The Top 5 Upstream Companies Based on Return on Equity

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1 The Top 5 Upstream Companies Based on Return on Equity By Keisha Bandz Jan 10, :06 PM The Top 5 Upstream Companies Based on Return on Equity Why return on equity is important Equity and debt financing are the two major sources of financing in the capital-intensive upstream or oil and gas exploration and production industry. Therefore, in order to measure management s effectiveness in investing shareholder equity, an important metric to consider is ROE (return on equity). A company s ROE is a profitability measure that indicates how much profit it has generated with the money invested by its shareholders. In this series, we ll look at the top five upstream companies based on their TTM (trailing 12-month) ROE. The data we ll use will be based on upstream companies included in these three key energy sector ETFs: Energy Select Sector SPDR ETF (XLE)

2 SPDR S& P Oil & Gas Explore & Production ETF (XOP) ishares US Oil & Gas Exploration & Production ETF (IEO) CRZO and LPI come in at the top The company with the highest TTM ROE as of 3Q17 is Carrizo Oil & Gas (CRZO) with an ROE of 52.1%. Laredo P etroleum (LP I) reported the second-highest operating TTM ROE of 45.7% in 3Q17. NFX, MTDR, and DVN Newfield Exploration (NFX), Matador Resources (MTDR), and Devon Energy (DVN) all made the top five upstream companies by TTM ROE. NFX s ROE in 3Q17 was 31.1%, while MTDR s TTM ROE came in at 28.5%. DVN s TTM ROE was 23.8%. In the rest of this series, we ll look at the individual ROE trends for these companies. What Drove Carrizo Oil & Gas s Return on Equity Last Year? Carrizo Oil & Gas In 3Q17, C arrizo Oil & Gas (C RZO) reported a positive TTM (trailing 12-month) ROE (return on equity) for the first time since 3Q15.

3 CRZ O s increased earnings drive ROE The rise in CRZO s ROE in 3Q17 on a TTM basis was due to a significant increase in CRZO s TTM earnings in the same period. Its TTM net income in 3Q17 was $103.3 million compared to a net loss of $1.1 billion in the TTM to 3Q16. In the 2015 comparative period, the TTM net loss to 3Q15 was $640.7 million. What drove earnings? C RZO s increased earnings were supported by higher revenues. The TTM revenue in 3Q17 was $643 million compared to the comparative period revenue of $399.2 million in 2016 and $493 million in Net profit margin As a result, CRZO s net profit margin, which is the net profit divided by revenue, averaged 17.2% in the past 12 months (as of 3Q17), while the similar period averages in 2016 and 2017 were % and -277%, respectively. How about other factors? A key performance study used when measuring a company s ROE is the DuPont analysis. That model breaks down the ROE ratio as a function of profitability (net profit margin), efficiency of asset use (asset turnover), and financial leverage (equity multiplier). The interpretation is that companies can increase their ROEs by increasing their net profit margins, generating more revenues from the same assets and increasing debt financing. As of 3Q17, CRZO s asset turnover ratio averaged 0.08 over the past 12 months. That compares to an average of 0.06 in the TTM to 3Q16 and 0.04 in the TTM to 3Q15. C RZO s average total assets divided by its average total equity (also known as the equity multiplier, a gauge of financial leverage) has averaged 19.3 over the past 12 months to 3Q17. That s higher than the average of 8.5 in the TTM to 3Q16 and an average of 2.7 in the TTM to 3Q15. As we saw above, C RZO s improved profit margins and increased leverage were the key reason for the increased ROE. Additionally, its increased asset turnover ratio helped drive growth in its ROE. Another important factor that affects ROE is shareholder equity, which is the denominator in the ROE calculation. C RZO s average equity as of 3Q17 was $206 million compared to $119.3 million in 3Q16 and $840.9 million in 3Q15. The decline in equity over the past two years helped push C RZO s ROE higher. What Made Laredo Petroleum s Return on Equity Rise in 2017? Laredo Petroleum Laredo P etroleum s (LP I) TTM (trailing 12-month) ROE (return on equity) in 3Q17 was 45.7%. That s significantly higher than the comparative period in 3Q16 and 3Q15, as we ll see below.

