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M&A Predictor 2018: Energy, Chemicals and Basic Materials

M&A Predictor 2018: Energy, Chemicals & Basic Materials

After some slower years in the sector, things are looking up in energy and natural resources, but the billion-dollar plus transactions will still be few and far between.

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Australian outlook – Energy, Chemicals and Basic Materials

Both domestically and globally, the trend for Mergers & Acquisitions (M&A) across the energy and resources sector is upwards. The year 2016 was the low point, but in 2017 we saw a lot more transactions in the $50 million-plus space, driven by metals and mining and in particular coal assets rather than oil and gas.

However, there were also several failed transitions in metals and mining, most likely a result of companies testing the market or pricing expectations being above market. We’re starting to see Brent crude oil heading back up towards $80 a barrel, and as a result, activity in that sector will likely follow.

Local look

In the 80s and 90s, a lot of mid-tier-to-large miners and oil and gas companies relied on the junior companies to do their exploration, and to find the new large resources. Following the tech crunch of the late 90s and the GFC in 2007, capital came out of the markets, and the juniors found it hard to finance exploration.

We have therefore experienced a really slow period of activity in exploration and major finds and, as a result, in M&A activity. The mid-tiers and majors have been struggling to increase their reserves and resources, and with mineable reserves depleting, this will become a priority.

However, reflecting that fact, the good news is we are starting to see a lot more money come into the sector, and the mid-caps and the majors taking stakes in juniors and their assets to accelerate and expand exploration programs.

What’s in store for 2018?

We won’t see any major shocks or outliers in 2018. We expect it to be business as usual for the next 12 months and transactions over $1 billion will be limited in number. However, the trend of increasing activity in the hard rock sector is positive, and with oil prices recovering and energy security becoming very important, this will likely be leading to green shoots in oil and gas and energy stocks.

Perhaps a broader but interesting trend is matched transaction arrangements to mitigate interloper risk. Boards and shareholders are trying to be very public and open with their processes, albeit with the caveat that they are always trying to attract the best prices.

Global outlook

We anticipate a mixed but promising year for energy sector M&A transactions in 2018 as the market continues to stabilise and companies increasingly position themselves for greater earnings growth.

According to M&A Predictor data, corporate appetite for M&A deals in the Oil & Gas sector, as measured by forward P/E ratios, is expected to decline by 10 percent in 2018 versus 2017, while appetite for M&A deals in the Utilities sector is expected to rise by 2 percent in 2018. The capacity of corporates to fund M&A growth is expected to rise by 11 percent for the Oil & Gas sector and 2 percent for the Utilities sector.

"Although they might never get back to the profitability levels of 2014 and earlier, energy companies will continue to realise that they are making money, paying down debt and getting healthier – and are now in a much better position to pursue transactions. The gap between the bid and the ask in the oil and gas markets could fully close in 2018, prompting the beginning of an increase in deal activity," says Henry Berling, KPMG in the United States.

Source: Dealogic, KPMG analysis

We see this playing out in Q1 2018 as deal value rose about 11 percent to US$184 billion, despite an 18 percent drop in deal volume to 484. The average size of deals in Q1 2018 (US$380 million) is now the highest in 10 years by a significant margin.

The 2018 renewables market continues to be attractive and promising, says Manuel Santillana, Global ENR Deal Advisory Lead. "We expect activity to continue moving toward clean energy businesses over the next year or two – the trend toward cleaner generation sources is happening and will continue. Specifically, Southeast Asia, China and India will continue their healthy growth into renewable energies and transactions."

"The Utilities environment, however, looks more complicated and challenging," Henry adds. "The market has shifted and we're entering an environment that's very short-term. The market is adjusting to an economic model that supports buying long-term assets with less contract coverage compared to previous years. The Utilities sector side of things will likely be fairly flat and somewhat opportunistic as people work through that market shift.'

For additional insights into renewable energy deal trends for 2018 read KPMG's report Great expectations: Deal making in the renewable energy sector.

Reviewing 2017

The oil and gas market 'hit a floor' in 2017, Henry notes, indicating a return to market stability and profitability and a drive for earnings growth. "We've gone from a 'sky is falling' perspective to a new comfort level now that things have stabilised. Energy businesses are beginning to drive for earnings growth and there is no shortage of available funding in oil and gas, particularly the services side. Companies are willing to re-enter the market, including a big push internationally to invest in North America."

Deal activity for 2017 in the Energy sector was flat at 2,311 deals while deal value in 2017 was down 16 percent at US$530 billion versus US$631 billion for 2016. Average deal size for 2017 was US$229 million, off about 15 percent from US$273 million for 2016. The M&A Predictor's outlook was for the Oil & Gas sector's corporate appetite to rise 16 percent and the capacity to transact to rise 23 percent and, in the Utilities sector, for corporate appetite to rise 6 percent and the capacity to transact to decline by about 3 percent.

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