Because of the difficult conditions in the oil and gas markets over the past two years, a number of energy companies have gone bankrupt. However, others have slashed costs and have thus far weathered the storm. In fact, more than two dozen energy companies have managed to generate at least $1 billion in free cash flow (FCF) over the past year despite the difficult market conditions.
To review, FCF measures cash generated by a company in excess of its spending. It is generally calculated from net income, adding back depreciation and amortization (because those non-cash costs relate to historical expenditures), adjusting for impairments to oil and gas properties (those non-cash impairments are applied against net income but not cash flow) and then subtracting interest paid, changes in working capital and capex.
It is always important to keep in mind that FCF is affected by many factors, in particular capital expenditures. A company that is investing heavily in the future may see deterioration in FCF with the anticipation of a future payoff. Likewise, a company may see a dramatic improvement in FCF if it stops spending capital from one quarter to another. Nevertheless, companies that consistently generate positive FCF are companies that should have money available to reinvest and grow their businesses.
According to the data from the subscription-only S&P Global Market Intelligence database, there are 2,278 energy companies that are publicly traded on exchanges around the world. Over the past 12 months, 26 of them (1.1%), generated at least $1 billion US dollars in FCF. Over a dozen trade on U.S. exchanges, while the rest are scattered around the world.
I will break the data up into three tables: Companies that generated over $2 billion in FCF over the past year, those that generated between $1 billion and $2 billion, and then companies that trade on U.S. exchanges that generated at least $1 billion. First, the >$2 billion club:
- FCF – Levered free cash flow in billions
- EV – Enterprise value in billions of U.S. dollars at the close of business on August 18, 2016
- EBITDA – Earnings before interest, tax, depreciation and amortization, in millions for the trailing twelve months (TTM)
- Debt – Net debt at the end of the most recent fiscal quarter
- YTD Ret – Total shareholder return (TSR), including dividends, through August 12, 2016
The global leader in FCF generation was China Petroleum & Chemical Corporation with $12.6 billion in FCF. The primary difference in the financial statements of China Petroleum and ExxonMobil (which generated $20 billion in FCF in 2011 and $10 billion in FCF in 2012) is that ExxonMobil continues to make higher capital expenditures.
Also note that nearly every company on this list has a solid double-digit total shareholder return for the year. A notable exception is Valero, which performed very well as oil prices fell. However, as oil prices began to recover somewhat this year, higher oil prices cut into the margins for the refining group leading to poor shareholders returns for the refining sector.
Most of the companies that generated between $1 billion and $2 billion in FCF can be found on the New York Stock Exchange (NYSE):
This group greatly under-performed the group in the previous table, primarily because it contains a number of companies with exposure to offshore drilling, which has a cloudier near-term outlook than oil and gas producers or onshore drillers.
Among the group of companies that trade on the NYSE, Occidental Petroleum led the group with $5.2 billion in FCF over the past year. However, the only pure exploration and production (E&P) company on this next list is EOG Resources, the 2nd largest pure E&P company in the U.S. behind ConocoPhillips:
While there are examples of companies that generated solid FCF, but did so while piling up debt that ultimately led to bankruptcy (e.g. Linn Energy), FCF over time is a pretty good measure of the health of a company. Companies that generate FCF on a consistent basis generally have money available to grow their business and to reduce debt. There are many important metrics to check as you carry out due diligence, but understanding a company’s FCF is one of the most important.