Oil firms may as well inhabit another dimension - Globe & Mail, Feb.17
By Eric Reguly
Once Talisman Energy is truly free of the "Sudan factor" that has hung darkly over its head, the company's shares will soar into the upper reaches of the stratosphere, right? Think again. Oil companies are so far from view that they may as well inhabit another dimension.
Talisman's shares have risen and fallen this week with the ebb and flow of threatened Canadian and U.S. government sanctions over its $800-million investment in Sudan, where one of the continent's grimmest civil wars has been raging for decades. But they are still well short of their 52-week high of $49.15 and probably half of where they should be based on traditional valuation methods such as the price-to-earnings ratio and cash flow per share. Remember them? If you do, you're obviously a dinosaur who hasn't a clue about making money in the new economy.
That's just the point. Oil producers are traditional companies, and traditional companies -- which include everything other than the Internet, new media, telecommunications and technology sectors -- are nowhere.
The stock market's greed factor is so appallingly high that a stock that doesn't have the potential to double every few months or so, even if the words "earnings" and "profit" have never graced the pages of its financial statements, are shunned like tax accountants at a cocktail party.
In fact, owning an oil, gas or pipeline company is not considered an investment at all; it is an opportunity cost, dead money. How else do you explain the 16-per-cent dividend yield on the Pembina Pipeline Income Fund? It's not like Pembina is a high-risk, problem-ridden play. It has never missed a payment to shareholders.
Pembina is not alone at the bottom of the equities well. Not long ago, oil producers would sell at about four times their cash flow per share. Now, you can pick many of them up at three or two times cash flow. Indeed, by historical standards, Canadian energy stocks are trading at giveaway prices. Research done by Peters & Co. of Calgary shows that oil producers now trade at the lowest price-to-cash-flow ratio in a decade. Renaissance Energy, Ranger Oil and Canadian 88, among others, trade at half or less of their 52-week highs. Energy analysts are taking long holidays because they're weary of telling their value stories to deaf audiences.
What is extraordinary about the shares' prices is that things have rarely looked better for energy companies. At the end of 1998, crude oil was worth about $10 (U.S.) a barrel. This week, prices rose to $30, their highest level since the 1991 Persian Gulf war. Supplies are close to 23-year lows, implying that prices could keep rising as the summer driving season approaches. Meanwhile, economic growth in North America and in other parts of the world continues to be robust.
While oil's role in the economy isn't as large as it used to be, economic growth usually puts upward pressure on oil prices -- unless prices get so high that they damage growth prospects. When they go past $30 or so, as they did in the early 1980s, oil shares tend to fall.
There is no doubt that the notoriously volatile oil prices have kept a lid on energy company values. In short, no one believes that $30 oil, let alone $25 oil, can be sustained for more than a few months, and you can see why. OPEC, which is already hinting that higher production rates are needed to replenish drained inventories, has a nasty habit of overshooting quotas. It happened in 1997, when oil, then trading at about $25, began its rapid descent to $10. The trend reversed only when the oil cartel got its member countries to tighten the spigot, and not cheat about it.
But the majority of oil companies would still be undervalued even if oil prices settled at $20. So why are the shares still so cheap? Greed is certainly part of the problem -- high-growth stocks are hard to resist, to the point that investors are yanking money out of value funds so they can sink it into growth funds. Another theory is that the oil companies are competing, and competing poorly, on the attention-grabbing front. With so many glamorous stock market stories out there, telling investors that they should buy oil shares simply because they are undervalued doesn't exactly set the imagination on fire.
This is why analysts such as Eleanor Barker of MacDougall MacDougall & MacTier are keen on oil companies with a twist -- compelling or unusual stories that set them apart from the oily pack. Among them are Hurricane Hydrocarbons, which, under Bernard Isautier, has come back from the dead and is investing heavily in Kazakhstan. Another favourite of hers is Ocelot International, which is gobbling up oil fields on the cheap in western Africa.
Oil stocks aren't lost causes forever. Some producers are bouncing off their lows, suggesting the selloff is coming to an end. If one or two oil companies, such as Hurricane or Ocelot, come alive, the herd mentality may kick in. But don't look for miracles as long as the tech sector dominates the show.
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