goldman Sachs oil demand outlook Goldman Sachs outlook suggests a later peak oil demand than other prominent forecasts. Goldman Sachs base case is that oil demand will peak in 2034 because of these two factors below. Slower adoption of EV vehicles Reduced Subsidies: The adoption of EVs in Europe has been reduced due to the cutback in subsidies. Price Competition: The high level of price competition puts pressure on automaker profits and, hence, limits investments in EVs. Technical Issues and Infrastructure: Problems relating to charging infrastructure and the affordability and resale value of EVs. Policy Uncertainty: Political uncertainties in areas like the US and Europe are hampering the pace of EV adoption. Rising income and higher energy demand Emerging markets: Emerging markets are expected to increase the demand for oil in the next couple of years, especially in Asia. Petrochemicals (Canadian Energy Regulator) Petrochemicals: The demand for petrochemicals is offsetting the slower demand for gasoline products. Petrochemicals are used for various different products like soap and plastics. If the global GDP per capita keeps rising, then it will impact the demand for petrochemical products, which are a day-to-day necessity. Goldman Sachs has identified different scenarios. The major threat to global oil demand comes from the adoption of EV vehicles and renewable energy sources. According to Goldman Sachs analysts, in 2028, the adoption of EV vehicles will offset the demand for gasoline; that is their base case. This suggests they believe the peak gasoline demand will be in 2028, but other products like diesel will continue to rise until 2034 because of heavy-duty trucks, according to Goldman Sachs analysis. Goldman Sachs different scenarios (Goldman Sachs) The analysts at Goldman Sachs have identified five different scenarios. Slow EV adoption is the most bullish outlook, with a global oil demand of 113 mb/d and low GDP CAGR being the most bearish scenario, with an expected oil demand of 102 mb/d. OPEC OPEC has shown commitment to a higher oil price in the last couple of years. Actively trying to influence the price of oil by using production cuts. I believe OPEC has aimed to have an even higher price than $80 per bbl, but other non-OPEC countries have slowly increased their supply as prices remain relatively stable. In 2023, the average annual oil price was $75 per barrel, and so far in 2024, the oil price has been $81 per barrel. OPEC has already committed to keep production cuts throughout this year. Production cuts of 1.65 mill barrels a day, which both Saudi Arabia and Russia have been particularly supportive of. This can give us investors some reinsurance that other powerful forces are influencing the price of oil to keep it at a high level, one of the reasons could be that a higher oil price is important for Russia to finance their war. Equinor’s role in energy security in Europe Norway is now become a crucial player in supplying natural gas to Europe, and Equinor is a major contributor here. Currently, Norway supplies about 30% of Europe’s gas supply. Equinor has actually signed a long-term contract to supply Germany with 10 billion cubic meters of natural gas every year from 2024 to 2034. This is about 1/3 of Germany’s industrial demand. We believe that gas prices could continue to stay elevated as other alternatives will take time. Renewables are both not very profitable in Europe at the moment and takes time to build, also it looks like the Ukraine-Russia war will not end very soon, unfortunately. EU Natural Gas (Trading Economics) Why have natural gas prices stayed elevated since 2022? Well, there is a combination of disrupted supply chains, expensive LNG, and infrastructural challenges with geopolitical tension. Performance and capital structure As with any other oil and gas company at the moment, Equinor makes a lot of money. They have a return on equity of 21% and a net margin of 9.14%. Financial health is also reassuring, with debt a debt-to-equity ratio of 0.75 and an interest coverage ratio of 31.70, which is more than safe. At the current oil price, Equinor is a very safe place to be. Additionally, Equinor has an agreement with Germany to provide approximately 1/3 of their industrial gas supply until 2034, which is another safety measure. Financial health and operating performance (Morningstar) Valuation Multiples Starting with Equinor’s multiples, we can clearly see that Equinor is at a quite big discount compared to the sector median. Why is this the case? This could be because of Equinor’s lower future growth rate compared to the sector median, as Equinor is more focused on growing its renewable division after 2030. Multiple valuation (Seeking Alpha) Still, I believe Equinor looks too cheap compared to the sector median. The average difference between the sectors is approximately 43% lower than the sector median. DCF Doing a DCF analysis for Equinor is hard because predicting future earnings for a commodity business is basically impossible, but