Oil stocks lack energy
Oil prices and energy stocks have charted similar paths over the last 14 years. Movements in oil prices and energy stocks may diverge in the short run, but time tends to bring them together.
Crude oil fell to $69.85 a barrel in October, the lowest point since August 2007 and well below the all-time high of $145.31 in July. The S&P 1500 Energy Sector Index, a capitalization-weighted index heavily affected by the movements of giant integrated oil stocks, has plunged 42% from June highs. Yet both oil prices and the Energy Sector Index remain well above historical norms.
Solid global economic growth, paced by China and other emerging countries, has helped sustain a six-year rally in oil prices. Not surprisingly, energy stocks shared in this run-up. Even after sharp declines over the last three months, per-barrel oil prices remain well above the $26 to $30 seen in October 2002. The Energy Sector Index is 121% higher than levels seen six years ago, more than double the gains of any other sector index.
News isn’t all bad
In recent years, investors have plowed capital into energy stocks. Much of the recent sell-off reflects investors taking profits and moving that money into investments perceived as safer. As a result, the entire sector looks cheap. The S&P 1500 Energy Sector Index trades at just eight times trailing earnings, well below the five-year average of 13 and the 10-year average of 18.
Recession fears have lowered expectations for global fuel usage, contributing to declining oil prices. China, the world’s second-largest energy consumer, cut gasoline and diesel imports in October, hoping to burn through a fairly large stockpile. In the four weeks ended Oct. 10, U.S. gasoline demand fell 4.8% from year-ago levels. Both businesses and individuals are cutting back, even as gasoline prices dip below $3.00 a gallon in many parts of the country.
China, India, and other developing nations have grown rapidly in recent years, and while growth is slowing, it is not stopping. Barring a catastrophic global recession, which we consider unlikely, demand for oil and gasoline should rise over the next several years.
While some pundits are warning that oil could fall to $50 a barrel if the financial crisis worsens, most analysts are more bullish. A consensus of the most recent Wall Street estimates projects per-barrel oil prices will top $95 in all four quarters in 2009.
The bullish case
• An emergency meeting of OPEC was scheduled for Oct. 24. Comments from leaders of several oil-producing companies suggest that OPEC hopes to keep oil prices above $80 per barrel. Oil prices have slumped despite news of the OPEC meeting.
• The Energy Information Administration expects upward pressure on prices, with the world’s economies consuming nearly 800,000 more barrels of oil a day in 2009. U.S. producers should soon pick up their pace to help satisfy that demand.
• If per-barrel oil prices stabilize at $80 or higher, drilling should remain profitable. That’s good news for the Forecasts’ top energy picks, which provide drilling services and supplies. The profits of oilfield-services stocks are not directly affected by oil prices, and we hope to see strong share-price bounces over the next few months.
• The average energy stock in the S&P 1500 Index earns a Quadrix® Overall score of 76 and a Value score of 73. Energy stocks trade at a steep discount to historical norms, suggesting expectations of a slowdown are already reflected in share prices.
Four of our favorite energy-related stocks are reviewed in the following paragraphs.
Exxon Mobil’s ($72; NYSE: XOM) portfolio features assets all over the globe. Many are in emerging markets, with 33% of the company’s refining capacity and at least 35% of gasoline stations located outside of Europe and North America.
At eight times projected year-ahead earnings, the stock trades near the low end of its five-year forward P/E ratio range. Consensus estimates project per-share-profit growth of 23% in 2008 but a 4% decline in 2009. Exxon is scheduled to release quarterly results Oct. 30.
At the end of June, Exxon held $38.97 billion, or $7.40 per share, in cash — enough to cover capital expenditures and dividends for the next four quarters while still funding stock buybacks. Exxon repurchased $17.93 billion in shares in the first half of 2008, lowering the share count by 3.5%. At current prices, we expect Exxon to keep buying aggressively. Exxon is a Long-Term Buy.
Oceaneering International ($29; NYSE: OII) stands to profit from the damage caused by hurricanes Gustav and Ike, as demand for inspections tends to rise after big storms. Oceaneering’s service segment could also help the company deal with the economic dowturn, as spending on repairs and maintenance tends to remain fairly steady. Consensus estimates project per-share-profit growth of 11% this year and 18% in 2009. At seven times the 2009 estimate, Oceaneering shares look unduly cheap.
Oceaneering differentiates itself from its peers through the quality of its service personnel. Each year, Oceaneering places 600 people in its training program, which is regarded as one of the industry’s best.
Drillers’ operating costs have risen sharply in recent years, and energy producers are seeking ways to improve efficiency. With rig-rental costs approaching $1 million dollars a day, delays can cripple the bottom line. Oceaneering’s extensive global network allows the company to respond quickly to problems and save companies money, a sustainable competitive advantage. Oceaneering, expected to announce September-quarter profits Oct. 30, is a Focus List Buy.
Schlumberger ($54; NYSE: SLB) issued mixed guidance in October. September-quarter earnings rose 15%, in line with consensus estimates, on 22% revenue growth. The company said tight credit markets and economic weakness were likely to slow customer spending in 2009. However, Schlumberger also said that a combination of low global oil supplies and aging production assets for many of the world’s largest producers would support a rapid recovery from any reduction in exploration spending.
Regardless of whether overall demand for energy slows, Schlumberger expects to grow faster than the rest of the industry over the next five years. The company has gained market share in four of its six largest segments this year, a trend likely to continue because Schlumberger has a knack for coming up with new technology. The company’s Q devices for monitoring reservoirs are becoming more popular and now account for about 40% of total revenue. Petrel software, which improves drilling accuracy, is now used by four of the world’s five largest integrated oil companies and nine of the 10 largest national oil companies. Schlumberger is a Long-Term Buy.
Both the strength of Transocean’s ($79; NYSE: RIG) backlog and the financial health of its customers suggest the contract driller can weather an economic downturn. In August, Transocean’s backlog had ballooned to $40.7 billion, about four times annual revenue. Transocean’s high-specification floating rigs, for example, are booked through this year and have only 3% of contract days in 2009 uncommitted.
The risk of widespread order cancellations appears minimal. More than 70% of Transocean’s oil and gas customers maintain credit ratings of A or higher, and so far, few oil producers have announced plans to cut back on deepwater projects.
In addition to the extensive backlog, strong liquidity should help insulate Transocean from falling oil prices and tighter financing. The company has $1.6 billion available on a $2 billion credit line, as well as another $1.5 billion short-term credit line — sufficient to cover more than a year of operating expenses. Transocean, slated to release September-quarter earnings Nov. 5, is a Focus List Buy and a Long-Term Buy.