Zak Mir’s Monthly Pick – Buy BG Group (BG.): Above 825p Targets 1120p

Recommendation Summary

BG Group has gone from being a part of nationalised British Gas, to being an international oil & gas player – one that is approaching the top tier. However, it has been evident over the past couple of years that the journey has become somewhat rocky – a position not helped by the plunge in the oil price in the latter part of 2014.

Nevertheless, it would appear that all the conventional bad news may be in the price, especially as the stock was slammed hard even before fuel prices fell. The key here is likely to be what comes on stream for the rest of 2015, a potential recovery in crude oil, and the massive promise of what the group is sitting on in Brazil.

While it may be that the perennial talk that the company is a bid play is a little too far-fetched, this talk does underline the way that resources-hungry China, or one of BG Group’s largest competitors, may eventually decide it is easier to take the group over for strategic interests, as much as anything else.

Technicals

Although it may be somewhat ambitious to suggest that the post December price action on the daily chart of BG Group consists of a triple bottom formation, this is the closest approximation to what we have seen over the past few months. Perhaps it is fair to say that the key feature from the autumn comes in the form of the November gap to the downside, a feature which was filled in February. In the near term, with regard to what is still dominating this situation we have the pressure of the 200 day moving average of £10.47.
However, the higher low from March and the unfilled gap to the upside of the latest support for the shares do suggest that we should be treated to at least an intermediate rally here. The favoured destination while there is no end of day close back below the March gap floor at £8.28 is as high as the top of a rising trend channel from October with its resistance line projection currently heading towards £11.20.

At this stage only cautious traders would wait on an end of day close back above the 50 day moving average of 907p before taking the plunge on the upside. This is especially the case given the way that the decline we have seen from the beginning of last year has all the hallmarks of an extended top and a negative re-rating.

Both of these factors will be difficult to shake off easily, something we are seeing clearly now via the obvious struggle between the bulls and the bears, and the way that it may yet require another test for support towards 800p before any recovery finally takes off.

Recent Significant News

22nd March – Reuters:

Britain’s BG Group and Australia’s Woodside Petroleum Ltd (WPL.AX) will invest up to $1.08 billion (£0.72 billion) to explore for oil and gas in four blocks off the coast of Myanmar’s western Rakhine state. The two firms were the winners of two shallow water blocks and two deepwater blocks in the country’s auction last year.

17th March – Morningstar:

We are changing our fair value estimate for BG Group to £12 per share from £14 after reducing our mid-cycle price estimates for oil and natural gas. Our valuation methodology incorporates three years of strip prices, with terminal prices defined by these longer-term forecasts. We currently believe the appropriate mid-cycle prices for oil and natural gas are $75/barrel Brent, $69/barrel West Texas Intermediate, and $4 per thousand cubic feet Henry Hub.

Our new fair value estimate also includes reduced capital costs and operating expenses, based on our expectation for falling oil-service fees.

3rd February – The Guardian:

The energy company BG Group has become the latest corporate casualty of the oil price slump, writing down the value of its assets by £6bn and sharply cutting back on spending plans. The company said it was taking the hit after oil prices – down by half since last summer – fell more steeply than it had expected.

BG said it would cut investment by almost a third this year to between £4bn and £4.7bn, after the lower oil price contributed to a £1.5bn pretax loss in 2014. “Planned capital expenditure on a cash basis in 2015 is expected to be significantly lower than 2014, as projects complete and the group reacts to a lower oil price environment,” BG said.

10th December – BBC News:

BG Group has sold its Australian gas pipeline network to APA Group for $5bn (£3.2bn). The 543km pipeline links BG gas fields in Queensland to a liquefied natural gas (LNG) export facility at Gladstone on Australia’s east coast.
BG Group said the sale of its Australian subsidiary was conditional on the start of LNG deliveries from Gladstone. The firm expects to make a post-tax profit of $2.7bn on the deal.

BG Group said it was reviewing its gas flow rates, long-term price assumptions and business plans in the light of movements in oil prices, which have slumped in recent months. The deal is expected to be completed in the first half of 2015.

Fundamentals

BG Group currently provides a fascinating education for us all on a fundamental front, from many angles. The most obvious one is that it is a play on the price of crude oil, with its shares tracking the halving of the underlying commodity. The other factors involved are that this company was already on the back foot relative to its peers, with heads rolling on the management front, as well as storms in teacups regarding executive remuneration.

All of this might suggest to some that the company should be avoided for an extended period unless or until there is a clear reason to get back into the fray. However, if there is one message which we should all be aware of in terms of the stock market, it is not only that bells are not rung at the top and the bottom of a move; it is also that the market tends to overshoot on both the downside and the upside.

In the case of BG Group, this is likely to be more so than most given the way that the stock has been hit by production warnings and various other negative events since the autumn of 2012. This would imply that the de-rating in the company’s value has been in place for nearly two and a half years, with the result that the worst case scenario – i.e. the plunge in the value of crude oil and associated hydrocarbons – will have been factored in.

But we can go into more specific detail than this. For instance, the expectation from most analysts in the know is that the oil price will not remain below $50 for long, if only because at these levels new exploration projects are being abandoned and this will impact on supply. For BG Group itself, March witnessed the first production from the Knarr Field in Norway which holds 80 million barrels in reserves. Later this year there will be the contribution from Queensland Curtis LNG (QCLNG) in Australia, with of course the biggest prize being the position in Brazil. Here the initial 3 billion barrels in reserves were upgraded to as much as 6 billion, all of which appear to be relatively easily recoverable.

But perhaps the best aspect of beaten down BG Group is the way that the bitter pills of writing down the values of reserves with the oil price and cutting the exploration programme have already been swallowed in February. That should have been the fundamental selling climax, and may explain why sentiment and share price have been improving ever since.