Excellent post and data charts, Arjun, though you lost me when you mentioned the Yankees in the World Series… A natural follow-up question is: what kind of CFPS growth makes the most sense for companies in the sector going forward? There’s price growth, which benefit most players, but then there’s also more targeted margin expansion, or even production growth, when market conditions support it. And what about U.S. Independents? Could they unlock additional value by integrating further into the value chain, especially within the evolving energy landscape? This could be particularly compelling, as it could reshape business models and create greater differentiation between companies?
Ricardo, if you think of 3% real GDP grrowh and 3% inlation, a growth in exces of that per share for large companies coupled with mid-teens structural ROCE and resulting FCF to repurchase shares can likely yield sustained outperformance. Smaller companies inherrently exist to exploit a niche opportunity so should be able to generate faster per share growth for the duration the opportunity exists. In terms of how to achieve that growth, I don't think there is a generic answer as it can be a mix of M&A, organic, and buybacks. And for sure, integrating in some capacity might make sense for some companies.
It's the key point you are making: the O&G business generates about 10% ROCE in the long run (meaning through multiple cycles), however the top quartile of management is able to consistently outperform the 10% ROCE. Did this thesis come from many observations of companies over time, and you saw that some management teams were empirically able to deliver in the long run?
I'm asking because as an investor I have taken the approach that management does matter, but not nearly as much as the structure of the industry (returns = ~20% management/~80% industry structure to my way of thinking), so it's best to find a business with a great structure (enduring competitive advantages through various barriers) and so-so management than a poor structure (hard competition, few barriers) with fantastic management. However in the O&G business I believe you are saying that select management teams HAVE been able to overcome the fundamental 10% ROCE limit that the O&G business imposes via industry structure, which seems somewhat at odds to what I've experienced. Very curious about your views on this.
Yes, my weighting would be 80% management / 20% industry structure. There is a wide dispersion between top and bottom quartile companies across time. It is indeed possible for a company to generate structurally superior profitabilty over many, many decades, somethign we have seen from ExxonMobil (and its predecessors) and Shell, really from 1910-2010.
Over the short-term (<2 years), the sector indeed moves somewhat as a group driven by commodity prices. But that is not the case over the long run.
Excellent post and data charts, Arjun, though you lost me when you mentioned the Yankees in the World Series… A natural follow-up question is: what kind of CFPS growth makes the most sense for companies in the sector going forward? There’s price growth, which benefit most players, but then there’s also more targeted margin expansion, or even production growth, when market conditions support it. And what about U.S. Independents? Could they unlock additional value by integrating further into the value chain, especially within the evolving energy landscape? This could be particularly compelling, as it could reshape business models and create greater differentiation between companies?
P.S. Maynard is lucky to have you!
Ricardo, if you think of 3% real GDP grrowh and 3% inlation, a growth in exces of that per share for large companies coupled with mid-teens structural ROCE and resulting FCF to repurchase shares can likely yield sustained outperformance. Smaller companies inherrently exist to exploit a niche opportunity so should be able to generate faster per share growth for the duration the opportunity exists. In terms of how to achieve that growth, I don't think there is a generic answer as it can be a mix of M&A, organic, and buybacks. And for sure, integrating in some capacity might make sense for some companies.
Hello Arjun,
It's the key point you are making: the O&G business generates about 10% ROCE in the long run (meaning through multiple cycles), however the top quartile of management is able to consistently outperform the 10% ROCE. Did this thesis come from many observations of companies over time, and you saw that some management teams were empirically able to deliver in the long run?
I'm asking because as an investor I have taken the approach that management does matter, but not nearly as much as the structure of the industry (returns = ~20% management/~80% industry structure to my way of thinking), so it's best to find a business with a great structure (enduring competitive advantages through various barriers) and so-so management than a poor structure (hard competition, few barriers) with fantastic management. However in the O&G business I believe you are saying that select management teams HAVE been able to overcome the fundamental 10% ROCE limit that the O&G business imposes via industry structure, which seems somewhat at odds to what I've experienced. Very curious about your views on this.
Hi Investor,
Yes, my weighting would be 80% management / 20% industry structure. There is a wide dispersion between top and bottom quartile companies across time. It is indeed possible for a company to generate structurally superior profitabilty over many, many decades, somethign we have seen from ExxonMobil (and its predecessors) and Shell, really from 1910-2010.
Over the short-term (<2 years), the sector indeed moves somewhat as a group driven by commodity prices. But that is not the case over the long run.
That's very interesting, thank you. I thought you would weight management more heavily, but 80% was more than I expected.