MARKET ACTIVITY/ WEEKEND EDITION OF TRADING NOTES JULY 5, 1998 (9)
WEEK'S TOP STORIES, Con't
It's Time To Pump Money Into Oil
Pittsburgh Post-Gazette
The oil business has fallen on tough times - and that's good news if you're looking for bargains.
The price of oil recently hit a 10-year low, less than $12 a barrel. It's down 26 percent in the second quarter. On the supply side, the problems are too much production by oil-rich tries in the Mideast and Latin America and increased pumping by Iraq. On the demand side: a warm winter in the United States and a drop in demand as Asia's economy slumps.
Last Wednesday, members of the Organization of Petroleum Exporting Countries pledged to cut production by 2.6 million barrels a day, or about 3 percent, over the next year. Lower supply means higher prices, but the markets weren't particularly impressed with these promises, and oil closed at $14.60 a barrel, little changed from its price before the OPEC meeting.
Below $16, it's hard for most drillers and oil service companies to make decent money. The big, integrated international petroleum firms that sell to consumers can still do well because their costs fall, but up the production chain, businesses get creamed.
Or, more precisely, the businesses themselves get hurt a little (or even continue to thrive), but a panicky Mr. Market causes their stocks to get hurt a whole lot. This is one of those "rolling depressions" that Marty Whitman, manager of Third Avenue Value Fund, talks about. Masked by the general good health of the economy and the market, some sectors are suffering. Oil service is a prime example.
A good way to find stocks to buy is to look closely at such sectors, and the daily list of "Global Industry Groups" in the Wall Street Journal is the place to start. Since the start of the year, oil drilling stocks are down 26 percent, drillers are down 11 percent and secondary oil companies are down 10 percent.
But those aggregates don't tell the whole story. Excellent companies have been devastated.
Take Smith International Inc., which makes drilling equipment such as diamond bits. It has a good balance sheet and sales that have gone from $220 million to $1.6 billion in four years. According to Bloomberg News, the mean estimate of the 15 analysts who cover the stock is that profits this year will rise from $2.58 to $3.11 per share, or 21 percent. Not bad, but not as good as in 1997 and 1996; the gain in each of those years was over 50 percent.
Still, look at Smith's stock. From a high of $87.88 a share in October, it had fallen to $37.31 Wednesday - down 58 percent in eight months. (Halliburton Co.), which Houston analyst William Herbert, of Howard Weil Labouisse Friedrichs Inc., told me is the "best-managed company in the oil-service industry," is down 43 percent since the Asian crisis broke in October. Deepwater driller [ Transocean Offshore Inc. ] , is off 46 percent. (Schlumberger Ltd.), the biggest of the oil-service companies and a popular stock on Wall Street, is down only 27 percent, but a smaller firm, (Parker Drilling Co.) is down 61 percent in eight months, while [ Ensco International Inc. ] , a contract driller whose earnings have more than sextupled in three years, has fallen 60 percent.
What's going on here?
The answer, in a word, is Asia. If you believe the Asian crisis has been overdone in the stock market, your best play - better, perhaps, than Asian shares themselves - could be oil-service stocks.
Typically, these shares go to extremes, either down or up, says Angeline Sedita, an analyst with [ A.G. Edwards & Co. ] in St. Louis. Oil service, she believes, "offers wonderful appreciation potential." But what about that oil price? I ask. "My view is that what goes down eventually comes up," she says. "Oil at these levels becomes 'naturally correcting.' " In other words, when prices get low enough, production slows significantly, thus crimping supply, thus pushing prices back up.
Gerard Feenan, the oil-service analyst for Value Line, is bullish on the sector: "Though persistent weakness in oil prices is a cause for concern, we think industry fundamentals remain very positive." He gives a timeliness ranking of one or two to 14 of the 22 companies he covers. The entire sector is ranked fifth highest of the 90 that Value Line follows.