4 Net income and revenue LPI s net income was the key driver of improved ROE. Its TTM net income in 3Q17 was $122 million, which compares to a net loss of $1.2 billion in the TTM to 3Q16 and a net loss of $1 billion in the TTM to 3Q15. LPI s TTM revenue in 3Q17 was $766 million compared to $536 million in the TTM to 3Q16. The comparative TTM revenue in 3Q15 was $921 million. As of 3Q17, LPI s average net profit margin over the past 12 months was 16%. In comparison, its net profit margins averaged -249% and -174% in the TTM to 3Q16 and 3Q15, respectively. Asset turnover LPI s asset turnover ratio averaged 0.10x over the past 12 months as of 3Q17 compared to a comparative 3Q16 ratio of 0.07x and a comparative 3Q15 ratio of 0.05x. Asset turnover is calculated by dividing a company s revenue with its average total assets. When a company generates higher revenue per unit of its assets, it s considered to be more efficient and is expected to earn a higher return on equity. Leverage LP I s leverage (measured by asset-to-equity ratio) averaged ~7.9 over the past 12 months as of 3Q17. That compares to an average of ~12.1 in the 12 months to 3Q16 and ~2.5 in the 12 months to 3Q15. Leverage also plays a key role in analyzing a company s ROE. By increasing its debt relative to equity, a company can increase its ROE.

5 In LPI s case, the key drivers for growth in ROE in the TTM to 3Q17 were an increase in net profit margins and asset turnover. The leverage increase between the 12 months to 3Q17 and the 12 months to 3Q15 compared to the 12 months to 3Q16 fell significantly. Newfield Exploration s Return on Equity and What Drove It Newfield Exploration Our next company in the top five upstream companies based on the highest TTM (trailing 12- month) ROE (return on equity) as of 3Q17 is Newfield Exploration (NFX). Newfield s TTM ROE in 3Q17 was 31.1%. A company s ROE is mostly driven by its net profit margin, asset turnover, and leverage. The breakdown of ROE performance is also called the DuP ont analysis. Net profit margin As of 3Q17, NFX s average net profit margin over the past 12 months was 20.6% compared to its 3Q16 12-month average of % and its 3Q15 12-month average of %. The increase in NFX s net profit margin was brought about by higher net income, which was $345 million in 3Q17 (on a TTM basis) compared to 3Q16 and 3Q15 at -$1.9 billion and -$2.3 billion, respectively. Asset turnover

6 NFX s asset turnover over the last 12 months as of 3Q17 averaged That compares to an average of 0.07 in the TTM to 3Q16 and 0.05 in the TTM to 3Q15. An increase in asset turnover indicates an increase in management s efficiency to drive sales (revenue) from the company s assets. So the increase in NFX s asset turnover ratio also contributed to the rise in ROE apart from its net profit margins. Leverage NFX s leverage (asset-to-equity ratio) averaged 7.1 over the past TTM to 3Q17, which is higher than its 3Q16 TTM average of 4.98 and 3Q15 TTM average of Increased leverage or additional debt means that a company might see an increase in ROE because net income is boosted by an increase in debt capital invested, even if equity capital is steady. However, additional debt means increased interest payments. So profits generated from additional debt should exceed the cost of debt in order for a company to actually benefit from taking on additional debt. NFX s equity NFX s declining equity over the past quarters (as a result of quarterly losses) also pushed its ROE higher. Its average shareholder equity as of 3Q17 was $938.6 million compared to $1.4 billion as of 3Q16 and $3.9 billion as of 3Q15. A declining equity means a lower denominator in the ROE formula (net income divided by equity), translating to a higher ROE. Key Trends in Matador Resources Return on Equity Matador Resources Next, we ll look at Matador Resources (MTDR) ROE (return on equity). The company reported a positive TTM (trailing 12-month) ROE in every quarter in 2017, as we can see in the graph below. Its TTM ROE in 3Q17 was 28.5%, which is significantly higher than its ROE in 3Q16.

