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Statoil Is Enticing on Correction

- By Faisal Humayun

Oil has witnessed some correction recently, and this presents a good opportunity to accumulate some quality names in the industry. Oil is likely to trend higher in the medium to long term; in sync with this view, I suggest exposure to oil and gas exploration stocks.

This article discusses one quality name in the energy sector that is not only trading at appealing levels but also offers a sustainable dividend of 5.0%. Statoil (STO) has corrected to $17.5 from near-term highs of $19.2. This 10% correction is worth buying into with a three- to five-year portfolio investment horizon. I will elaborate on factors that will deliver robust returns for shareholders.


U.S. assets to deliver value

Statoil has significant shale operations in the U.S., and the assets that need to be discussed as potential improvement in break-even cost can be game changing. Just to put things into perspective, Statoil has 4 billion barrels of oil equivalents in resources with the company delivering equity production of 270mboe/d in fiscal 2016.

Statoil needed oil priced at $90 per barrel for positive earnings in 2014. With a sharp decline in oil prices, the company pursued an aggressive cost reduction strategy; for 2016 the company's break-even declined to $66 per barrel for positive earnings.

Further, by 2018, the company expects U.S. shale operations to be profitable at $50 per barrel of oil. This is a significant positive trigger for the long term, and I expect oil to be well above $50 per barrel in fiscal 2018.

From a production perspective, Statoil expects to deliver production of 360mboepd by 2018. While the company was targeting cash margin of $5 per barrel (WTI $50 per barrel) in 2014, it has been ramped up to $12.5 per barrel for 2018 at the same oil price target.

U.S. assets will deliver value in the long term, and free cash flow from the assets can be robust as oil trends higher. This will help Statoil in investing in other big projects in the NCS that have even more attractive IRR.

The next generation portfolio

Besides reducing cost that can translate into good IRR from U.S. shale, Statoil has been working on lowering the break-even cost for the entire portfolio of assets with focus on the NCS.

With big projects such as the Johan Sverdrup coming in the next few years, Statoil expects these NCS assets to have break-even of $27 per barrel with IRR of approximately 25% at $70 per barrel of oil. Considering a three- to five-year horizon, I am bullish on oil to be well above $70 per barrel.

Therefore, Statoil is well positioned to deliver strong cash flows in the coming years. I must mention that even for 2017, Statoil expects to incur capital expenditure of $11 billion, but the company will remain FCF positive at $50 per barrel of oil. I do expect oil to average above $50 per barrel in fiscal 2017. Positive FCF will ensure that dividends remain at current levels and fundamentals remain strong.

Coming back to the core portfolio focus in the coming years, NCS is one of the most cost competitive regions for Statoil, and organic and inorganic growth will be seen largely in the NCS region. However, Statoil is looking to enhance its Brazilian portfolio in the coming years and that could provide interesting growth opportunities.

Conclusion

Besides the interesting projects that are in development in the NCS coupled with improving break-even for U.S. shale, Statoil is interesting for dividend investors, and I expect dividends to sustain at current levels through 2017.

Further, as the big cash flow projects go on stream in the next three to four years, free cash flow will swell and ensure steady dividend growth coupled with a deleveraging balance sheet. All these factors make Statoil attractive for portfolio investment.

Disclosure: No positions in the stock.

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This article first appeared on GuruFocus.