Equinor Stock: Outperformance Since My Last Piece – Downgrading To ‘Hold’

Dear readers/followers,

It hasn’t been all that long since my last article on Equinor (OTCPK:STOHF) in March – but the company is worth your attention at this time nonetheless. It has an attractive yield, and at the right valuation, and right investment perspective and entry, an excellent upside.

Since I last posted my piece on Equinor, a piece which by the way you can find here, the company has shown us outperformance, rising 5% while the market has gone negative. While this is not a major move, I believe that this shows us how cheaply valued Equinor can be considered as being when I last wrote about it – and that it no longer is that cheap as things stand here.

I’ve made money with Equinor before – and I’ve also been “stuck” with the company at a too-high valuation. So I’m not inexperienced when it comes to determining when a good time is to “go in” to this company.

My last article was a big one – because I changed my rating on Equinor. I’m about to change my rating again.

Why am I doing this?

That is what I intend to show you here.

Equinor – Why the company is attractive, but not a “BUY”

As a top-10 oil major, Equinor is neither small nor insignificant. But its size is not the main reason I choose to focus my European energy investments on Equinor, just like I focus my American ones on Enbridge (ENB). No, the reason that I am working on buying more Equinor, if the valuation aligns with my price target, is, in fact, its fundamentals relative to its risks.

What do I mean by this?

I mean that Equinor is actually one of the very few energy companies that have an AA rating in terms of credit from S&P Global. It has an incredibly low long-term debt/leverage – less in fact than 35% as of the latest data.

And it’s frankly speaking, a market-outperforming business. By that, I mean that Equinor manages to beat many energy company fundamentals in terms of operating and gross margins, together with that aforementioned debt/EBITDA of less than 0.8x. (Source: Equinor IR). The company’s current EBIT and gross margins come to over 30% on the operating level, and over 40-50% on the gross margin level (45% for the last year (Source: S&P Global)).

To be clear, most analysts believe the company to be undervalued at this juncture. I say this because the analysts following the company average between $29/share for the NYSE ticker on the low side, and $42/share for the high side, with an average of $33/share, with all but one analyst at a “BUY” or “Outperform” (Source: S&P Global, TIKR.com)

if I were to summarize Equinor’s strategy as it currently looks for the next two decades, I would do so in the following way – Low-carbon/ESG for the long term, hydrocarbon/legacy for the short term.

Equinor is accelerating its move into the renewable sector, all in accordance with the net-zero goal in 2050 – and central to this strategy is the fact that the company must grow its renewable operations. If the company does not do this, there will be no meeting this goal – and if you as an investor don’t want part of a company that does this, I would argue that this is not the investment for you.

Equinor’s capital allocation will be going towards low-carbon investments, carbon transportation, storage (such as the Northern Lights project coming online), as well as a few clean hydrogen projects. In fact, when it comes to clean hydrogen, the company intends to become a market leader here.

This leaves Equinor in a position of moving into a vast variety of renewable generation – which can be considered both good and interesting, but also comes with a number of risks.

Further positives include the company’s new projects that are coming online, which are likely to push the company’s break-even on a per-barrel basis down to below 35 USD/barrel, and a sub-20 month payback time for the next projects beyond 2030. (Source: Equinor IR)

In terms of renewables, the company has plans to increase its sub-0.9 GW capacity by a factor of 13-17x in less than 6 years – which are of course high goals that will influence how the company does business.

The way that I see it is this – if any company or business manages to execute this transition in a profitable way, I believe that company to be Equinor. This is not just because of the progress that the company has already made on the 2030 ambitions – though it would be foolish, in an update like this, not to at the very least mention this.

The company’s online-coming projects including Castberg, Bacalhau, Irpa, Rosenbank, Raia, Sparta, Snövit Future, and Sverdrup Phase 3 are all set to put the company in an enviable legacy position of not really having any major issues in terms of O&G CFFO and production. This leaves the company ample resources to focus on its renewable ambitions, which, as you can see, are significant.

The company is building entirely new infrastructure networks, and unlike many of the more optimistic players here, do not believe that returns over 8%, or 4% on the low side, are possible here – though optimism is always in the cards, of course. I agree with their assessment and would say that 4-8% is what’s possible for these sorts of investments.

Shareholders are likely to be well-compensated as well. Divided yield for Equinor is a tricky thing because the company goes between bonuses and ordinary dividends, and at times not pay any sort of bonuses. Equinor pays a quarterly dividend, which means based on current ordinary dividend levels, the yield is just below 4.8%. (Source: Equinor IR)

However, because of the extraordinary dividends, most are currently considering the company yielding twice this. As you can see, though, the company is clearly communicating an end to the extraordinary dividend payments after 2024, to focus on growth. As such, even if the company yields over 8% now, I would say we’d be wise to consider it yielding less than 5% at this time, and any increases are likely to keep the company at that 4-5%, which you need to be happy with.

Share buybacks, as you can see, are also continuing – and in a big way.

O&G is a volatile segment by any measure – it has global and political exposure, and to call it anything but volatile is fooling yourself. As such, I expect Equinor to still be volatile in the future, and I only want to buy it when it offers me a “good price” – which I do believe that it currently does, even if this price is at the upper range of what I would consider to be acceptable.

Let’s look at some upsides and risks for this company, as things stand.

