Repsol, SA (OTCQX:REPYY, OTCQX:REPYF) is taking advantage of the recent increase in oil prices. In my opinion, the recent industrial transformation initiated in 2020 works as a catalyst for net income growth. If Repsol continues to accelerate digital initiatives and investments in decarbonized models, free cash flow is likely to increase. Even taking into account political risks and commodity shortages, I think Repsol is undervalued by the market.
Repsol: industrial transformation already contributing to significant growth in net income
Multinational energy and petrochemical company Repsol has global upstream and downstream operations.
I think the company is quite interesting because the management, in 2020-2021, initiated an ambitious strategy to expand its industrial activities as well as to reduce its exposure to carbon fuels:
The president recommended drawing the paths to achieve a decarbonized model in 2050 based on technological neutrality without dogma and guaranteeing that there will be no “shortages” or “unacceptable increases in energy prices”. Source : Antonio Brufau calls for the design of a “realistic” energy mix for a strong Europe.
In this regard, in the last quarterly report, management noted an acquisition of a minority stake in Enerkem, investments in renewable H2 initiatives and the production of biofuel plants.
We could see the results of recent investments in 2022. Industrial turnover increased from 7 billion euros in the first quarter of 2021 to 14 billion euros in 2022. The other business segment also shows growth in revenues, but not as important as the growth in industrial sales.
Finally, in the last quarterly report, Repsol announced more digital tools to develop new relationships with customers and generate more cash. The growth in net income just looks pretty impressive. Look at the details in the images below.
Repsol looks undervalued: it could trade at €31 per share
In my opinion, the further development of digital applications such as Vivit will probably improve the reputation of Repsol. With the price of oil at its highest level in decades, consumers will likely appreciate the digital tools on offer to make more efficient use of energy. More satisfied customers will likely lead to increased sales.
Repsol has launched Vivit, a mobile application for home customers that aims to personalize the relationship with our customers through individualized management of energy consumption, thus providing users with simple tools to help them use the energy of more efficient way. Source: 10-k
Repsol is also investing a significant amount of money in new projects in the United States and in the countries of the OECD. Developed countries are investing in energy storage and alternative energy sources. I therefore believe that Repsol’s initiatives will be reinforced by subsidies or public investments. The acquisition of Hecate Energy Group, LLC, and the creation of the multi-industry consortium SHYNE are good examples:
Acceleration of internationalization in the United States with the acquisition of 100% of Jicarilla 2 and 40% of Hecate Energy Group, LLC, an American company specializing in the development of photovoltaic projects and batteries for energy storage. Hecate Energy Group has a portfolio of over 40 GW of renewable and storage projects under development. Of this number, 16.8 GW relates to advanced photovoltaic projects and 4.3 GW to battery projects. The vast majority of Hecate Energy Group’s assets are located in US electricity markets.
Repsol has created the multi-sector consortium SHYNE with the participation of 30 Spanish companies (Iberia, Talgo, Enagás, Alsa, Bosch, Scania, among others) to promote the use of renewable hydrogen in all transport segments. This objective will be achieved by producing fuels and creating an extensive infrastructure of at least 12 hydrogen plants. The project, which aims to reach an installed capacity of 500 megawatts by 2025 and 2,000 megawatts by 2030, will require an investment of 3.23 billion euros. Source: 10-k
According to the researchers, the global oil and gas EPC market size is expected to grow at a CAGR of 5.4% through 2028. In this scenario, I assumed that this figure was correct.
The global Oil & Gas EPC market size is expected to reach US$252560 million by 2028, from US$173290 million in 2021, at a CAGR of 5.4% during the period 2022-2028. Source: Industry research
I assumed an operating margin close to 11%, which Repsol has reported in the past. In my opinion, my numbers are not far off from the numbers reported by management over the past four years.
