Earnings for the second quarter are in for most oil and gas companies, and as expected they were dismal. My initial plan for today’s column was to highlight exploration and production (E&P) companies that managed to deliver free cash flow (FCF) despite the dismal conditions. After all, companies that managed to cut costs enough to still eke out positive FCF under these conditions will likely survive this downturn — and then thrive when oil prices inevitably recover. They are also the companies in the best position to buy out attractive but financially strapped rivals on the cheap. 

My plan ran into a little problem though. When I ran the latest screen of financial metrics on oil and gas producers, of the 122 publicly traded companies covered by my screen, only a handful reported positive FCF, and only one — Alabama-based Energen (NYSE: EGN) — achieved both positive FCF and had a net debt to EBITDA ratio of less than 1.0.

So I will focus instead on sampling the Q2 earnings reports.

EOG Resources (NYSE: EOG) is one of the top U.S. shale drillers, but even with aggressive cost-cutting measures second-quarter profits fell to $5.3 million, or 1 cent a share, down from $706.4 million, or $1.29 a share, a year earlier. The company announced that it wouldn’t spend to increase output until market conditions improve. CEO Bill Thomas predicted that U.S. crude production will decline substantially in the second half of the year, adding that the drop won’t become evident until September or October, when more accurate federal data on domestic oil output is released.

ConocoPhillips (NYSE: COP), the largest E&P company in the U.S. after the integrated majors, reported adjusted earnings of 7 cents a share, which beat the consensus estimate but was down 96% year-over-year. The company reported 4% year-over-year production growth from continuing operations and an 11% reduction in operating costs. ConocoPhillips also reduced its  2015 capital spending plan from $11.5 billion to $11 billion.

Devon Energy (NYSE: DVN) reported adjusted earnings of 78 cents per share, beating consensus estimates by 36 cents. The company reported average production of 270,000 barrels per day, a 32% increase since the second quarter of 2014. This was the fourth consecutive quarter in which Devon exceeded oil production expectations. Its U.S. crude output averaged a record 172,000 barrels per day, 32% higher than a year ago. Growth in U.S. production came mostly from the Eagle Ford and Delaware Basin (part of the Permian Basin).

Chesapeake Energy (NYSE: CHK) reported a loss of 11 cents per share, in line with expectations. Production averaged 703,000 barrels of oil equivalent (BOE) per day, an increase of 13% from a year ago. Capital spending dropped 38% year-over-year to $957 million.

Small Bakken producer Oasis Petroleum (NYSE: OAS) was upgraded to a Buy at Wunderlich after beating market expectations for the quarter. The company reported adjusted earnings of 38 cents per share, down from adjusted earnings of 70 cents per share a year ago but 10 cents per share above the analysts’ consensus. Daily production averaged 50,261 BOE per day, a 15% increase over the second quarter of 2014, beating the company’s production guidance for the third straight quarter. President Taylor Reid said Oasis can achieve internal rates of return (IRR) between 20% and 35% on its core acreage with West Texas Intermediate at $50/bbl, and IRRs above 20% at $60/bbl WTI outside the core.

Marcellus gas producer Cabot Oil and Gas (NYSE: COG) reported adjusted second-quarter net income of $14.6 million, or 3 cents per share, compared with $115.3 million, or 28 cents per share, in the second quarter of 2014. Marcellus Shale output rose 7% year-over-year, while Eagle Ford production jumped 74%. Cabot reiterated its plan to increase production volumes by 10% to 18% this year but, echoing EOG, noted that “we do not believe that accelerating activity and allocating incremental capital in this commodity price environment is the appropriate investment decision.”

Integrated oil and gas producers also saw profits decline, but fared much better on the strength of refining operations. ExxonMobil (NYSE: XOM), for example, reported second-quarter earnings of $4.2 billion, down 52% from the $8.8 billion it earned a year ago. But this earnings decline was less drastic than the slump at pure E&P companies, thanks to strong performance from ExxonMobil’s refining and chemicals operations. Global energy production rose modestly year-over-year from 3.84 million BOE/day to 3.98 BOE/day, while capital expenditures fell from $9.8 billion to $8.3 billion.

