Why Don't The Great Investors Own Shale Producers?

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Includes: AR, CLR, CNX, EOG, FANG, PXD
by: Superinvestor Bulletin

Summary

The top investors in the world have very little exposure to shale oil producers.

Digging into the financial statements of shale oil producers provides a clear reason why that is.

These businesses don't generate any free cash flow.

Note: All portfolio details and financial statement info is sourced from SEC filings at SEC.gov for the respective companies and investors.

The top investors in the world tend to be value investors. They also tend to be contrarians.

Why is it then that none of these world-class investors owns American shale oil producers even after the oil collapse?

Don't believe me? Well, let's look at a few.

Here are Warren Buffett's 10 largest holdings as of December 31, 2016:

Ticker

Company

Market Value

% of Portfolio

KHC

Kraft Heinz

$28,434,432,000

19.21%

WFC

Wells Fargo

$26,436,503,000

17.86%

KO

Coca-Cola

$16,584,000,000

11.21%

IBM

IBM

$13,483,751,000

9.11%

AXP

American Express

$11,231,321,000

7.59%

PSX

Phillips 66

$6,972,414,000

4.71%

AAPL

Apple

$6,643,394,000

4.49%

USB

U.S. Bancorp

$4,369,696,000

2.95%

DAL

Delta

$2,952,679,000

2.00%

CHTR

Charter

$2,718,970,000

1.84%

Source: Huffington Post

Not a shale or any kind of oil producer in the bunch. In fact, there isn't a shale producer in Buffett's portfolio period.

Here are David Tepper's 10 largest holdings as of December 31, 2016:

Stock

Company

Market Value

% of Portfolio

AGN

Allergan

$894,938,000

15.87%

ETP

Energy Transfer Partners

$428,354,000

7.59%

GOOG

Alphabet

$372,789,000

6.61%

WPZ

Williams

$360,802,000

6.40%

FB

Facebook

$251,079,000

4.45%

PNC

PNC Financial

$228,186,000

4.05%

SPY (PUT)

S&P 500

$223,530,000

3.96%

ALL

Allstate

$192,329,000

3.41%

TEVA

Teva

$183,171,000

3.25%

PFE

Pfizer

$156,229,000

2.77%

Same thing, not a shale oil or even an oil producer in the bunch.

Here are Mohnish Pabrai's 10 largest holdings as of December 31, 2016:

Stock

Company

Market Value

% of Portfolio

FCAU

Fiat Chrysler

$109,184,000

31.46%

GM-WTB

General Motors

$95,733,000

27.58%

GOOG

Alphabet

$53,401,000

15.39%

AER

AerCap

$27,949,000

8.05%

RACE

Ferrari

$23,222,000

6.69%

SRG

Seritage

$22,598,000

6.51%

LUV

Southwest Airlines

$15,001,000

4.32%

Again, no exposure to our shale oil companies that have turned the oil business on its head.

Now, I realize that I've only provided details of three Superinvestor portfolios, which isn't much of a sample.

However, I spend all my time going through the portfolios of the world's top investors and I can tell you that it is rare, very rare that I see any oil and gas producers. The sightings of shale oil and gas producers are virtually non-existent.

The few shale producers that I have seen in Superinvestor portfolios have been shale gas producers. David Einhorn has one with CONSOL Energy (NYSE:CNX) and Seth Klarman owns Antero Resources (NYSE:AR). Einhorn is publicly bullish on natural gas which would explain his CONSOL investment, and Antero is extremely well-hedged and, I would agree, holds some very high-end natural gas assets.

Einhorn, of course, is also well-known to be short a basket of oil frackers, most notably Pioneer Natural Resources (NYSE:PXD).

My opinion (and I'm pretty sure I'm right) is that the great investors really don't like the business of shale oil production.

Here Is Why - No Free Cash Flow Ever!

Over and over again, I try and encourage my kids to ask "why". I want them to understand the reason behind things. I believe that is crucial to learning and always thinking this way will turn them into more effective adults no matter what the vocation is that they choose.

To understand "why" the world's great investors hate the shale business simply requires actually looking at the financial statements of these companies. Doing so will show you that at no point do these companies generate any free cash flow.

Warren Buffett taught us that the value of a business is the present value of all of the future cash flows that the business will generate. Well, the shale producers generate no free cash flow.

So wouldn't that mean that their businesses aren't worth anything?

I pulled the cash flows from the 10-K reports of four of the "best" American shale producers for 2016. Here is how the numbers look:

(In Millions)

PXD

CLR

FANG

EOG

Total

Cash Inflow From Operations

$1,498.0

$1,125.0

$332.0

$2,359.0

$5,314.0

Cash Outflow For Capital Spending

($1,857.0)

($1,154.0)

($362.0)

($2,490.0)

($5,863.0)

Net Cash Outflow

($359.0)

($29.0)

($30.0)

($131.0)

($549.0)

The companies are Pioneer Natural Resources, Continental Resources (NYSE:CLR), Diamondback Energy (NASDAQ:FANG) and EOG Resources (NYSE:EOG).

Combined, these have a market capitalization of almost $120 billion and a much higher combined enterprise value. Combined for the $120 billion these companies are valued at for shareholders, they generated negative free cash flow of $549 million last year.

2016 was a tough year in the oil business, but you could run the numbers for any year and would find this group of respected shale producers spending more cash than they generate.

High oil prices, low oil prices. It doesn't matter.

The reality is that commodity production business is a tough one. It is capital intensive and the revenue stream is unpredictable. Even when commodity prices are helpful, service costs go up so fast that most of that benefit is eaten away.

Yes, I would agree that there is room for the true low-cost producer to generate attractive returns on capital over time. But for the vast majority of companies that isn't the case.

Because this is a bad business, it is also a very hard sector to make any money investing in. You might as well just speculate on the commodity directly.

This lack of free cash flow is why you don't see any of these companies in the portfolios of the world's top investors.

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Thanks for reading.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.