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By Julian Murdoch
It's been a rough few weeks to be a stock investor - especially if you don't like volatility. On Friday, General Motors (GM) posted a horrific quarter, posting a $15.5 billion loss. Its stock lost 10% in market value, and is now trading at a 54-year low. Meanwhile Ford (F) announced that sales had plummeted 15% in one month (July). The biggest victim (if there were any doubt) were SUVs, with a 26% drop in sales that gas-guzzling vehicle and pickup trucks.
Even Toyota (TM), one of the best-positioned companies with the strongest presence in the hybrid market, posted a 12% drop in sales. In Toyota's case, the drop can be accounted for almost entirely by SUVs and pickup trucks, with car sales flat. And Toyota still can't make enough Priuses to satisfy the market. It's the Nintendo (NTDOY) Wii of cars.
Now let's look at the other side of the profit spectrum. Exxon (XOM) just reported its best quarter ever, with $11.68 billion in profit. A naive (read, political) interpretation of these two news items would be that some kind of transfer of wealth had happened - high oil prices mean big money for big oil, and layoffs and doom for Detroit.
As noncausal as these two events actually are, there's a certain intellectual purity to the argument - in every commodities story there is a winner and a loser. Higher commodity prices nearly always benefit the producer at the expense of the consumer, and in this case, the consumer's enabler: the car maker.
It's inevitable that these kinds of numbers stir up a kettle of hate. As expected, there's been a barrage of calls for windfall taxes, and some minimal defense of fundamental capitalism. Perhaps more troubling is the consumer sentiment problem. With major news outlets running nonsarcastic headlines like "Should the Oil Industry Make a Profit?" the specter of radical change is out there. Now, I don't honestly think we're in any danger of a nationalized oil industry. After all, companies like Exxon and Mobil are hardly "U.S." companies in any meaningful sense of the word; they're global. But increased scrutiny will put pressure on big oil to explain itself - like a petulant child caught with its hands in cookie jars.
Production Is King
That scrutiny will inevitably focus most sharply on production. Exxon reported that global production was down 8%; most of that from strikes in Nigeria, but down exogenously a few percent as well. One would hope - indeed expect - that the combination of free cash and record high net sales would result in increased exploration and production, which hasn't really happened. Of course, tossing a windfall tax on Exxon and its ilk won't actually do anything to stimulate exploration; if anything, it will suppress exploration over the long term by lowering the marginal return for each dollar invested in getting new oil.
The best case scenario, oddly, might be continued high oil prices. It's only feeling the pain that will spark increased investment not only in exploration, but in alternative energy sources. Of course, in the current political environment, that's not a tenable position. Neither candidate will sing the praises of high oil prices. Neither will come out and defend big oil and tell Detroit to suck it up. If anything, the pressure will be to do exactly the opposite - come to the rescue of the U.S. automotive industry at the expense of big oil. In other words, to effect a classic corporate redistribution of wealth.
That's got us thinking about a possible pairs trade. Going long the beaten-down Autos and short the high-flying Oils might seem to be playing everything in the wrong direction, but that's often the place where the biggest money can be made. Heading into the election, there will be tremendous pressure to help one at the expense of the other, and that could show up in the vectors of the two groups.
If you don't want to (or can't) go short with individual stocks, you can get short oil and gas with the ProShares Short Oil & Gas fund (DDG). You're going to have to get your auto exposure one at a time though - there's no automotive ETF yet.
Of course, that's not a recommendation to make that trade - just an example of the kind of thinking that's worth considering as we move into the political season.
As always, caveat emptor.
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This article has 9 comments:
why does anyone need to ride a 6,000lb steel monster going 12 mpg to stay in traffic jam? it makes no economical sense from consumer point of view, but when the sheeple are being cutured that big is good and sweet is sexy, they just drift with the herd. well, cultured sheep are being sheared as well.
As in housing, the boom in autos was brought about with easy credit. The credit is now gone and people must buy those $40,000 trucks instead of leasing for half the monthly cost of buying.