Feenan's highest ratings go to [ Varco International Inc. ] , which sells and leases highly advanced drilling tools and carries a backlog of orders that is as large as its entire 1997 sales volume, and [ Global Industries Ltd. ] , a Lafayette, La., provider of offshore construction and support services.
One large mutual fund specializes in oil-service companies: notably Fidelity Select Energy Service, whose portfolio is headed by Cooper Cameron and Halliburton.
For funds that buy energy stocks of all sorts, the choice is broader. Top performers, according to Value Line, include [ T. Rowe Price ] New Era, which I own myself and which has returned an annual average of 14 percent for the past five years at relatively low risk, and Dean Witter Natural Resources Development Securities, whose top holdings include big internationals such as (Exxon Corp.) and (Royal Dutch Petroleum Co.)
But if you are thinking of buying a diversified oil portfolio, consider a closed-end fund that trades, just like a stock, on the New York Stock Exchange. It's called (Petroleum & Resources Corp.), (PEO), and a recent report by Morgan Stanley Dean Witter calls it a "strong buy" partly because the investment firm expects "energy stocks to rebound as the price of oil recovers" and partly because the fund is so well run.
Oil Stocks Only Good For Long-Term Investors
Triangle Business Journal - Raleigh/Durham
How quickly we forget. Gasoline was cheap when I got my driver's license in 1970. At 30 cents a gallon, you could cruise for a week on $5. But then the unthinkable happened. Our Middle Eastern "friends," believing that we were living too high on the hog, decided to take us down a notch or two by quadrupling the price of oil - overnight.
Today, the '70s mindset again reigns supreme. Speed limits are at all-time high" sport utes" are the vehicles of choice, even though they drink gasoline like Sherman tanks. Might we be setting ourselves up for yet another fall? Our first question takes a closer look.
Q: With the price of oil at a 10-year low, should investors be buying or selling oil stocks? - A.F.
A: Probably buying, but that's assuming that the buyer has a lot of patience - something for which Wall Street isn't renowned. Oil prices recently dipped below $13 a barrel for the first time since 1988, reflecting the fact that much of Asia is in recession or depression, depending upon who you believe. In such a weakened state, the Far East's appetite for oil has shrunk significantly from just a year ago when oil was $19 per barrel. OPEC says it's going to limit production to drive prices higher, but if it's successful in doing that, it would be the first time in a long while.
Will things get better in the future? At some point they probably will, but itmay take a year or more, so this type of investment is only appropriate for those with a long time horizon. For the risk averse, the integrated oils such as [ Texaco ] , Mobil and [ Amoco ] may have more appeal because they are less volatile and pay better dividends.
For the risk-oriented, drilling companies like Haliburton might be attractive because of their current depressed prices.
Q: I heard about a mutual fund that invests in nothing but initial public offerings. What are your thoughts about this type of investment? - D.Y.
A: I'd avoid it, and here's why. Every mutual fund manager wants as many shares of "hot" IPOs as he or she can get. So the IPO Plus Aftermarket Fund is not unique in that respect. What does make it unique, and what would worry me as an investor, is the fact that this fund's managers intend to invest in nothing but IPOs and will buy shares in the aftermarket when they can't get them on the initial offering. That strategy seems very risky to me.
Analysts View From England
Daily Mail
Watch my face, said Saudi oil minister Ali al-Naimi after the latest Opec meeting in Vienna. 'You can see the confidence,' he boasted when asked whether oil producers really would cut production by another 1.4m barrels a day.
Watch for September, said analysts. If the deal holds until then prices should rise - but not before.
Together with cuts agreed earlier, oil ministers have thrashed out a deal to cut global production by nearly 10pc. Yet Brent crude slipped back 30 cents to $12.25 a barrel.
Flemings analyst Alan Marshall says: 'There is no rush to buy oil because every storage depot in the world is full of the stuff. All the speculative money got out at the start of the year and it will only go back in when supply shrinks.' Jonathan Wright at Merrill Lynch adds: 'The market has got to see a couple of months' data before Opec is given any credit.' If the deal sticks, Marshall sees Brent hitting $18 in September and $20 by the year end.
