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Energy M&A Heats Up

What do super major oil company Chevron Corp (NYSE: CVX) and leading US rooftop solar installer Sunrun Inc (NSDQ: RUN) have in common?

They’re on the leading edge of a building wave of energy mergers and acquisitions, according to Roger Conrad, co-editor, Energy & Income Advisor.

The primary catalysts for deal making:

• A battered industry landscape littered with high quality assets and motivated sellers.

• Deep-pocketed companies positioning to dominate the energy sector recovery they increasingly believe is at hand.

COVID-19 fallout has hit the oil and gas business hard. Recent data from Baker Hughes highlights a 20-year low in drilling activity outside the US. And just 14 percent of the rigs in service at the shale boom’s peak are still running now.

Rooftop solar has fared little better. Before the pandemic, energy consulting firm Wood Mackenzie forecast 3.1 gigawatts of new installations this year. They now predict just 2.1 GW, or 25 percent fewer additions than in 2019, as consumers delay major new purchases and in-person sales channels remain stymied.

Sharply lower selling prices and reduced output have put immense pressure on oil and gas companies’ cash flows and balance sheets this year. The result has been a flood of industry bankruptcies, the largest so far being Chesapeake Energy (OTC: CHKAQ) in late June.

Rooftop economics still benefit from falling prices and rising efficiency rates, despite US tariffs. But even in times of booming sales, companies haven’t found a consistently profitable business model, and even the largest are bleeding cash now.

Sunrun Inc (Nasdaq: RUN), for example, ran a $1.2 billion free cash flow deficit for the 12 months ended March 31. That’s roughly equivalent to 20 percent of assets and 75 percent of shareholders’ equity. And the gap will widen even more when Q2 results are released on August 10.

Super major oils are in a far stronger place financially. Chevron draws an Aa2 rating from Moody’s with a stable outlook. The company also generated $12.7 billion in free cash flow for the 12 months ended March 31, enough to cover its dividend by a solid 1.4-to-1 margin.

The company’s surplus is likely to shrink considerably with Q2 results, reflecting the combination of even lower selling prices and reduced demand for both crude and refined products. And the pace of oil and gas sales and rooftop solar installations faces more challenges in the second half of the year, as states slow economic openings to combat the Covid-19 pandemic.

Chevron and Sunrun, however, have two huge advantages that position them as opportunistic acquirers: They’re weathering industry challenges far better than most rivals. And at a time when liquidity is at a premium, they have the currency to do deals.

For Chevron, it’s a relatively steady share price combined with balance sheet cash and an extremely low cost of debt capital. The company’s bonds of May 2050 currently yield just 2.42 percent to maturity, near the lowest borrowing rate in the super oil’s long history.

For Sunrun, the currency for deals is high priced stock. Shares have risen by almost 180 percent year-to-date and trade for the premium multiple of 5.3 times trailing 12 months sales. That’s despite the company never having proven it can consistently turn a profit, and the likelihood sales will actually fall this year.

This month, both companies put their capital to work, buying assets on the cheap that have the potential to kick long-term profitability into a higher gear. Sunrun agreed to exchange approximately 0.55 of its shares for each of Vivint Solar (Nasdaq: VSLR). Chevron announced a 0.1191-to-1 swap of its shares for Noble Energy Inc (NYSE: NBL).

For Chevron, this deal is all about adding Noble’s 2 billion barrels of proved oil and gas reserves. That’s an increase of 18 percent to current holdings, at an estimated cost of less than $5 per barrel of oil equivalent (BOE).

Noble owns 92,000 net acres in what management calls the "core" of the Delaware Basin in the Permian Basin of west Texas. That’s been a key target area for prospective Chevron M&A since it lost a bidding war for the former Anadarko Petroleum to Occidental Petroleum (NYSE: OXY) last year.

Noble also has valuable assets in Colorado’s DJ Basin (Denver-Julesberg) and operates the Tamar and Leviathan natural gas fields off the coast of Israel, which have offtake agreements with that country as well as Egypt and Jordan. And the company also owns 62.46 percent of Noble Midstream Partners (Nasdaq: NBLX), with pipelines serving its Colorado and Texas properties and with a market value of around $500 million.

Chevron is locking in a price for Noble shares roughly 60 percent lower than what it would have been January 1. And the $5 billion all-equity price tag is little more than its target’s book value.

That limits the financial risk of the acquisition. So will projected annual run rate synergies of $300 million and opportunities to reduce leverage costs by refinancing and retiring the target’s roughly $8.5 billion debt burden. And management expects the transaction to be immediately accretive to free cash flow, earnings and return on capital employed when it closes in Q4.

Together, Sunrun and Vivint now provide about 75 percent of new US residential solar leases. That high share could raise regulatory concerns especially in California, by far the most important state for the rooftop business.

If the companies can overcome that potential hurdle for a Q4 close, Sunrun management expects $90 million annual cost synergies from overlapping service territories and enhanced online selling. There’s even reason to hope the post-merger company may develop a sustainable business model, by partnering with California’s power grid-focused utilities like Edison International (NYSE: EIX) as an aggregator of solar energy with scale.

Whatever the case, these acquisitions demonstrate that management of these leading companies believes the energy cycle is bottoming. And that’s the best possible sign energy M&A is a long way from cresting, with many more opportunities to place our bets.

Editor’s Note: Energy & Income Advisor is edited by Roger Conrad and Elliott Gue, a semimonthly online newsletter that’s dedicated to uncovering the most profitable opportunities in the energy sector.

EIA is your complete guide to the energy sector, from growth stocks to royalty trusts, master limited partnerships and other income-oriented fare. For more information on Energy & Income Advisor visit www.energyandincomeadvisor.com.


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