E - Eni: Don't Let The Headline Risks Fool You Into Selling

2023-06-23 06:40:51 ET

Summary

• Eni continues to deliver on its strategy despite negative press and a weaker-than-anticipated short-term outlook.
• The company is close to acquiring Neptune Energy and is in talks to sell a minority stake in its green energy division, Plenitude.
• I maintain a STRONG BUY rating for Eni, given its double focus on green energy for growth and strong cash flow from legacy operations.

I am picking up Italian oil major Eni ( E ) again for a quick update, at roughly unchanged levels since my initial investment thesis was released on the website at the end of March, and to which this coverage is a follow-up. The company has provided a slightly positive return to investors, also driven by the dividend distributed in May. Although the position has lagged behind the broad US indexes, I am not concerned by the short-term underperformance, as it is apparent that the stellar performance of a handful of high-flying stocks has fueled the recent rally entirely. Since the article's publication, the stock has outperformed the Energy Select Sector Fund ETF ( XLE ), and I am satisfied with that.

What happened in the last months?

In recent months, O&G investments, particularly those in oil majors, have continued to suffer considerably from headline risk. In a most prominent example, a few days ago, UN Secretary-General Antonio Guterres slammed O&G companies, calling the O&G majors "planet-wreckers," whose goods and services are "incompatible with human survival." Somebody could probably identify the main target of the UN's chief ire in Shell ( SHEL ), who just days before scrapped its plans for oil output cut and reverted to a new strategy of keeping oil production steady or slightly higher into 2030, but the message still haunts all industry players, including Eni.

Guterres also asked financial institutions to stop financing fossil fuel projects, a call that I see as largely void. O&G firms' balance sheets are in great shape. Eni's Net Debt on Assets is well below 10%, and the company's new financing proceeds as smoothly as ever. Eni tapped the market back in January to place a $1 billion, 4.3% yielding, 5-years bond to retail investors in Italy. The emission was so successful that Eni doubled it to $2 billion and still closed the placement well ahead of the anticipated deadline because the requests were several times over the offer. However, at least somebody in the financial markets seems to be responding to the UN Chief's call.

Following other funds' footsteps, the Church of England endowment fund declared its intention to eliminate O&G positions, saying such companies are "failing to address climate risks." Fortunately, the fund is relatively small ($11.3B), so investors should not expect any real pressure on Eni or other O&G holdings from the selling. However, the possibility that additional institutional money follows the same path constitutes a significant risk that oil companies will continue to face downward pressure, and investors should be aware of that.

Regarding fundamentals and supply-demand balance, investors also continued to see more weakness in the price action than one would think is due. As we left a Q1 with oil futures ( CO1:COM ) struggling to keep the $80 level, we are now closing another quarter with the price seemingly about to fall below $70. Despite the puzzling price action, oil could be finally approaching an inflection point and see better pricing in H2 2023, despite macro worries. My go-to analyst for the oil market, HFI Research, explained in his work that oil inventories would fall with oil demand rising and OPEC+ cutting production, allowing prices to move higher again, and I share his sentiment.

Eni undeterred in its plans

Despite the bad rap from the press and an uncertain macro outlook for the rest of the year, from a micro-perspective, Eni continues to deliver.

Regarding traditional O&G investments, as promised by the massive CAPEX plan outlined in the last capital markets update, the company seems incredibly close to acquiring Neptune Energy, backed by Carlyle Group and CVC Capital Partners. The deal could be worth about $5 billion or even slightly more, as Eni needs to beat the competition from rival suitors such as TotalEnergies ( TTE ). However, Eni has already entered the exclusive talks stage, significantly increasing its chances of winning the bid. Neptune Energy, which operates in the North Sea, North Africa, and Asia, has a portfolio that could strongly complement Eni's assets in these regions and is approximately 75% natural gas. The move is highly strategic as it fits Eni's long-term commitment to reshaping its production mix toward natural gas while adding to European energy security and fostering its decoupling from Russian imports.

Neptune Energy produced 135.0 kboepd during 2022, and the plan is to reach an average of approximately 160.0 kboepd in 2023, with an acceleration in H2 2023 towards 180.0 kboepd, a 33.3% YoY increase. Its assets include over 1 billion boe 2P+2C reserves, which could sustain 2023 production for 15 years. Neptune generated $2.4 billion in cash flow from operations last year and $1.7 billion in free cash flow out of $4.6 billion in revenues. Eni's deal price could hence equal about 3x FCF, although everybody is already aware, at this point, that last year's record results won't repeat in 2023. Still, Neptune Energy has recently guided for $1.7 billion in CFFO and $1.2 billion FCF. Eni would be looking at acquiring the business for 4x - 5x this year's FCF.

Regarding Eni's green energy division, Plenitude, rumors have also continued to pile up, with multiple suitors reportedly interested in acquiring a stake in the fast-growing business. A few months back, Norway's HitecVision seemed close to achieving a deal for a 10% partnership share, with Plenitude reportedly valued at $8.4 billion. The new talks for a 5% to 15% minority stake are with Swiss asset manager Energy Infrastructure Partners, among others. According to Reuters, the unit could fetch about $6.5 billion in a private transaction. The Reuters report seems to underestimate Plenitude considerably, and I would be surprised if Eni's CEO Descalzi decided to go ahead with a sale (that doesn't need to happen from a purely financial perspective) at such a low multiple. Eni continues to invest aggressively in Plenitude and expects to spend almost $10 billion within three years. Because of the heavy investments, Plenitude's EBITDA should reach $1.8 billion by 2026. With Eni set to remain the main sponsor and provider of growth capital, I don't see why any transaction should happen at less than 12x fwd EBITDA, equal to the $8.4 billion already rumored back in February.

Staying the course

Despite the negative press and weaker-than-anticipated short-term outlook, Eni continues to deliver on its strategy. Descalzi and his team are laser-focused on successfully reshaping Eni as a significant player in the coming green energy era while continuing to drive profitability on legacy operations.

Operational developments at the firm remain positive, so I am maintaining my STRONG BUY rating. I like the prospects of a closing M&A transaction with Neptune Energy (at the rumored levels of $5 - $6 billion) and the selling of a minority stake in Plenitude. While the IPO delay was a setback, Eni should not try to force things because its finances are in perfect health, and the company should try to maximize returns. Considering its prospects of tripling 2022 EBITDA within five years, I hope a deal that values Plenitude at less than 12x 2023 EBITDA does not happen. Eni doesn't need the cash; the IPO will do just fine sooner or later, regardless of a prior transaction.

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