Add in tight financing for purchasing, plus high fuel costs and the pool of potential buyers shrinks considerably.
This is going to take years to work out. Considering the Big 3 are losing billions of $$$ per month, bankruptcy appears likely before the bottom is reached.
As for the blame game, no one from a major oil company put a gun to the heads of millions of idiots and told them to buy a gas-guzzler. GM and Ford were apparently too short-sighted to understand that oil's a finite resource and that betting their businesses on producing gas-guzzling SUVs was a losing gamble. Are we going to extend the new socialism to business now, punshing success and rewarding failure? I hope not.
Historically speaking, GM and XOM tend to move in the same direction for a number of reasons which anyone of them is too long for a comment.
We do get from time to time several months where one takes the lead while the other catches up and sometimes while one changes direction the other will tread water for several months before following.
See the following weekly close charts for 2008 and compare GM and XOM (or CVX or COP for that matter). Don't forget to compare 2007, 2006 etc. You can go back 5+ years with just one click.
GM www.crossprofit.com/vi...
XOM www.crossprofit.com/vi...
However, the long awaited break in the correlation was always envisioned as the exact opposite to your prognosis!
GM is no longer the GM of yesterday. It is NOT the world's largest manufacturer and for the past decade has slowly, yet steadily, been losing the efficiency and quality battle with Honda and Toyota. Such being the case, GM is likely to decline during an up-tick in the price of gasoline while XOM will prosper on all levels. (Notice that this is linked to the price of gasoline and NOT directly to crude.)
The current (temporary) slack in energy stocks is not because the bottom is falling out from the price of crude ($145 was way overdone and $120 is still too high), as crude at $100 should send XOM up 15% from current levels. Proof that the market is not expecting crude to fall to $85 is the fact that VLO (a refining pure play) has declined as well. Had the market anticipated a drop to $85, VLO would be trading +30% from where it is today.
Have to go - to be continued later.
In May 2008 a number of institutions cashed out of energy in order to raise cash or just because it was May and they will be back in October! Since oil stocks had done so well over the past two years, it made sense to book profits. In August (so far), one institutional investor reported selling about 60M shares of XOM while Blackrock and others bought, albeit, far less than 60M shares. This puts downward pressure on the stock price. You can check the volume for mini spikes on the chart above and see exactly when the institutions sold more than they bought.
A quick check shows that the same is true for many of the oil stocks, regardless if they are E&P, drilling or services. The NG pure plays tend to fluctuate more in line with the price of NG which has come down drastically from 12+ to 8+. This would be the equivalent of crude oil being $95 today!
As for XOM, lower prices are a blessing as long as they don't go too low.
First, as prices increased, based on the multi year contracts that XOM has with several sovereign holders of rights, XOM was limited to the amount of oil it could withdraw. No one knows the exact numbers as these are heavily guarded trade secrets. However, the relatively steep drop in production from the previous quarter does give us an indication that the trigger point is somewhere around the 120 mark.
Second, XOM has considerable refining and retailing operations around the world. The higher prices were choking off the crack spread in many markets. With lower crude prices, not only will volume increase to offset the lower production margins; throw into the mix better results from refining and other segments.
The only snag in XOM's performance for the latest quarter is reserve replacement. The market tends to use the number of years left of proven reserves in order to fix the multiple. In other words, profits can increase however, if the number of years in reserve decrease, the multiple will decline resulting in a lower P/E yielding a lower stock price. The market tends to look at the numbers on an accumulative basis, meaning that prospects in the pipeline are given a certain value though not the same as proven reserves.
The bottom line is that XOM is very profitable and well managed. Though it is struggling with reserve replacement right now, due in part to Chavez shenanigans, there are a number of areas that can make up for the lost reserves, albeit, at higher production costs than XOM would like. The days of $5 per barrel are long gone.
The general trend for XOM common is up, not down, as lower crude prices will not diminish overall earnings. The multiple will increase once new reserves are proven. EPS growth will come in the interim from buybacks thus reducing heavy swings as was prevalent in the recent past.
Now let's look at GM.
To be continued…