Putting all the previous assumptions together, I got 2028 revenue of 65.8 billion euros, 2028 EBIT of 7.2 billion euros and 2028 EBIAT of 5.6 billion euros . It should also be noted that with an EBITDA margin of around 16%, 2028 EBITDA stands at 10 billion euros.
In light of the results reported by Repsol, in my opinion, capex/sales of 7% and working capital/sales of 1% seems conservative.
If we add the D&A and subtract the changes in working capital and investments, the 2028 free cash flow amounts to 3.6 billion euros. I used discount close to 6%-7% like others investment analysts, and an exit multiple of 6x, below the industry median. The results include a net present value of the terminal value of €46 billion.
Adding up the total amount of cash and subtracting debt, I got an implied valuation of almost $31. It is significantly higher than the current market price.
In my opinion, the fact that Repsol is to acquire his own actions is very significant. The board seems to think the stocks are undervalued. In light of this scenario, the Commission would be right.
Commodity supply issues, negotiations with transportation providers or political risks could push the stock price down to $10
Repsol operates in countries where a change of government could lead to changes in taxes and royalties to be paid. It’s a bit risky because we can’t really say when changes in oil and gas regulations may occur. In this scenario, I have assumed certain detrimental changes in certain regions, which could lead to lower free cash flow growth:
Part of Repsol’s activities are carried out in countries subject to social, political or economic instability which could lead to illicit behavior on the part of the Group’s counterparties or to unilateral changes imposed by governments or institutions. Examples here include increases in taxes and royalties payable, production or export limits, forced renegotiations or cancellation of contracts, regulation of product prices, nationalization, eminent domain or seizure of rights. assets, loss of franchises, changes in government policies, changes in business customs. and practices, or delays in payment. Source: 10-k
Repsol could be affected by inflation, wage increases or raw material supply problems. In particular, the company collaborates with third parties who offer infrastructure and transport services. If these third parties decide to negotiate their deals, management could soon experience a decline in free cash flow margin. As a result, the share price may fall:
The Repsol Group is exposed to adverse impacts related to the unavailability or scarcity of market goods and services, fluctuations in prices and costs, as well as interruptions and variations in time and form in the supply of goods or the supply of services, including the supply of raw materials, which may eventually force the interruption of the relevant business activities. In particular, part of the processing, transportation and marketing of crude oil and gas production from Upstream assets is carried out through infrastructure (pipes, processing and purification units or liquefaction terminals) operated by some thirds. Source: 10-k
In my downside scenario, I used sales growth of -30% in 2024 and around 2.5% from 2025 to 2028. If we also assume an EBITDA margin of between 10% and 15%, the 2028 EBITDA amounts to almost 3.35 billion euros.
In this scenario, I thought it reasonable to use an exit multiple of 5.25x, which implied a terminal value NPV of €25 billion.
By adjusting cash and debt, I got implied equity of 14 billion euros and a fair price of 10 euros. The internal rate of return is negative.
Balance sheet: a good amount of cash and new funds from the sale of 25% of its renewable energy business
As of March 31, 2022, Repsol had €5.3 million in cash and an asset/liability ratio close to 1x. Given the current price of oil and the balance sheet, in my opinion, the financial situation appears rather healthy.
In my opinion, Repsol’s total cash position will probably increase as the company has signed an agreement to sell a major asset for 905 million euros. Greater liquidity could lead to an increase in the valuation of the company as more traders see the cash flow increase:
Repsol also has non-current financial liabilities worth €10.9 billion and current financial liabilities of €3.2 billion. If we assume a forecast EBITDA of 10 billion euros, I don’t think the total amount of debt is that much of a concern.
Repsol’s latest quarterly report included significant growth in net profit, and market estimates look quite positive. In my opinion, more investments in industrial transformation and new digital initiatives could bring even more free cash flow than expected. Even taking into account the political risks associated with oil and gas exploration, commodity supply shortages and inflation risks, I see upside potential in the stock price. With the board acquiring its own shares, Repsol appears to be an interesting stock to watch closely.