7 In order to study the factors driving MTDR s ROE, we ll look at the DuPont analysis, which breaks down ROE into three primary metrics. By studying these metrics, we can ascertain how MTDR s management is generating value for its shareholders. Net profit margin Over the past 12 months, MTDR s net income was ~$192 million as of 3Q17. That compares to a TTM net loss of $432 million in 3Q16 and a TTM net loss of $403 million in 3Q15. The net profit margin over the past 12 months as of 3Q17 averaged 47% compared to 3Q16 and 3Q15 when the averages were % and -153%, respectively. Asset turnover and leverage MTDR s asset turnover over the past 12 months averaged 0.07 in 3Q17. That compares to a 12- month average of 0.04 in 3Q16 and a 12-month average of 0.06 in 3Q15. MTDR s asset-to-equity or leverage ratio averaged 2.0x over the past 12 months (as of 3Q17). That compares to an average of 2.4x in the TTM to 3Q16 and 1.7x in the TTM to 3Q15. So the increase in MTDR s TTM ROE in 3Q17 was largely the result of improved profit margins and asset turnover, which have improved consistently since 3Q15. Key Factors That Drove Devon Energy s Return on Equity Last Year Devon Energy

8 Our final company in the top five upstream companies by TTM (trailing 12-month) ROE (return on equity) is Devon Energy (DVN). Like Matador Resources (MTDR), Devon also reported a positive TTM ROE in every quarter in Read the previous part to know more about what drove MTDR s ROE last year. We ll conduct a DuPont analysis, which breaks down ROE into three elements, to see what could have driven DVN s ROE. Net profit margin, asset turnover, and leverage are the three key elements. Net profit margin DVN s TTM net income as of 3Q17 was $1.5 billion. That compares to a TTM net income of -$8.1 billion in 3Q16 and a TTM net income of -$10.3 billion in 3Q15. DVN s TTM revenue as of 3Q17 was $12.7 billion compared to 3Q16 and 3Q15 at $10.3 billion and $16.2 billion, respectively. In 3Q17, DVN s net profit margin over the past 12 months averaged 12% compared to 3Q16 and 3Q15 at -82% and -74%, respectively. Asset turnover DVN s asset turnover has averaged 0.12 over the past 12 months (as of 3Q17), whereas the comparative period average in 3Q16 and 3Q15 was 0.09 for both periods. An increase in asset turnover means that a company s management has become increasingly efficient in driving sales or revenue from the company s assets.

9 Leverage DVN s leverage ratio averaged 2.4 over the past 12 months (as of 3Q17). That compares to an average of 2.7 over the TTM to 3Q16 and an average of 1.97 in the TTM to 3Q15. So the key elements driving DVN s ROE were net profit margins and asset turnover, which have both risen over the past two years. DVN s average shareholder equity has declined significantly over the past two years, falling from $34.3 billion as of 3Q15 to $16.3 billion as of 3Q17, which also explains the growth in ROE since 3Q15. How Our Top 5 Upstream Stocks Performed in 2017 Stock performances In this part of the series, we ll look at the YTD (year-to-date) stock performances of the top five upstream companies by TTM (trailing 12-month) ROE (return on equity) that we ve been looking at in this series. The five companies are C arrizo Oil & Gas (C RZO), Laredo P etroleum (LP I), Newfield Exploration (NFX), Matador Resources (MTDR), and Devon Energy (DVN). We ll compare their performances to the broader energy sector ETF, the Energy Select Sector SP DR ETF (XLE), as well as to the broader market S& P 500 SPDR ETF (SPY) (SPX-INDEX). Highest returns The above graph shows that Matador Resources has had the highest returns since January It s the highest ROE upstream player at almost 18%. Devon Energy s return in the same period was -10%.