Wright says BP, down 15p to 875p, and Shell, up 3p to 425p, have most to gain from a higher oil price. Among explorers, Enterprise Oil (unchanged at 563p) and Lasmo (51/2p lower at 240p) stand out.
$827M Oilpatch Merger
Strong Canadian gas sector, weak C$ draw Devon Energy into friendly merger deal with Calgary's Northstar Energy
The Financial Post
The ranks of large independent energy firms in Canada declined again yesterday with Oklahoma based Devon Energy Corp.'s announcement of an $827-million share-swap merger with Northstar Energy Corp.
Based on a June 26 closing price of US$36.50 for Devon, the bid equals $12.17 for each Northstar share, a 25% premium to its closing of $9.75 June 26. The total value of the deal, including assumption of $455 million in debt, is about $1.2 billion.
Northstar and Devon announced the proposal after the market closed. Earlier, after a request from the Toronto Stock Exchange, the company confirmed it was in merger discussions. Shares of Northstar (NEN/TSE) closed up 85› at $10.60 before trading was halted. Devon's shares (DVN/AMEX) rose to US$36-11/16, a gain of 3/16. Northstar shares have ranged between a high of $13 and a low of $8 in the past year; in the same period Devon has fluctuated between US$49-1/8 and US$32-5/8.
John Hagg, Northstar's president and chief executive officer, said the merger creates one of the largest independent energy firms in North America.
He said Northstar started thinking about a cross-border structure a couple of years ago after seeing similar deals in the financial and pipeline sectors.
"We think we're at the leading edge of new kinds of structures and visions for a North American energy company," he said in a conference call with reporters.
The operating philosophies of the two companies are quite close and there is little overlap in operations, he said.
Larry Nichols, president and CEO of Devon, who will occupy the same slots at the combined corporation, said Northstar's attractions included its assets, staff and management.
"By combining the expertise and local knowledge of Northstar ... with the financial statement that Devon has, the resulting entity will be much stronger and much more exposed to greater growth," he said.
Devon already has a small presence in Canada, from its purchase of Kerr-McGee Corp.'s properties in December 1996, which will be rolled into Northstar's operations.
The resulting company will have 53% of its reserves in the U.S. and 47% in Canada. It will have total reserves of 1.2 trillion cubic feet of gas and 117 million barrels of oil.
Nichols said the new firm would have only US$312 million in total debt while having some US$500 million available in lines of credit.
In a different twist from other transactions already announced, Northstar will continue to operate under its own name and with existing management.
A strong US$ plus optimism about the future of Canadian gas prices are bringing many U.S. producers shopping north of the border. Northstar had been a target in many analysts' eyes because of its debt and operational problems stemming from last year's takeover of Morrison Petroleums Ltd. In the first quarter ended March 31, the firm had earnings of $30.2 million, including proceeds from assets sales, on net revenue of $53.2 million.
Paul Beique, a Calgary analyst with Dundee Securities Corp., said the proposal will recapitalize Northstar and may allow it to pursue opportunities more aggressively.
He was somewhat surprised that Northstar was able to attract a friendly bid. "I thought the stock was cheap. I thought the stock was vulnerable to a hostile bid," he said.
Northstar joins a long list of Canadian firms that have been bought or taken over by American companies. In late May, Marathon Oil Co. gave investors a choice of cash or stock for a US$1.1-billion takeover (including debt) of Tarragon Oil & Gas Ltd., while Union Pacific Resources Group Inc. kicked off this year's trend by paying US$2.6 billion in cash for Norcen Energy Resources Ltd. and assuming another US$900 million in debt.
Oil prices continue to languish around US$14 a barrel despite promises of production cuts by big producers around the world as well as members of the Organization of Petroleum Exporting Countries. Second-quarter financial results are not expected to be pretty for many firms, especially oil-oriented producers. Dundee's Beique expects the merger and acquisition trend will continue. "There are a lot more to come," he said. "There are a lot fewer big ones to come because there aren't that many big ones left."
