Oil Is Not Well!

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Includes: BRK.A, BRK.B, EMR, FAST, FLR, KORS, MA, PCP, SLB, TJX, UPS, WBA, WMT, XOM
by: Ingrid Hendershot, CFA

Summary

The supply of oil has dramatically increased in the United States, thanks to new drilling technologies.

At the same time, global demand for oil has slowed due to economic weakness in much of the rest of the world.

This has investment implications for many high-quality companies.

Thanks to new drilling technologies, more crude is bubbling in the United States today than when Jed Clampett became a millionaire on The Beverly Hillbillies. The U.S. supply of oil, black gold and Texas tea has increased dramatically, thanks to horizontal drilling and the ability to draw oil from shale rock (fracking). The U.S. Department of Energy reported that crude oil stockpiles reached 406.7 million barrels in January, the highest level since the government started keeping records in 1982.

At the same time, global demand for oil has slowed due to economic weakness in much of the rest of the world, notably China and Europe. The combination of rising supply and lower demand created a Jethro-sized drop in oil prices. Oil prices plunged almost 60% from a peak of $107 a barrel last summer to a low of $44 in January. Oil prices have recently recovered a bit, hovering around $50 a barrel. Where oil prices head next might be a good guessing game between Elly May's dart-throwing chimpanzee and Milburn Drysdale and his banker colleagues. Citigroup (NYSE:C) says oil could fall to $20 a barrel, while other experts point to breakeven prices in the mid-$60s. With OPEC not cutting production as usual in response to lower oil prices, Saudi Arabian billionaire Prince Alwaleed bin Talal made comments on the future of crude oil prices by stating, "We will not see $100-a-barrel oil again."

While we do not try to predict oil prices, what we do know is that lower oil prices have shifted wealth from oil producers to oil consumers. This has investment implications for many of our high-quality companies.

In response to lower oil prices, Schlumberger (NYSE:SLB) recently slashed 9,000 jobs to right-size its business during the downturn. Emerson (NYSE:EMR) and Precision Castparts (NYSE:PCP) also face challenges from the slumping price of oil as customers cut capital expenditures. On the other hand, despite the uncertainty of lower oil prices, Fluor's (NYSE:FLR) oil and gas business was its strongest segment in 2014, as the backlog grew a hefty $8 billion. Many oil-related companies have seen their stock prices drop to attractive valuations. Fluor is a prime example as its business continues to prosper. However, the large, integrated oil companies appear fully valued, based on dramatically deteriorating business fundamentals. With oil not well, ExxonMobil's (NYSE:XOM) revenues and earnings are expected to plummet in 2015, with a recovery hard to predict.

Other companies like Berkshire Hathaway (BRK.A, BRK.B), not to be confused with Miss Jane Hathaway, both win and lose from lower oil prices. For example, Berkshire's railroad, Burlington Northern Santa Fe, will likely see shipments of crude by rail fall if oil prices remain low, but will benefit from the lower cost of fuel for its trains. Lower fuel prices will also aid UPS Corp. (NYSE:UPS) and Fastenal (NASDAQ:FAST), as it reduces their transportation costs.

More importantly, lower gas prices serve as a giant "tax cut" for consumers. As consumers spend less money at the gas pump, they have more disposable income to spend at Wal-Mart (NYSE:WMT), Walgreen (NASDAQ:WBA), TJX Companies(NYSE:TJX) and Michael Kors (NYSE:KORS).

During the holiday season, MasterCard (NYSE:MA) had yet to see spending improve, as cautious consumers appeared to be first paying down debt and saving their extra petro dollars. Once consumers are confident lower gas prices are sustainable, the company expects consumers to charge ahead with their spending, which should spur economic growth in the quarters ahead.

With oil not well, Mr. Market appears to be sipping from granny's "medicine" jug as stock prices sway up and down along with oil prices. Keep in mind, volatility creates buying opportunities for the long-term investor. While one might have to grow older than granny, eventually oil will come back now, y'hear!

Disclosure: Hendershot Investments holds a long position in each stock presented. The content in this article should not be taken as investment advice or construed as a recommendation to buy or sell any security. Ideas expressed may not be suitable for every account, depending on an individual's investment objective, risk-tolerance and financial situation. Information presented here was obtained from sources believed to be reliable but accuracy and completeness and opinions based on this information are not guaranteed. It should not be assumed that investments discussed will be profitable or will equal the performance of securities listed here or recommended in the past. All data, information and opinions expressed are subject to change without notice. Further information on companies mentioned is available upon request.

Disclosure: The author is long SLB, EMR, PCP, FLR, XOM, BRK.B, UPS, FAST, WMT, WBA, TJX, KORS, MA.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it. The author has no business relationship with any company whose stock is mentioned in this article.