If supply and demand are any indication, crude oil prices should remain weak. Sustained low crude oil prices will, over time, translate into lower gasoline prices and lower jet fuel prices. These price movements will make cruises, air travel, and remote vacations more affordable. Investors seeking to play lower oil prices should consider attractively-priced stocks from these industries.
The Case for Cheaper Crude Oil
The price of crude oil recently dropped to below $90 per barrel. The decrease is part of an ongoing, multi-month downward trend in oil prices. Current weakness in oil prices has been blamed on the eurozone crisis. Economies continue to struggle in Europe and may speculate that the euro will weaken relative to the dollar more than it has over the past two years. Others believe that the steady descent in oil prices may simply be a part of crude oil's ultimate demand destruction, a consumer response to the persistent high price of gasoline.
Will supply decline as well? The reported sales of crude oil were lower and oil companies have reported their oil supply is going down. Oil companies themselves point to the reduction of imports as an explanation for the declining inventories. But others are more skeptical of achieving a balance between supply and demand. Summit Energy analyst Jacob Correll said, "Even though inventories fell, I don't think that's enough to overwhelm what's already going on in the market."
This price weakness is the natural result of a free market increasing long-term supply in response to higher market prices. Remember the cries of "peak oil" from energy bulls? Speculation in the 2008 commodity bubble provided substantial funding for new drilling projects and investment in new energy technologies. This funding catalyzed the rise of natural gas fracturing, the long-term of threat of renewables as unexpected new energy challengers.
Four years after we were allegedly running out of energy the United States has many sources of energy to choose from. The coal industry is becoming obsolete as it is getting replaced by natural gas supplied by hydraulic fracturing. Solar cells are cheaper than ever, and are another competitor for fossil fuels.
Unfathomable energy sources are coming by land and by sea. Seaborne liquefied natural gas plants are emerging as a new threat to energy sector profitability. The largest LNG producers in the world, led by Royal Dutch Shell (RDS.B), have figured out how to move their processing plant's floating barges so they can tap into remote underwater fields. Shell has plans to build a floating LNG plant in South Korea within a year. This will be the world's biggest floating LNG plant, and will weigh six times more than the largest aircraft carrier. About 5,000 workers are expected to build this vessel, and it is expected to cost about $13 billion. These plants may offer a cost savings in addition to geographical flexibility since a land-based facility costs about $20 billion to build.
Many of Shell's rivals, including France's GDF Suez and Malaysia's Petroliam National are also planning to turn gas into liquid at sea. This technology could unlock a virtually untapped resource. Most of the world's largest natural-gas deposits have been found out in the ocean over the last 10 years.
In addition to hydraulic fracturing this technology further substantiates natural gas as a cheap substitute for petroleum oil on a global scale. This substantiates a structural change in the energy markets.
Declining Crude Winners
Jet fuel is a major expense for airlines, and these stocks stand to benefit from declining crude oil prices. However, most stocks in this industry are not value investments. The firms listed below were selected because they are trading at attractive price multiples.
At prices near $37 per share, Alaska Air (ALK) stock affords investors an acceptable risk/reward trade-off. When compared with the 1.29 price-to-sales ratio of the S&P 500, the 0.57 ratio of this stock is very attractive. ALK shares are trading at an attractive 10.62 price-to-earnings ratio, lower than the 14.1 average of the S&P 500 index. Shares trade at a 2.01 price-to-book ratio, which is near the 2.05 S&P 500 average.
Another attractive airline value stock is Spirit Airlines (SAVE). At prices near $17 per share this stock is an acceptable risk/reward trade-off. This stock is cheap at a 1.04 price-to sales ratio, less than the1.29 average of the S&P 500 and a 11.55 price-to-earnings ratio, lower than the 14.1 average of the S&P 500 index. Analysts expect that the firm's earnings growth will accelerate with five-year estimates at 19.3% per year since it offers passengers lower fares than many other airlines.
Cheaper oil means consumers will fly and drive to vacation destinations more frequently. Often when they reach their destinations, they like to gamble. One stock in this space, which offers investors attractive price multiples, is Penn National Gaming (PENN). At prices near $43 per share the firm's price-to-book multiple of this stock is 1.53, cheaper than the 2.05 S&P 500 average. Its 1.16 price-to-sales ratio is a bit cheaper than today's prevailing market multiples. Unfortunately, PENN shares currently trade at a 17.46 price-to-earnings ratio, a higher value than the 14.1 average of the S&P 500 index.
Royal Caribbean Cruises (RCL) is a promising value buy at $32 per share. At a price-to-sales ratio of 0.89 this stock trades at a fraction of the S&P price-to-sales average. RCL shares are trading at a fair 14.39 price-to-earnings ratio, in line with the S&P 500 average. The 0.83 price-to-book multiple of this stock is very attractive, much cheaper than the 2.05 S&P 500 average. Analysts expect that the firm's earnings growth will accelerate with five-year estimates at 9.9% per year, a turnaround from declining -1.2% annualized earnings growth over the past five years.
Income investors will also like RCL shares since they pay a 1.52% dividend yield, comparable with the 1.74% 10-year treasury yield. Future dividend payments are likely because the company pays out 0.23 of earnings as dividends, so earnings could drop considerably before dividends must be cut.
At current prices there are many stocks that afford investors reasonable valuations and a means to benefit from declining crude oil prices. Today, investors should consider Royal Caribbean, Spirit Airlines and Alaska Air as cheap ways to bet on declining crude. Investors should also consider Penn National Gaming if its price-to-earnings ratio converges with the broader stock market.