The ugly budget fight and the fallout from the lack of a meaningful debt reduction plan once again took a heavy toll on the markets last week. The energy sector SPDR Fund (XLE) plunged down 10.9% last week, on the back of a 4.1% drop the prior week, and it was down an additional 8.5% on Monday. Of the approximately 350 stocks in the energy sector, 33 stocks trading above $1 at closing on Friday, August 5th, went down more than 20% during the week and none went up more than 20% during the week (see Table). The fall in the energy sector index mirrored the overall weakness in the broader markets as the indices plunged 7%-8% last week on the back of a 4% dive the prior week, and they fell an additional 6.6% on Monday. This article covers our analysis of the top movers in the energy sector last week:
Oil and Gas Exploration and Production Companies such as Sandridge Energy Inc. (SD), Hyperdynamics Corp. (HDY), Abraxas Petroleum Corp. (AXAS), ATP Oil & Gas (ATPG), Magnum Hunter Resources (MHR), and GMX Resources Inc. (GMXR): The entire oil and gas exploration group swooned down last week, and on Monday. SD, engaged in the exploration and production of crude oil and natural gas, was among the biggest movers in this group, suffering a crippling 32.4% loss last week, followed up by an additional 15.9% drop on Monday. Others, such as GMXR, engaged in the exploration and production of oil and natural gas in east Texas, suffered similar declines, losing 30.9% last week and an additional 15.9% loss on Monday; HDY, engaged in the exploration of oil and gas in the offshore coast of the Republic of Guinea in West Africa, dropped 26.4% last week and another 16.9% on Monday; ATPG, engaged in oil and natural gas exploration and production in the Gulf of Mexico and the North Sea, lost 26.1% last week, and another 17.7% on Monday; MHR, engaged in the acquisition, exploration and production of oil and natural gas in WV, ND, TX and LA, lost 24.0% last week, and an additional 12.6% on Monday; and finally, AXAS, engaged in the exploration and production of oil and gas primarily in the U.S. and Canada, lost 20.9% last week, and an additional 14.9% on Monday.
Of these, only SD and GMXR had significant recent news. GMXR reported that in its June quarter announced on Thursday morning, that it missed estimates (3c loss versus breakeven) and lowered full year production guidance by 5% to 7%. Similarly, SD announced missing estimates (breakeven versus 2c) in its June quarter report announced on Thursday after the market-close. However, the major reason for the collapse in all of these stocks is the bad news about the economy tied to the European credit crisis and the U.S. budget/deficit woes. If the global economy does indeed go into a double-dip recession due to lack of effective political action in the U.S. and Europe that actually addresses their issues, it will lead to a lowering of the demand for energy. This will have an immediate corrective action in lowering the speculative excess in the oil and natural gas markets, pushing down prices and consequently, the profits and share prices of exploration and production companies. It is this scenario that traders maybe focusing on in pushing down the prices of these exploration and production companies. Forward P/E ratios using old earnings numbers in this case, are meaningless in this dynamic environment when speculation is that commodity prices and hence company earnings could crumble.
The best long-term bets in this scenario would be larger more integrated players such as Chevron Corp. (CVX), Exxon Mobil Corp. (XOM) and ConocoPhillips (COP) that may offer some downside protection, although if you are more risk tolerant, then SD might be a better bet with its diverse oil and natural gas assets and an aggressive drilling program going forward for drilling more wells in the Permian and the horizontal Mississippian.
Oil and gas refining and marketing companies such as Western Refining (WNR) and Alon USA Energy (ALJ): Like the exploration and production group, the oil and gas refining and marketing companies also experienced steep losses last week. WNR lost 27.4% last week, and dropped an additional 11.6% on Monday; and ALJ lost 23.2% last week, and dropped an additional 15.2% on Monday. Both WNR and ALJ reported earnings misses in a bad tape last week, and got severely punished as a result.
WNR, a refiner and marketer of crude oil and refined products in West TX, AZ, NM, UT, CO and the mid-Atlantic region, reported missing earnings (94c versus $1.11), and revenues rose 19.3% to $2.56 billion versus the estimate of $2.16 billion. The improved results for the quarter were due to stronger refining margins, which were primarily the result of the continued price advantage of WTI crude oil as compared to Brent and other water-borne crude oils. WNR after the deep hair-cut last week trades at a forward 4-5 P/E, a steep discount compared to its peers Hollyfrontier Corp. (HFC) that trades at forward 7 P/E, Delek US Holdings (DK) that trades at forward 8-9 P/E, and CVR Energy Inc. (CVI) that trades at forward 6-7 P/E. ALJ, a refiner and marketer of petroleum products primarily in the south central, southwestern and western regions of the U.S., also reported missing earnings (30c versus 32c), while revenues rose 90% year-over-year to $1.6 billion versus the estimate of $1.69 billion. At Monday’s closing price of $9.34, ALJ trades at a forward 5-6 P/E, at a discount to other refining and marketing peers as explained above. Of course, all of the analyst estimates could get revised downwards if oil prices drop amid a double-dip recession, but the conclusions on relative valuation from peer multiple comparisons made above would still hold.
Oil and gas equipment and services companies such as McDermott International (MDR), Flotek Industries Inc. (FTK), ION Geophysical Corp. (IO), Nabors Industries Ltd. (NBR) and Hercules Offshore Inc. (HERO): This group suffered even more severe losses, with MDR dropping 26.5% last week, followed by a 19.8% swoon on Monday; FTK dropped 25.6% last week, and followed up with a 13.0% loss on Monday; IO dropped an astounding 42.4% last week, further adding 13.4% to that loss on Monday; NBR dropping 21.1% last week followed by a 13.3% fall on Monday; and HERO dropping 22.3% last week followed by 14.0% fall on Monday. Of these, MDR reported missing earnings by 5c (27c versus 32c) in its June quarter earnings report announced on Wednesday after market-close, and IO also announced a 2c miss (2c versus 4c) in its June quarter report announced on Tuesday after market-close. Of the three groups of energy companies covered in this article, the equipment and services companies’ maybe the best bet as oil prices would really have to fall very hard for it to have a meaningful impact on the operations of these companies. In other words, we will probably keep drilling for oil unless prices drop to say south of $50 a barrel, a scenario considered highly unlikely at present. As such, we view current prices on equipment and service companies after the steep fall last week as attractive, and would be buyers here, buying in stages to take advantage of any further weakness in price.
Credit: Historical fundamentals including operating metrics and stock ownership information were derived using SEC filings data, I-Metrix® by Edgar Online®, Zacks Investment Research, Thomson Reuters and Briefing.com. The information and data is believed to be accurate, but no guarantees or representations are made.
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Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.