Energy Stocks I'm Buying During The Corona-Oil-War
- I tend towards choosing the unpopular and hated sectors when i find investments worth pursuing.
- During the throes of the coronavirus mixed with the ongoing oil price war between the major oil powers in the world, one of these sectors has become oil/energy.
- The companies I'm looking to invest into are Equinor, Royal Dutch Shell and Total S.A.
As an investor, I'm pretty damn underweight oil and energy, compared to most investors. It's because as a whole, I've always been pretty convinced - without any real reason other than a gut feeling - that we're in for an oil correction or drop sooner or later and I was unwilling to allocate too heavy amount of capital in the sector, despite valuations which at the time looked appealing, but which now - for the time being at least - look to have been too expensive.
This means that I do own names I consider quality - such as Royal Dutch Shell (RDS.B), Equinor (EQNR) and also some quality midstream companies like Energy Transfer (ET) and MPLX LP (MPLX). I also own a bit of Enbridge (ENB) and I have a small position in the Pembina Pipeline Corporation (PBA). All great companies, and all companies I like.
However, Oil and Energy currently make up less than 4.5% of my total portfolio. Compare this to Consumer Staples (15%), Industrial Cyclicals (16%) or Finance (18.8%). Even my position in pure Cash (9.8%) is more than twice the size of my stake in oil and energy.
Well, it seems that the market is bringing me a "gift" to change that fact.
The Oil War of 2020
As I'm writing this, Russia has on Friday/over the weekend initiated a price war on oil. This has caused futures of crude now changing hands at below $28/barrel. Banks are already calling the current climate and outlook for oil, to quote Goldman Sachs, "even direr than 2016".
While I try to not write parabolic articles shrouded in doomsday rhetoric, it seems not unlikely that we could see crude prices approach $20/barrel, or even below. It's set to make Oil/Energy one of the least popular investments in the entire market.
Not only will it put stress upon the balance sheets of qualitative companies, bringing back 2016 and other stressful times for oil companies, but it will most certainly affect those producers both in and outside of the US who are unable to produce crude at a low cost. In fact, one of the targets Russia seems to have with this entire war is to hurt US companies active in shale. Financial Times quotes the following:
“Russia has had enough of the shale guys living off Opec-plus,” said one person familiar with negotiations, referring to the cartel and allied non-members.
The Kremlin has also been riled by recent US sanctions on the trading arm of Russian energy major Rosneft and Nord Stream 2, the proposed new gas pipeline between Russia and Europe, said two people familiar with the Vienna talks.
(Source: Financial Times)
From Russia's point of view, it's certainly time to do something about these things - and now they have done just that. As we're speaking, Norwegian giant Equinor is down more than 18% in trading, taking the nation's finance sector as well as related companies down with it.
It certainly is a great time to be an investor with capital on hand.
To wait or to buy
An argument could certainly be made for why this initial fall is just the tip of the iceberg, and why one could wait for this to play out a little more, especially as the effects ripple across the world's economies and markets. Chances are, in doing so, we'd be able to lock in yields and even more attractive prices for these companies.
However, it could also mean foregoing these opportunities altogether. My approach is, and will continue to be buying in steps. As those of you who follow my articles know, I've got plenty of capital on hand even if the market decides to take this down another 20-30%. I'll also have more capital going in going forward.
In short, I'm not really worried about running out of cash per se - it's more about where to deploy capital going forward, and when to deploy it.
First, I've adjusted all of my buy prices to better correspond with the 2016 oil crash - something I view as an excellent beginning, as companies are already trading at or below this level. Beyond this, we're a bit in unchartered waters. However, my strategy on simply deploying capital in quality companies in steps to set myself up for long-term capital gains and appealing yields continues to be one I follow.
And to this effect, I've identified three companies I mean to buy during this oil war, to both increase my oil/energy exposure and to lock in some very appealing yields.
Why These and not MLP's?
So why these three major companies, and not some of the safer MLP's I already own? Well, a few reasons.
- Even if I can handle K-1's at tax-time, they are an annoyance I consider negligible with valuations as low in energy as we're seeing at this time.
- A majority of my current exposure is towards MLP's - my desired exposure includes a majority towards the more traditional producers.
- MLP's offer me exposure to USD only. In these companies, I can go Euro, NOK and even GBP. As a non-US investor, I also value currency diversification due to my "base" currency being the SEK.
This means that my method certainly isn't valid for everyone - but it works for me. As always, make sure that your own methodology lines up with your investment goals and your acceptable risk allocation/exposure.
