Companies in the energy exploration and production space have not fared well over the last year after a prolonged decline in oil and gas prices hurt profitability and cut the outlook for both spending and investment across the industry. One of the companies most impacted by the downshift in energy prices has been Noble Energy (NBL:NYSE) considering its substantial upstream operations. The upcoming earnings report is anticipated to underline the challenges facing the company as it works to cut costs and maintain profitability amid the price slump. Although the company has a strong long-term upside case, there is unlikely to be a solid recovery in the valuation over the near-term unless a sustainable uptrend in energy prices emerges. While maybe not hitting value territory yet, the upcoming earnings report is likely to highlight the efforts Noble is undertaking to reverse shareholder losses.

Well Recovery Improving and Costs Falling

After a difficult year in 2015, Noble Energy is still under pressure to perform considering the backdrop for the energy sector on the whole.  The 9.66% rebound in the shares year-to-date may be looked upon favorably by analysts, however, remains overshadowed by the disappointing 1-year performance of -26.89%. The real progress for Noble Energy cannot be seen on the top and bottom line of the income statement, but rather manifests itself in the way the company is gradually improving efficiency and recovery rates. During the fourth quarter, Noble was able to cut costs by -22.00% compared to the same quarter a year prior, with total operating costs per barrel of oil equivalent (boe) falling to $6.93.During the same period, approximately 422,000 boe/day were sold, emphasizing the progress being made towards growing production.

First quarter results are unlikely to match the fourth quarter gains owing to project downtime, however, the company is projecting production of 390,000 boe/day for the whole of 2016, representing a 10.00% gain over 2015 results. The sustained focus on cost minimization has seen the company shave capital outlays while raising production levels, a truly remarkable feat considering the current price landscape in the in energy environment. Capital expenditures are expected to number $1.50 billion in 2016 according to current management projections, down from the $2.98 billion spent for fiscal 2015. Aside from helping margins, reduced capital expenditures also enables the company to maintain cash levels at $1.61 billion which can be deployed to other strategic acquisitions within the exploration and production space. While unlikely to translate to near-term value for shareholders, these moves do create longer-term value.

Value and Income Investors Beware

Many sell-side analysts are shifting gears at this point, stressing the compelling value available in upstream firms now that market sentiment is on the side of energy prices having bottomed. However, much of the conditions that drove prices lower over the last year and a half remain intact. The persistent level of oversupply will continue to weigh on prices going forward, especially as storage levels reach capacity.If oil and gas prices start to tumble again, Noble Energy share prices will undoubtedly reflect these developments. Furthermore, current prices for shares do not necessarily represent value, especially if the company cannot reverse the top and bottom line destruction of fiscal 2015 during which revenues fell by -38.29% while net income slumped by -301.07%.  Real value could have been harnessed when shares were trending at 52-week lows of $23.77 which was below tangible book value of $24.18 per share.

Aside from the recently announced dividend of $0.10 per share, income investors should not feel pressed to chase after yield at these levels either. Although Noble Energy has been consistent in its ability to deliver shareholder returns in the form of dividends, this latest dividend marks the first time in the company’s history it has actually slashed the value of the dividend instead of either maintaining or growing the figure. Until the company can return free cash flow to positive territory, income investors would be wise to wait for an entry point that ensures dividend gains are sustainable and the company will once again be able to grow its disbursements. While rising production and falling costs may help meet this end, the outlook for cash flow will be highly dependent on how prices behave over the medium-term.

Earnings Expectations

In spite of the company embarking on a campaign to rein in costs and cut investment, analysts have continued to lower their earnings estimates for Noble, declining from -$0.31 per share just three months ago to the current expectations of -$0.58.  Although shares are rapidly approaching the average price target of the 37 analysts tracked by the Wall Street Journal of $38.13, the overweight rating of the consensus is in indirect conflict with the fundamental picture.The thesis is largely underpinned by the prospect of recovery in energy prices over the medium-term, conditions that may not materialize.While rising production and falling costs could help improve the outlook, weakness in the upcoming earnings announcement may not necessarily be “baked-in” to current prices.Earnings per share that match or miss expectations are likely to send shares reeling once more.

Longer-term, there is a lot of value Noble Energy shares thanks to its emphasis on growing production and reducing total costs per barrel of energy extracted.The high degree of exposure to upstream operations means that any recovery in energy prices will translate to exceptional value for shareholders.Yet, for this value to be realized, not only must energy prices rebound further from current levels, the ongoing supply imbalance must be fixed to ensure the durability of Noble Energy’s outlook.