Crude Oil: You would be forgiven if you’re feeling either a sense of déjà vu or nausea today after seeing energy stocks suffer another sharp sell-off. The difference this time is obviously the implosion in broader markets (the Dow Jones falling 4.1 per cent on Thursday), which seems to have magnified the selling pressure in oil and energy stocks.
What's different today when the XOP (The SPDR Oil & Gas Exploration & Production ETF) is trading only five per cent away from the August lows, when oil was at $46 per barrel? Well first, oil is at $60 per barrel. Second, inventories have been drawn down by the greatest extent in history and U.S. surplus storage has fallen from 140 million barrels ;ast March to about 13 million barrels. Third, every U.S. oil company is coming out with capital budgets that show capital discipline, production growth constraint and a renewed focus on returning capital to shareholders, which means that U.S. production growth will be tamer than historical standards. Fourth, oil demand growth is rocking, with Goldman Sachs estimating growth of 2 million barrels-per-day this year. Fifth, OPEC compliance remains very strong and likely to stay that way for all of 2018. Sixth, we are in a four-to-five year bull market for oil (ask for our updated presentation or listen to the webcast coming out next week — or call me).
Where have valuations fallen to? We entered into “cheap territory” a long time ago. At today’s levels, after the 20-per-cent sell-off from the highs two weeks ago (!), our service stocks (whom I met with last Friday … business is good!) have fallen by 25 per cent year-to-date (YTD) as of Feb. 9.
A particular pressure pumper now trades at an 18-per-cent free cash flow (FCF) yield on 2018 and a 22-per-cent FCF yield on 2019 numbers. They’re buying back $100 million of stock (10 per cent of their outstanding) and I think they will buy back even more.
We had a land driller report results yesterday which slightly missed expectations (first quarter estimates got revised down by two per cent) and the stock sold off by 14 per cent. This is a $4-billion market cap company that lost $400 million of value for a $9-million miss due to very cold weather delaying work in January. UBS this morning actually increased their 2018 estimates by one per cent.
Our oil producers in Canada (only a few of them) can, on average, buy back 15 per cent of their outstanding stock with the FCF being generated today. One pays a 10-per-cent yield already that is well covered. On strip, the average Canadian oil company is trading at 4.6-times enterprise-value-to-cash-flow when they used to trade at seven-to-eight times. Our U.S. producers have been equally mauled falling by up to 18 per cent YTD. In short, there’s been nowhere to hide.
Given the extent of the sell-off after a horrible 2017, people have clearly given up on the space. What is very odd with this is that oil a week ago was trading at a 3.5-year high and even today after the correction, the oil strip is over $50 per barrel out past 2021. Companies are trading at their lowest valuations in memory and are starting to step up to the plate and buy back their own shares, given the very significant disconnect between how their companies are doing and how their stocks are doing. We continue to encourage this action with all of our holdings.
We’re in a multi-year bull market for oil. Fortunes are made when people take advantage of the disconnect between perception and reality. Admittedly, this is the absolute hardest thing to do and the lag time can take longer than one ever thinks possible (like right now). The stopgap is now corporate buybacks. If the investment public won’t step up and buy shares then the corporates will and we’re seeing this in action today.
Eric Nuttall on BNN.ca Friday Feb 9th @ 1300ET |