First, the company I've bought this morning, Equinor. Keep in mind, while the numbers I provide have been updated, the graphs I'm showing you have not. The graphs are meant as illustrative in terms of oil companies being undervalued in general, not the exact degree of undervaluation - as this will grow better during the day/s to come.
As of the time of writing this article, Equinor yields over 8.8%. My latest article on the company was this one, which given its title seems amusing at this point. However, long-term I'm very sanguine (positively) about the company's prospects.
(Source: F.A.S.T Graphs)
Equinor is an AA- rated oil giant with exposure not including the middle east. While analyst accuracy isn't as high as we'd like it to be, the company is nonetheless expected to grow EPS to $2.14/share in 2023 and forward. Even if this current conflict takes a dent out of those numbers, the company could trade negatively from today's levels and you'd still not be losing money in the long term, based on current numbers.
At an expected EPS of 14.75 NOK for 2020E, the company currently trades below 8 times P/E, for one of the largest oil companies on the planet. Equinor's many other graces are covered somewhat in my article on the company - and I encourage you to peruse it to get a sense of why, besides from chronic undervaluation, I'm staking out a deeper cut of this company.
Secondly, we're talking Royal Dutch Shell. The U.S market isn't open yet as I'm writing this article, but pre-market trading shows the company drop to about $34/share, which would indicate a 10.8% yield at current dividends.For Shell, I recommend this article by The Value Portfolio, which provides a good summary of the company and its many positives.
(Source: F.A.S.T Graphs)
Shell is another company which in terms of its expected earnings is perhaps even more extremely undervalued than is Equinor. The company is also AA- rated, and even if analyst accuracy is just as lacking as with Equinor, the fact is that the company's dividend on the basis of operating cash flows remains well-covered - and it was this even during the oil crash of -16 (even if just barely).
On this basis, and the basis of overall company quality, I consider Shell to be one of the strongest names to invest in when considering Oil/Energy stocks. At current valuations, you're paying a P/Operating cash flow valuation of below 4X, a valuation unheard of outside of a recession. In terms of future earnings, at a price of $34/share, you're paying a forward P/E of 7.2X for Shell, if the estimates by FactSet analysts for 2020E come to pass. This is choice number two - and again, the dividend is well-covered by operating cash flow. Even during the outlier years when FCF didn't cover the dividend, Shell didn't cut the dividend, and over the past few years, the company has made itself more resilient towards these trends.
In terms of these valuation prospects, I'm happy to let the market give me these sorts of discounts as i "follow" Shell down as deeply as it'll go.
The last company here is Total S.A. (TOT)Once again, we're talking about an oil company that's A-rated, A+ in this case, with a 100+ year history and a $100B+ market cap. A good article describing the company, as I've not yet done this, is this good article by Joseph L Shaefer.
It too trades at a 2020E 7.2X P/E-ratio, given that the profits hold (which seems somewhat dicey given what's currently going on, of course.) The company seems to not take as severe a hit in pre-market trading, something I believe can in part be attributed to Total's greater renewable focus as opposed to the other companies mentioned here. The company doesn't cut the dividend either, at least not for 15+ years, and any volatility here instead has to do with FX.
At market opening today, Total is set to yield nearly 8%, which is almost 3% above its 5-year yield average. When buying the company at this valuation, it could trade sideways or negatively for extended periods of time and you'd still not be losing money here, given the high dividend which much like with these other companies, is well-covered by operating cash flows even during oil slumps (such as 2016). This weighs up the analyst inaccuracy which seems to be chronic in these companies.
These are the companies I intend to keep a look on, which I own (excepting Total), and which I intend to invest more in during this oil crisis. What sort of deployment cadence we're looking at depends on how quickly they drop. I don't intend to overexpose at any specific price, but purchase methodically exactly how I purchase other types of stocks - smaller positions, and as prices fall.
This strategy certainly might not work for everyone. Chances are, you don't even want to be involved in owning Energy/oil stocks given the volatility we're seeing here. But studying past trends and results, what becomes clear is that buying major oil companies during times of market panic due to "oil wars", has resulted in one thing long-term: Profit.
Even if you hold Shell today, for instance, after a catastrophic drop and had made your buy during the 2016 oil scare, your annual rates of return would still have been nearly 7%. Less than 2 months ago your returns would have been twice that, nearly 15% annually. The current drop is exclusively due to the market's irrational reaction, and my view is that these will revert given time.
