Berenberg sees 'more value' in the exploration and production space

Berenberg, which initiated its coverage on London-listed outfits Cairn Energy, Nostrum Oil & Gas, Premier Oil and Tullow Oil on Thursday, noted that integrated oil and gas companies - given their more diversified business model and in most case stronger leadership - had been able to address the key issues affecting them more swiftly, while E&P groups had adjusted more slowly to the new reality.

Despite that, Berenberg believed there was "more value in the E&P space".

"We estimate an average FCF yield of 17% and 3% for the sector in 2019/2020 (both at $65/bbl), respectively, with a relatively conservative leverage of 2x on average. This compares with an FCF yield of c.7% for the integrateds."

In the case of Cairn Energy, which Berenberg started off with a 'buy' rating and a 240p target price, the German broker said the company's current valuation was "broadly in line with the sector average", which led it to believe the market had not assigned any value to the potential $1.3bn coming the firm's way from its ongoing disputes with Indian tax authorities.

"This upside, coupled with Cairn's operational momentum, offers strong risk/reward, in our view."

With Cairn's operations being spread out across the UK, Norway, Mexico and Mauritania, Berenberg said it would prefer "a more concentrated approach from a geographic perspective" but highlighted the group's partnerships with bigger peers that have strong exploration track records, such as Lundin Petroleum, AkerBP and Eni as a positive.

The German broker also initiated coverage on Kazakhstan-focused operator Nostrum with a 'buy' rating and slapped it with a 280p target price, noting that in the near term there was a potentially strong risk/reward as the group focuses on continuing its success in unlocking the northern part of the Chinarevskoye field, which may potentially add 50m barrels of oil of 2P reserves.

However, the analysts did warn that in the medium/longer term, risks relating to Nostrum's booked 2P reserves would "still linger" and could only be addressed with increased development drilling.

On North Sea explorer Premier Oil, Berenberg started the shares at 'hold' rating with a 140p target price, stating that, although it was "one of the cheapest E&P companies" under its coverage, management still needs to demonstrate its commitment to capital discipline before it would feel comfortable changing its stance.

According to Berenberg, an E&P company needs to offer "strong operational momentum and/or attractive risk-reward via exploration and appraisal" in order to avoid being a "basket case" play on oil price, something it said the last London-listed group in its coverage had failed to do.

"We believe Tullow offers neither and yet trades at a similar multiple to the likes of AkerBP and Cairn – a too rich valuation for Tullow and an unfair reflection of the fortunes of the other two."

The broker started Tullow off at 'hold' with a target price of 240p.