EQNR - Equinor Ignites Electrification Momentum In Europe

2023-10-12 14:55:31 ET

Summary

• Equinor's valuation at 5x its 2024 free cash flows points to a rewarding investment.
• Equinor's robust capital returns program reflects its commitment to shareholders.
• Equinor's strong balance sheet position, with a net cash position of approximately $12 billion, provides a solid foundation for future growth.

Investment Thesis

Equinor ( EQNR ) is priced at about 5x its 2024 free cash flows. What's more, Equinor is returning to investors significant capital. While it's impossible to accurately predict what natural gas prices will be in 2024, it's very fair to conclude that Equinor's current valuation doesn't need any heroics to be a rewarding investment.

Natural Gas Demand is Going to Rise, Here's Why

Here's the graph that many readers will be familiar with. The amount of electricity that comes from renewables is increasing with time.

Since 2014, Europe's electricity from renewables has gone from 15% to close to 40%. A tremendous amount of progress. The problem here is twofold.

Firstly, shifting to renewable energy often begins with low-hanging fruit and high-ROI projects because they are cost-effective, set up essential infrastructure, gain public support, and coincide with technological advancements. Transitioning from 15% to 40% renewable energy is typically easier due to these favorable conditions. However, going from 40% to 60% becomes more complex as it involves upgrading the grid, advanced energy storage, and changes in consumer behavior, making it a more intricate phase of the transition.

Secondly, the majority of renewable energy sources in Europe have predominantly relied on hydropower and wind turbines, see below.

Hydropower has played a significant role due to its established infrastructure, but its potential for substantial growth is limited by the high costs associated with constructing new dams.

Wind turbines, while initially promising for their environmental benefits, are showing signs of diminishing economic viability. The expense of building and maintaining wind turbines, coupled with challenges in achieving anticipated returns, raises concerns about their long-term sustainability as a primary renewable energy source in Europe.

Having discussed the energy supply situation, now let's talk about electricity demand. The growing adoption of EVs, which use electricity instead of oil-based fuels, is poised to drive up the demand for electricity significantly. This shift in the automotive sector toward electricity aligns with the broader trend of electrification across various industries. Notably, AI, which has caught many by surprise due to its unexpectedly high energy demands, is a prime example of this electrification trend. As AI and other energy-intensive technologies gain momentum, including data analytics, the demand for electricity will continue to rise, necessitating a robust and adaptable energy infrastructure.

Equinor's Capital Returns Program 2024

For 2023, Equinor's capital returns program is on a path to return approximately $17 billion in total. This program includes a combination of share buybacks and cash dividends. Further, these capital returns are despite experiencing negative net cash flow due to high tax and capital distribution payments in Q2 2023.

Given that Equinor has consistently stated that it's committed to its capital returns strategy, let's form an opinion on Equinor's capital returns program for 2024.

To be clear, Equinor has not made any announcement about its 2024 capital returns program. However, I urge investors to spend a moment thinking about Europe's natural gas dynamics.

We know that winter 2022/2023 was abnormally warm. And we also know that the northern parts of Europe had an unusually mild summer. This allowed LNG storage facilities in Europe to rapidly fill up ahead of schedule and cheaply. And yet, the price of natural gas in Europe continues to steadily increase. Again, that's even though Europe's gas storage facilities are already full. Why are natural gas prices rising?

There's no need to overthink it! Simply know that demand is outstripping supply.

Let's turn our focus to discussing Equinor's cash flow profile.

How Much Free Cash Flow is Equinor Going to Make in 2024?

We know that Equinor's capex will rise to around $13 billion next year. And we also know that after its capex, Equinor's free cash flow in 2021-2022 reached approximately $24 billion.

Furthermore, let's ignore the abnormal pricing environment of 2022.

Let's look back to 2021 when the price of natural gas in Europe averaged around EUR45 per MHW. And while it's impossible to make predictions about what the price of natural gas will be in 2024, if we presume that natural gas prices in Europe end up similar to 2021, this could see Equinor making another $18 to $20 billion of free cash flow. Note, that this figure already factors in a large margin of safety.

What's more, as you can see above, Equinor's balance sheet is in a strong position, with a net cash position of approximately $12 billion. Yes, there's around $4 billion of taxes coming due in Q3, with more taxes due in Q4. But as we look ahead to 2024, Equinor's high windfall taxes will be in the rearview mirror.

The Bottom Line

In my analysis of Equinor, I found that its current valuation, priced at about 5x its 2024 free cash flows, makes this stock very attractively priced. The increasing demand for natural gas in Europe, driven by a shift toward renewable energy and electrification trends, underscores the potential for Equinor's growth.

Additionally, the company's robust capital returns program demonstrates its commitment to shareholders. The natural gas market dynamics and Equinor's strong balance sheet position also bode well for future prospects.

Overall, Equinor seems poised for a favorable performance in the coming years.

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