The third quarter is shaping up as a repeat of Q2, if not slightly worse. But if EOG’s CEO is correct and U.S. production begins to fall significantly during the quarter (which I also believe will happen), crude prices should finally make a substantive move higher.  

(Follow Robert Rapier on Twitter, LinkedIn, or Facebook.)

Portfolio Update

SunEdison’s Melted Wax Wings   

You know the type of wreck that clogs traffic in both directions long after it’s been cleared from the roadway because everyone simply must get a good look at all the twisted metal? Even in a stock market as weak and jittery as this one has been lately, SunEdison’s (NYSE: SUNE) spectacular flameout has turned heads.

The solar project developer’s stock was trading near $32 as recently as July 20, which was when SunEdison announced the acquisition of second-largest U.S. residential solar panels installer Vivint Solar (NYSE: FSLR) for $2.2 billion in cash, stock and convertible debt.

And since then, it’s been pretty much a vertical drop into an abyss, the stock falling below $12 at the lows today before rebounding into positive intraday territory.

We’re hardly disinterested observers after calling SUNE our #4 Best Buy on July 27. And while the panic selling that has ensued has been painful to watch, I think I have a good handle on why it’s taken place and why it provides an excellent buying opportunity rather than the chance to cut your losses.

SunEdison markets yield vehicles that function very much like MLPs, milking them for progressively richer incentive distribution rights just as many MLP general partners do with their affiliates.

It’s an excellent business model when industry growth is brisk and investor demand for current income strong, conditions that persist notwithstanding the recent market action. Solar remains the fastest growing energy source thanks to an unmatched and ongoing decline in production cost. Interest rates remain mired near historic lows, and the hunger for yield is unlikely to abate even if the Federal Reserve raises its target rate to 0.25% sometime this year.

SunEdison’s problem seems to be that, like Icarus, it flew too close to the sun, throwing money at alternative assets left and right in a rush to produce yield inventory that could than be dropped down to its yieldco affiliates. The domestic one spun off last year, TerraForm Power (NASDAQ: TERP) has forecast a 2016 distribution based on the successful completion of the Vivint deal that would be nearly twice its projection barely a year ago.

Rapid growth is all well and good, but yieldco investors understand perfectly well that it disproportionately benefits the sponsor. TERP wilted on news of the Vivint deal before SUNE started to, perhaps because investors view residential installations as a riskier business than the utility-scale projects that have been SunEdison’s bread and butter.

Since SUNE is a leveraged play on the appetite for yield at the affiliated yieldcos, its shareholders began getting spooked in an environment of weak energy prices, apprehensions about a looming rate hike and rising market distaste for the more speculative equities.

The stock picked up a lot of fair-weather friends on its run from $14 in mid-October to this summer’s highs above $32, and many of them didn’t bother to understand SunEdison’s complicated business and accounting.

Among those were the many hedge funds that flocked to the stock, and hedge funds have notoriously itchy trigger fingers when their trades start to go against them. So SUNE got taken out back and shot, no questions asked.

As selling snowballed, the valuation has gone from attractive to dirt-cheap, with SUNE’s project-development business selling for as low as 4 times next year’s earnings (after factoring out the value of stakes in its two yieldcos even at today’s depressed prices.)

This for the leading developer of power projects based on what’s likely to become the lowest-cost energy source in the near future.

The presumed risk is that investors will no longer value yield, permanently crimping SunEdison’s access to project finance. But even after declining 33% over the last month TERP still yields only a little more than 5%. Recently launched global yieldco TerraForm Global (NASDAQ: GLBL) is now offering a prospective yield above 10%, but it will will not remain shunned once current emerging-markets jitters ease a little.

At this point, the rewards of owning SUNE, both short and long-term, dramatically outweigh its considerable risk. Without re-ranking the Best Buys. no other recommendation is currently offering as attractive an entry point. SUNE remains a Buy below $32 in the Aggressive Portfolio.

— Igor Greenwald