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Elliott Gue knows energy. Since earning his bachelor’s and master’s degrees from the University of London, Elliott has dedicated himself to learning the ins and outs of this dynamic sector, scouring trade magazines, attending industry conferences, touring facilities and meeting with management... More
My company:
Energy and Income Advisor
My blog:
Capitalist Times
My book:
The Rise of the State: Profitable Investing and Geopolitics in the 21st Century
  • Questions & Answers from the Orlando MoneyShow 0 comments
    Feb 12, 2010 12:43 PM | about stocks: CSCO, SU, SLB
     It was my pleasure to attend InterShow’s Orlando MoneyShow for the seventh consecutive year last week. The event brought together thousands of individual investors and dozens of exhibitors. As an added benefit, a trip to Florida allowed me to miss out on the record-setting 30 inches of snow that have blanketed my hometown of Alexandria, Virginia, snarling the region’s air, rail and ground transportation systems.

    As always, one of my favorite aspects of this year’s event were the question-and-answer (Q&A) sessions held at the end of each of my presentations and on an impromptu basis in the corridors at the show. Here’s a rundown of some of the most common questions posed and my answers to each.

    • You’re calling for an economic recovery and believe the economy exited recession last summer. How can this be with the unemployment rate hovering near 50-year highs at 10 percent?

    The unemployment rate is a lagging indicator; historically, the actual percentage of the workforce without work continues to rise for months after a recession ends. The main reason is that companies are still nervous about hiring new workers or expanding hours worked for existing employees in the early stages of an expansion while the pain of the downturn is still fresh in managers’ minds. Similarly, companies also hold on to workers for months after a downturn starts--a process known as labor hoarding--because they’re reluctant to lay off qualified employees.

    To gauge the near-term health of the economy, I prefer to watch weekly initial jobless claims data, a measure of how many workers are filing for first-time unemployment benefits. The best way to look at data series is to monitor the four-week moving average of claims to smooth out the week-to-week volatility. This is one of the two indicators related to employment in the US Leading Economic Index (NYSEMKT:LEI), an indicator that I follow closely and have written about extensively in this e-zine. As recessions draw to a close, initial claims data tends to improve steadily as was the case in the back half of 2009. We’ve seen some slight softening in this data so far in 2010, but that’s not an uncommon phenomenon in any cycle and is only a concern if it continues through the rest of the quarter or gets worse.

    Some companies are already talking about hiring workers. For example,Cisco Systems (NSDQ: CSCO) noted that the recovery in technology spending has spread to enterprise spending--business spending on IT gear and services. They’re planning to hire a small number of workers to meet growing demand. Some of the rails also appear to have brought back furloughed workers in the second half of 2009 as volumes shipped began to rebound from depressed levels early in the year.

    However, over the longer term the unemployment rate will play into the strength of the recovery.  If, as I expect, the unemployment rate remains elevated, this will mean that consumers have less disposable income. Since consumption is two-thirds of US gross domestic product (NYSE:GDP), less consumer spending means a subpar recovery.

    Prospects are even worse if you consider that many workers that should be considered unemployed do not get counted as part of the official headline rate--the total unemployment rate is closer to 20 percent. This all backs up my call for a weak cyclical recovery.

    • When will US companies see actual revenue growth rather than simply earnings growth due to cost-cutting and laying off workers?

    Actually, that’s no longer the case. In the second and third quarters of 2009, most companies that reported growth did so through cost-cutting, but this quarter the profits recovery is broadening out. S&P 500 companies reporting fourth-quarter results to date are showing average revenue growth of 10 percent year-over-year, and 69 percent of the S&P stocks reporting have beaten revenue estimates.

    It’s also important to remember that earnings for the S&P 500--and for US corporations in general--are increasingly leveraged to a global economic recovery. Although US economic growth is likely to remain anemic this cycle, growth in emerging markets has been robust and faster than most predicted a year ago. Companies that have extensive overseas exposure will benefit disproportionally to that upturn.

    • How much does it cost to produce oil from the Canadian oil sands? How about from deepwater plays in Brazil, the Gulf of Mexico, and Africa?

    Estimates as to the cost of producing these plays varies widely. The truth is that it varies from project to project and in the case of Brazil’s Santos Basin deepwater plays, no one can give you a clear answer because these plays just haven’t been fully developed yet and are largely still in various stages of testing and appraisal. The estimates you hear are often based on rather vague comments made by various international energy producers.

    In my view the best way to gauge an answer to this question is to look at what happened in late 2008 and early 2009, when oil prices collapsed from over $150 per barrel into the mid-$30 range. Actions speak louder than words and analysts’ estimates: What we saw was that projects all over the world were canceled or delayed. Suncor Energy (NYSE: SU), for example, delayed the planned development of its Voyageur oil sands project early in 2009 that would have resulted in an incremental 200,000 barrels a day (bbl/d) of production by the middle of this decade. In total, roughly 2 million to 2.5 million bbl/d of planned global production capacity expansions were delayed or canceled over the span of just a few months because of a sharp but relatively short-lived dip in oil prices.

    And several of the major oil services companies have reported that companies were reluctant to increase their spending again even as oil prices rebounded to above $70 in the middle of 2009. The reason was that producers don’t just look at current oil prices when making long-term decisions on new projects but also at the volatility and sustainability pricing; oil service giant Schlumberger’s (NYSE: SLB) management team has stated that oil companies wanted to see oil prices around the $70 to $80 range for a period of time before they actually increase spending. In that company’s most recent report, management indicated that it’s finally seeing an uptick in spending again now that producers have gained confidence in the sustainability of the recovery in oil prices.

    Thus, the actual marginal cost of any play is less relevant than the sustainable average oil prices needed to incent producers to increase their spending on complex and tough-to-produce fields. I believe average oil prices will need to remain at relatively elevated levels.

    • What has caused the selloff in master limited partnerships (NYSE:MLP) so far this year? I have more money I’m looking to invest in this high-income group; should I be concerned about the selloff and when should I buy?

    For the most part, the MLPs are simply seeing a correction after a big rally in 2009. The Alerian MLP Index had its best year ever in 2009, and several of our favorites recently hit new all-time highs. After a rally of that magnitude, it’s only natural to see a bit of profit-taking and a pullback. This is healthy market action and for the most part has nothing to do with company-specific issues.

    Over the longer term, the sector doesn’t look overvalued. Although the 2009 rally was dramatic, 2008 was the worst year ever for the group; it was recovering from depressed valuations. The group still offers a historically high yield relative to US Treasury bonds and other key income-producing groups of the market such as the REITs. And fundamental performance is strong; many MLPs announced boosts in their distributions or intentions to boost their payouts over the next few quarters.

    There’s no way to pinpoint these short-term corrections with any degree of accuracy. One way to make use of these moves is to divide the amount you intend to invest into three or four parts and resolve to commit only a portion of your funds to MLPs each month over the next quarter or so. This way, if there is a continued correction you’ll benefit by buying at more attractive prices. But if the sector runs to new highs you’ll also benefit by committing some of your capital at current prices.

    Another point to note is that several MLPs have been taking advantage of the recovery in the group to sell new units in secondary offerings. This usually causes a short-lived dip in price as investors fret over the dilution to existing unitholders’ stakes. But secondary issues are actually a big positive because the MLPs use this capital to fund expansions that ultimately spell higher distributions for unitholders. We've covered these opportunities at length in MLP Profits.

    Use these dips to buy into top names at attractive prices.

    Disclosure: "No Positions"
    Themes: economy, MLPs, Energy, Oil Sands Stocks: CSCO, SU, SLB
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