10 Newfield Exploration and Laredo P etroleum had similar returns in the same period of -22% and -28%, respectively. The bottom-performing stock in terms of year-to-date returns was C arrizo Oil & Gas, which has had a return of -40% since January As a benchmark, the Energy Select Sector SPDR ETF (XLE) has returned -1% since January The S& P 500 SPDR ETF (SPY) has returned ~18% since the beginning of 2017, while crude oil prices (USO) (UCO) returned 16% in the same period. Next, let s take a look at analysts recommendations for these companies. Analysts' Views on Top 5 Upstream Return on Equity Stocks Analyst recommendations Let s now turn to Wall Street analysts targets for the top five upstream companies by TTM (trailing 12-month) ROE (return on equity). Those companies are C arrizo Oil & Gas (C RZO), Laredo P etroleum (LP I), Newfield Exploration (NFX), Matador Resources (MTDR), and Devon Energy (DVN). They all have TTM ROEs above 20%. To know more, be sure to read Part 1 of this series. Consensus recommendations

11 Matador Resources has the highest buy recommendations, with 74% of analysts giving it that rating. It s followed by Devon Energy and Newfield Exploration, with 72% and 71% of the analysts, respectively, giving it that rating. MTDR s analyst target price implies a return of -4%, whereas DVN s and Newfield s average target prices imply returns of 5.5% and 10.5%, respectively, over the next 12 months. Laredo Petroleum has the most hold ratings, with 48% of the analysts giving it that rating. The implied returns based on average target prices for CRZO and LPI are 17.5% and 24% (the highest in the peer group), respectively. Recent upgrades and downgrades On December 12, 2017, Seaport Global upgraded Devon Energy from neutral to buy. On December 19, 2017, it upgraded Carrizo Oil & Gas from sell to buy. On December 19, Seaport Global upgraded Newfield Exploration from sell to neutral. On December 15, JP Morgan downgraded Newfield from overweight to neutral. Implied Volatility of Top 5 Return on Equity Upstream Stocks Implied volatility On January 3, 2018, C arrizo Oil & Gas (C RZO), Laredo P etroleum (LP I), Newfield Exploration (NFX), Matador Resources (MTDR), and Devon Energy (DVN) had implied volatilities of 54%, 47%, 34%, 32%, and 29%, respectively. These upstream stocks are in the top-five category when scaled by a TTM (trailing 12-month) ROE (return on equity). Using implied volatility to forecast stock price ranges If we take the implied volatilities of the above companies and assume a normal distribution of stock prices with a standard deviation of one, their stocks will likely close in the following ranges with a probability of 68.2% over the next seven days:

12 Carrizo Oil & Gas (CRZO): $25.28 $29.38 Laredo P etroleum (LP I): $12.89 $14.71 Newfield Exploration (NFX): $34.84 $38.30 Matador Resources (MTDR): $29.24 $31.92 Devon Energy (DVN): $43.28 $46.86 Implied volatility is an options-model-based estimate of a stock s future volatility. While it enables a theoretical estimate of a stock s potential moves, the direction can t be forecast. As we can see above, CRZO has the highest implied volatility among its peers, while DVN has the lowest implied volatility. A higher implied volatility means less expectancy of stability in a stock and that investors expect the stock to move significantly in either direction, meaning higher implied risk. In the next and final part of this series, we ll look at short interest trends for these companies. Short Interest Trends for Top 5 Upstream Return on Equity Stocks Short interest trends In this final part of our series, we ll compare the short interest trends of the top five upstream stocks by TTM (trailing 12-month) ROE (return on equity). Short interest is an important indicator of investor sentiment in stocks. Short interest as a percent of float, or short interest, in Carrizo Oil & Gas (CRZO) stock was the highest. As of January 3, 2018, short interest in CRZO stock was 22.7%.

13 As we can In the above chart, we can see that short interest in CRZO has risen significantly since the end of 1Q17 when its short interest ratio was 16.4%. Increasing short interest indicates an increasing bearish sentiment for a stock. Short interest in CRZO fell from 23% at the end of 2Q17. That means that at least some investors no longer see a downside and have cut their negative bets on the stock. Short interest ratios in Laredo P etroleum (LP I), Newfield Exploration (NFX), Matador Resources (MTDR), and Devon Energy (DVN) as of January 3, 2018, were 15%, 4%, 13%, and 2.4%, respectively. As we can see, short interest ratios have increased since 1Q17 except for NFX and MTDR, whose short interest ratios have declined. That shows a mix of bullish and bearish sentiments for these stocks.