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How do you play oil reserves after the Chevron-Anadarko deal?

To buy in motion
Anadarko Petroleum

for $ 33 billion
Chevron

made a wise decision – and yet was punished by Wall Street.

His shares closed nearly 5% on Friday. And for Chevron (ticker: CVX) there is a good chance that investors will continue to avoid the stock, at least in the short term.

The deal, however, gives new impetus to other companies whose shares have been inactive for months, even though the price of crude has risen.

Drills operating on oil-rich land and offshore operations are now able to outperform. That includes big US names like
Diamondback Energy

(CATCH),
Concho Resources

(CXO) and
Noble energy

(NBL). Of these, we are most optimistic about Diamondback, whose valuable land in the fast-growing Permian Basin and intelligent capital management should appeal to investors and possibly a purchaser.

Chevron acquires Anadarko (APC), a global oil and gas producer, for $ 65 a share, a 39% premium over Thursday's closing price. The deal estimates Anadarko's equity at $ 33 billion and $ 50 billion at enterprise value, respectively. Chevron pays 75% of the storage costs and 25% in cash.

The logic of the deal makes sense. This 39% premium may seem relatively steep, but Anadarko did not make more than $ 70 in October. With the purchase of Anadarko, Chevron will increase its daily output to nearly 3.6 million barrels
Exxon Mobile
'S
(XOM) 3.8 million barrels. Anadarko's oil reserves are located in areas where Chevron has already gained a foothold and will allow the company to scale in critical areas.

The deal makes Chevron the second largest player after Concho in the Permian Basin, which according to IHS Markit is the country's most productive oil field. Chevron now controls a 75 km wide land mass in the heart of the basin.

"They think of driving 70 miles an hour for an hour, and you're on our plane all the time," says Chevron CEO Michael Wirth Barron's, "This acreage sits layer by layer by layer of this slate. And we are currently recovering only 10% of the hydrocarbons. "

Anadarko also holds valuable assets in the Gulf of Mexico. A promising natural gas development that controls Anadarko in Mozambique will help Chevron invest more in natural gas and much lower capital costs.

But energy investors currently have little patience for acquisitions. Large oil reserves are regarded as steady income investments, not growth engines, and are valued on the basis of their cash flow.

Chevron has a dividend yield of 4%, and it has received many honors because it has limited spending and has not been used for mega deals. This discipline has caused the stock to rise 16% on Thursday. The last thing Wall Street demands is that the company spend money that could go back to shareholders. However, Chevron will partially fund the acquisition by issuing 200 million shares and assuming net debt of $ 15 billion.

So why, when investors clearly want the opposite?

CEO Wirth argues that the deal will increase the company's annual cash flow so that more shares can be repurchased in the future – $ 5 billion a year instead of $ 4 billion.

"We're issuing stocks that we bought back at about $ 100 a share over the last decade and spend them as a currency at a much higher price. We take advantage of that, "he says.

"As a result of this transaction, we will have the opportunity to make further distributions to shareholders, and we will have the ability to sustain them through the up and down of the commodity price cycle."

Despite the promised return on investment, investors may not be able to reward chevron in the short term. If anything, people who like the chevron deal could be better off buying Anadarko. It rose 32% from the deal announcement but was still trading below the deal price at $ 61.78.

Owners of Anadarko will own approximately 9% of Chevron at closing of the deal. And there is still the chance that another buyer can bid higher.

The potential for further business is an opportunity for investors.

Other oil companies may pressure to keep up with Chevron. And even if other deals do not materialize, market chatter about acquisitions tends to keep stocks in the industry for months, says David Heikkinen, CEO of Heikkinen Energy Advisors.

Other stocks considered as potential acquisition targets rose Friday, including Concho, Diamondback and Noble. But even after a gain of more than 6% each, they still look cheap.

This is because investors have shunned the sector despite rising oil prices over the past three months. The
SPDR S & P exploration and production of oil and gas

The Exchange Traded Fund (XOP) rose 6.8%, despite the West Texas benchmark rising 24% to $ 63.89 a barrel.

Oil analysts say that investors do not trust that drills are smart, how they use their money, and that they want to generate more cash flow. Heikkinen agrees that investors are rightly cautious about this cyclical industry.

Nevertheless, the three US companies we have identified are in a good position. Concho is the largest producer in the Permian area and has "dramatically underperformed" the market after buying a company called RSP Permian last year. Noble is attractive because the offshore gas field project Leviathan will help the company achieve a positive cash flow by 2020.

And Diamondback was one of the smartest companies to keep its spending balanced while accumulating important oil and gas interests. It has the fifth largest production in the Perm, a value that other companies will clearly pay.

"Diamondback has a lower risk [of overspending] In the first half of the year check the box as a takeout candidate, has minerals and midstream assets and is also a significant size – a company worth $ 20 billion is important for companies, "says Heikkinen.

Diamondback is also cheaper. The company generated an estimated gain of 6.9 times 2019 before interest, taxes, depreciation and amortization, compared to 7.2 times Noble and 8.2 times Concho. Chevron is rated 6.2.

The Anadarko deal could take a while to help the Chevron share. But it gave the oil drills a jolt, and that could take time.

"I think they will close part of the valuation gap [of the drillers]"Says Heikkinen. "There will be a thesis for at least a few months [other big oil companies] I'm scared to miss. "

Write to Avi Salzman at avi.salzman@barrons.com

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