The five integrated oil super majors closed their financial books for 2020 and their numbers looked dreadful. However it could have been worse. Their revenues fell an incredible 36%, from $1,218 billion to $778 billion, year over year due to a combination of lower commodity prices and lower volumes sold. Reported net income over the same period plunged from a positive $48 billion to a loss of $77 billion. While earnings losses are seldom a positive sign we believe the number are not as bad as they may appear. Not all financial losses are created equal so to speak.
First the net loss of $77 billion consisted of two parts: 1) a relatively modest $6 billion loss on operations and 2) a $71 billion after tax loss due to corporate write offs (largely non cash). In other words the industry almost broke even in its operating businesses despite experiencing drastically lower sales and prices,
The bulk of these reported losses were in effect discretionary on the part of senior management (and their accountants). Corporate officers decided that a part of their balance sheet assets, investments made years ago under vastly different assumptions about price and industry growth, no longer had as much value. This reflects to a degree a judgement call — a major change in assumptions about the future. The financial press for obvious reasons devotes little attention to depreciation.
It is the antithesis of sexy or attention grabbing. But when major write offs occur in any industry management’s are tacitly admitting they messed up and that often billions of dollars of previous investments are now deemed worthless. In large capital intensive industries like oil facing uncertain outlooks, to say the least, there is also a considerable room for disagreements among companies on this issue. But from a practical perspective managements almost always have a strong incentive to minimize depreciation expense since lower depreciation levels equals higher earnings. In effect large write offs of this sort are like deferred chickens finally coming home to roost.
Second, on a positive note the oil companies generated considerable cash flow from operations of roughly $96 billion. This more than covered their capital expenditures of $74 billion but did not provide enough surplus to sustain the old level of stock dividends. Investors focused on dividend yield please take note.
Third, the companies ended the year with the ratio of debt to capitalization at 36% and debt to EBITDA of 3.4x. For those of you who are not debt analysts, those numbers may not qualify as outstanding for an industrial credit but certainly are not signs of imminent financial disaster either.
Looking forward to 2021 the consensus of Wall Street analysts is that the five major oil companies will enjoy net income of $33 billion, a huge improvement over 2020’s dismal results. However this only equates to a meager 5% return on equity, compared to 7% in 2019. (Regulated electric companies in the US by contrast earn far higher equity returns while experiencing much less business risk). Cash flow from operations are expected to rise to about $135 billion.
This would permit the payment of a respectable 4% dividend yield equating to a cash outlay of $28 billion and finance a bigger capital program of $80 billion. This would still leave $12 billion left to fund new ventures and $15 billion for debt retirement. Cutting the dividend yield to 2% would free up another $14 billion for either new ventures, capex or debt retirement. But either way the available cash flow after capex and dividends just isn’t big enough to make the new, green businesses significant for a long time. But what’s the rush? The companies are solid. They have time.
And that is the irony of 2020’s results. Maybe they were not bad enough to shake up the industry. They did some short term damage but 2021 will be better, so where’s the sense of urgency? In the meantime, buy enough windmills to fend off complaints from ESG investors.
By Leonard Hyman and William Tilles