These buys/considerations are made on the following assumptions and risks:
- The companies won't take a major, long-term hit due to this oil scare which could influence their ability to pay their dividends. If this does happen and a company does cut its dividend, the equation changes, of course.
- I consider it likely that this oil scare/war is a temporary thing, and won't last longer than a few months at most. If it drags out, things are likely to become worse, and valuations could go even lower, to historical lows not seen since the gulf war.
- I consider this scare compounded by the Coronavirus and the effects from here which is currently influencing worldwide demand for crude.
What seems clear is that there are two winners from the current way things seem to be going - Russia and China, with everyone else being on the losing side in this.
A prolonged period of time of poor crude prices could be the nail in the coffin for the USA's position as a net crude exporter due to shale becoming unprofitable. With Russia's position, involving a comparatively low production cost combined with a very liquid currency and extensive purchases of gold for the past few years, acting as a hedge, the nation is set up to enjoy some benefits as a result of this political cat-and-mouse game. This game has also been influenced over the past few years by the aforementioned pressure against Nord Stream II, which is set to make Europe more independent from NA energy.
There is a real danger of instability here. While Saudi Arabia's production costs, according to Goldman Sachs, is close to $10/barrel as opposed to the world average of $35/barrel, this goes diametrically opposed to what intentions Saudi leadership has communicated previously. A prolonged instability and sub-40/barrel price would first break Oman, followed by Saudi Arabia and Bahrain, with waves of bankruptcies, currency devaluations, increased taxes and a stop for investment, which certainly would trickle over into the financial sector.
This is not even mentioning the danger to nations suffering from hyperinflation, such as Venezuela and Iran. These nations are living only because of a somewhat stable crude price, and following this could teeter on the verge of total collapse, with humanitarian catastrophes as a result.
The danger for NA is, as I see it, the shale industry. The DoE has calculated that a sub-$50/barrel price isn't sustainable in the shale industry. In 2011, crude was trading at nearly $120/barrel, which made shale oil insanely profitable. At 30-40/barrel, (as I see it) it's a business from which you want to run and never look back from - the same go for Canada's tar Sands.
In the end, I'm not a crude analyst/expert. What I try to focus on are the overarching effects, the more general and easily conceivable results of a certain event.
This event tells me to, more than ever, stick to quality companies in this space. Frankly, I expect this to get too volatile for most investors, and I would recommend that you consider with care whether this is a sector you want exposure to even at this valuation. I know investors who as of late have sworn off the oil sector entirely, and given their mindset, I think it's the right decision for them.
I'm happy with my current exposure, and happy in adding more - in certain companies. If I were adding shale/tar sand producers at this time, I'd do extremely careful due diligence on the company I was interested in to make certain that their indebtedness is where I'd want it to be for overall safety in the face of a crude price war.
In the end, however, I'm an extremely long-term investor. What happens now in terms of negativity will be a fading memory in 5 years - and more so even in 10-20. What I believe, however, is that these companies certainly won't be fading memories - bust still standing strong and supplying the world with quality crude.
I won't add any sort of stances for these companies in this article. I do think you could consider them buyable, but given the uncertainity here, and the fact that the article is being written pre-market opening means it's very hard to even guess at the fact where the S&P and the DOW might be closing today.
Because of this, I'm simply saying that as of now, I'm both LONG EQNR and Shell, I intend to initiate my first position in TOT today, and I'm going to be watching these companies very closely as we go forward.
Thank you for reading.
This article was written by
Mid-thirties DGI investor/senior analyst in private portfolio management/wealth management for a select number of clients. Invests in USA, Canada, Germany, Scandinavia, France, UK, BeNeLux. My aim is to only buy undervalued/fairly valued stocks and to be an authority on value investments as well as related topics.
I am a contributor for iREIT on Alpha as well as Dividend Kings here on Seeking Alpha and work as a Senior Research Analyst for Wide Moat Research LLC.
Analyst’s Disclosure: I am/we are long EQNR, RDS.B, ET, MPLX, ENB, PBA. 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.
While this article may sound like financial advice, please observe that the author is not a CFA or in any way licensed to give financial advice. It may be structured as such, but it is not financial advice. Investors are required and expected to do their own due diligence and research prior to any investment. I own the European/Scandinavian tickers (not the ADRs) of all European/Scandinavian companies listed in my articles. Disclosure: I intend to open a position in Total S.A. today, the 9th of March 2020.
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