Risks & Upsides for Equinor

The upsides for this company are relatively simple. Equinor is in a strong position due to significant discoveries in the Barents Sea, indicating that Equinor can use existing infrastructure assets for synergies, adding production at high returns. This is a huge plus. The company’s geographical proximity to Europe also means it’s a favored partner for many nations, and it can capitalize on good prices to reduce the overall reliance on Russia by increasing its NG production.

Equinor has also been building assets in extremely harsh environments for decades at this point. This experience is worth a lot, given that it’s looking to build assets and facilities in equally difficult/tricky areas when it comes to wind power and the like. This, once again, gives Equinor what I consider to be an edge here.

On the downside, we have the ever-present danger that renewable assets will fail to bring about the returns the company expects, or at the very least, investment returns at the level of its legacy assets.

Also, the secondary risk is to shareholder returns, and it’s one we can already confirm. Because of the company’s increased investments, it’s unlikely that the current levels of yield are going to be seen again in the near future – at least this is what I believe.

Let’s look at valuation.

Equinor – Looking at the upside

In my last article, I upgraded Equinor to a higher PT – 285 NOK, and considered it a “BUY”. While the company currently has exceeded my conservative PT, this remains a play with risks as well as upsides. From the previous parts of my article, it’s entirely possible to interpret my stance as a positive one. And generally, I am positive about Equinor.

But for now, I believe we’re seeing a bit of an overreaction on the positive side due to the remaining high yield that the company currently still has.

As things stand, we’re now trading at a 9.1x normalized, and this company typically trades at about 10.5x. If this holds, we’re looking at no more than an 11% annualized RoR for the next few years, based on an expected EPS growth rate of less than 2% per year.

Equinor is coming out of a very profitable period but is now moving into a far less clear, and investment-heavy period. This is the company’s own estimate, and that is why they are cutting shareholder returns and have already announced dividends potentially going down a bit.

So, again – care is warranted here. It is also warranted because Equinor, unfortunately, does tend to miss its estimates quite a bit. It’s a hard company to forecast accurately.

My position in Equinor remains small – but is now in the positive. My position in Enbridge is very large – and it’s up double digits. This is because I focus on valuation and quality. Both Equinor and Enbridge are qualitative plays in energy as well as renewables. Both are not expected to grow massively. However, one has an outsized offshore risk and a lower dividend yield – that is Equinor. It’s a qualitative home-field player with structural advantages. In my last article, I made it clear that:

At a 10x P/E, which sounds decent enough for an oil major of this size, Equinor does have a 15%+ annualized upside. That would be the only reason why I could see an upside here for this company, and why I in fact change my rating to “BUY” here. I go by the numbers – and the numbers do speak of an upside.

(Source: Seeking Alpha, Equinor Article)

This is no longer the case, as things stand now. I considered for some time increasing my share price – and I will do so, but only to represent a slightly higher upside and safety, to 290 NOK/share.

My rationale for this change is that I do believe that the company’s new additions of renewables do, in the end, represent a value-add for Equinor, but at a non-trivial risk rating. However, between margin stability and the company becoming less and less cyclical in the O&G segment, we find ourselves looking down at a forecast that’s relatively stable, compared to where the company has been historically. For that reason, I believe that as long as the company keeps adding and clarifying to its post-legacy setup, and providing us with realistic IRRs for their new projects (which I believe they are), and with the dividend cut incoming (by that means taking away the bonus dividend), I believe an increase in the company’s share price is, in fact, justified here – albeit a small one.

Beyond that, I’m not willing to go at this particular time, and I do not believe that you should invest in a company as clearly overvalued as I believe this one is. However, if your investment goals are met, this is of course a different thing entirely.

As it stands, my Equinor thesis is as follows.

Thesis

• Equinor is an attractive company, but it’s also a great European player. I can understand investors being curious about it. The NYS-based EQNR ticker is attractively liquid, despite being a Norwegian 1:1 ADR. Equinor is also one of the best-rated E&P companies on earth, with an AA rating.
• I own a small stake in Equinor and may go ahead and expand this, but I would not view the company as massively cheap unless it dropped below 240-250 NOK/share. Then I might start increasing the allocation pace quite a bit – but at this time, that is not possible at the right price.
• As it stands, this is an attractive company, and I am updating my PT to 290 NOK/share, and downgrading Equinor to a “HOLD” rating.

Remember, I’m all about:

• Buying undervalued – even if that undervaluation is slight and not mind-numbingly massive – companies at a discount, allowing them to normalize over time and harvesting capital gains and dividends in the meantime.
• If the company goes well beyond normalization and goes into overvaluation, I harvest gains and rotate my position into other undervalued stocks, repeating #1.
• If the company doesn’t go into overvaluation but hovers within a fair value, or goes back down to undervaluation, I buy more as time allows.
• I reinvest proceeds from dividends, savings from work, or other cash inflows as specified in #1.

Here are my criteria and how the company fulfills them (italicized).

• This company is overall qualitative.
• This company is fundamentally safe/conservative & well-run.
• This company pays a well-covered dividend.
• This company is currently cheap.
• This company has a realistic upside that is high enough, based on earnings growth or multiple expansion/reversion.

I no longer believe this company has the sort of upside to justify a “BUY” recommendation here. I’m now at “HOLD”.

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.