the point of this analysis is to ask yourself if you believe that oil demand will continue well beyond 2029 or not. If you believe this to be true, then I believe you can expect an oil price of around $80 per bbl for the unforeseeable future. DCF sensitivity valuation (Authors calculations) Sensitivity analysis (Authors calculations) The EPS estimate is based on the median of the last eight quarters and with an 80% safety margin, so a quarterly EPS of $0.69. I used a WACC of 8% and calculated with 0% expected growth. Even with 0% expected growth, a realistic terminal multiple of above ten, and an EPS of 2.4, which equals a quarterly EPS of 0.6, we get a share price above $27 per share. This is slightly above the current price, even with 0% growth and an EPS margin of safety of 80%. Also, looking at the sensitivity analysis, we can see that today’s share price is relatively cheap, even with lower EPS and terminal multiple. A EPS of 2.4 is a -27% dispersion of today’s basic EPS. Additionally, a WACC of 8% is almost 40% higher than the average according to my sources. Historical basic EPS and WACC (Seeking Alpha) All of these scenarios are priced with 0% growth, this gives even more confidence that the market is pricing Equinor really cheap today. Dividend yield The current dividend yield is slightly above 11%, but this is because of Equinor’s extraordinary dividend, which has doubled the dividend yield the past years. This will end after 2024 back to ordinary dividend; therefore we can expect a dividend yield closer to 5% at today’s price if ordinary dividend continue like previously. Buyback yield In Q1, Equinor announced that they will buy back shares worth $6 billion in 2024, this is equal to around 8% if the price is around $26 per share, and buybacks worth of between $4 or $6 billion in 2025. According to Equinor, they have spent $947 million the first half of 2024 on buybacks. This means an additional $5.053 billion is expected the last half of 2024 according to their plan, this is a 7% buyback yield until the end of 2024 based on a price of $26 per share. Renewable projects If we do a quick valuation comparison by between existing companies like EDP who produces 26 GW and ReNew who produces 10 GW, we can try to estimate what the 12-16 GW could be. EDP is valued at €15 billion and ReNew is valued at €2.1 billion. At first hand-sight, ReNew looks quite cheap if we just compare production compared to value against EDP, which can be for various reasons. If we do a bear case of the valuation for Equinor’s renewable projects based on EDP valuation, since that is in a more comparable market. We can estimate that Equinor’s renewables project can be valued at $6 billion. That is currently equal to 3 dollars per share. Not a significant amount, but it is an 8% increase from today’s price. Conclusion Equinor is projected to maintain a stable oil and gas production outlook of 2 mboe/d until 2030. Simultaneously, the company is set to significantly expand its renewables division to meet its environmental targets, which is something investors can benefit from the next couple of years. My calculations suggest the current price is relatively cheap. According to my sensitivity analysis, the current share price is really low compared to all the different scenario’s. At the current price, my calculations show that the current price does not include any growth from the renewables projects, which investors will get for free at the current price. Additionally, Equinor’s multiples appear undervalued compared to the sector median, with an average discount of 43%. Equinor’s current price offers a strategic entry point to benefit from stable high oil prices. Investors can anticipate a buyback yield slightly above 7% and a dividend yield of 5% this year, with a future dividend yield of 5% if oil prices remain stable. This analysis hinges on the belief in the pace of electric vehicle adoption. The IEA forecasts that EVs will constitute over 60% of vehicle sales by 2035 under the “Stated Policies Scenario.” Furthermore, the IEA predicts that by 2035, EVs, including buses and trucks, will make up over 50% of vehicle sales in the US. I, along with others, find this rapid adoption scenario unlikely. I align more with Goldman Sachs’ slower EV adoption scenario, which anticipates peak oil demand occurring after 2040. In summary, if you believe that the adoption of EVs will progress more slowly than the IEA projects and that Goldman Sachs’ late scenario is more likely, this could justify investing in Equinor. This belief stems from the expectation that oil demand will peak later. Ultimately, it comes down to your perspective on what will be correct. Predicting oil demand is nearly impossible, but one certainty remains: if you anticipate a significantly later peak in oil demand and manage to maintain your composure during potentially turbulent periods, you will probably make an exceptional return by betting against the market sentiment.

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