Northstar Was Prospect-Rich But Cash-Poor
Grand plans to drill a spate of expensive, high-risk Canadian natural gas wells but shrinking cash to fund them led Northstar Energy Corp. to its planned merger with Oklahoma based Devon Energy Corp. , Northstar Chief Executive John Hagg said on Tuesday.
"We think we're prospect-rich in these deep, exciting things but on the other hand, relative to our overall size and relative to having C$400 million or so in debt, maybe we were a little bit too skewed to those kinds of projects," Hagg said in an interview.
"You want to pursue them all. The quality is so good you don't want to give them up, so this is one way to give us the time to develop them."
Devon on Monday announced a C$830 million stock-swap offer for Northstar , a Calgary based company that had struggled after its 1997 takeover of Morrison Petroleums Ltd.
Under the friendly deal, which has the approval of both firms' boards of directors, shareholders of Northstar would receive 0.227 of a Devon share for each Northstar share.
The bid circular was expected to be mailed in the next three to four weeks. Morgan Stanley and RBC Dominion Securities acted as financial advisers to Northstar in the deal.
Northstar is involved in drilling three deep exploratory gas wells in the southwestern Alberta foothills, where drilling costs can run as high as C$10 million a well. Most industry experts agree that vast gas reserves lie deep beneath the foothills of Alberta and British Columbia, but drilling success rates are low because of the tricky geology.
Through a joint venture signed late last year with Chicago-based Amoco Corp.'s
Canadian subsidiary, Northstar also gained numerous exploratory drilling prospects in another gas rich region, northeastern British Columbia.
Northstar at the time committed to spending C$45 million over three years.
"We're seeing more opportunities up in northeastern British Columbia to spend more money there and those are very deep, high-cost, remote-location wells there as well," Hagg said.
He said he had been in discussions regarding a merger with another U.S.-based company about two years ago because of a belief that Northstar could benefit from the higher cash flow multiples U.S. markets afford independent oil companies in their stock prices.
Current low oil prices, which have constrained financial fortunes throughout the Canadian energy sector, rekindled Northstar's desire to merge with a U.S.-based company armed with a strong balance sheet, he said.
"We think a lot of the value in Northstar is in our deep prospects that don't have any reserves booked right now and we felt, quite frankly, with our debt a little too high and oil prices as low as they were that there was a risk that in the months ahead we could be getting into a bit of corner."
He pointed out that none of the prospects would bear fruit within the next few months and getting a well on stream would be a lengthy process if the company made a discovery, so financial wherewithall was a prerequisite.
Devon Chief Executive Larry Nichols said on Monday that Northstar's gas prospects and a strengthening outlook for Canadian gas prices attracted him to the company.
"The cold, hard facts are that it's a higher-debt company getting together with a low-debt company and we think that over the next couple years it's the best way for us to get the full value out for our shareholders," he said.
Northstar on Tuesday closed up C$0.60 to C$10.60 on most-active turnover of 16.2 million shares, representing nearly 24 percent of the company's outstanding stock.
Devon's shares on the American Stock Exchange closed down US$0.75 to US$34.94.
DCR Comments on Devon Energy's Merger Agreement
Duff & Phelps Credit Rating Co. (DCR) views Devon Energy's planned acquisition of Northstar Energy Corp. as a positive from both an operational and credit perspective. DCR rates Devon's implied senior debt 'BBB-' (Triple-B-Minus) and its preferred stock 'BB' (Double-B).
Under the agreement, Devon will acquire Northstar, based in Calgary, Alberta, for about $565 million in stock and will also assume about $312 million in debt from Northstar. Devon will issue 0.227 share for each of Northstar's 68 million shares outstanding. The transaction also has a provision that allows Devon to pay as much as 0.235 share for each Northstar share if Devon's stock price falls below $32.95. The transaction will be accounted for as pooling of interests.
The acquisition provides Devon with additional proven reserves of 550 billion cubic feet of natural gas and 36 million barrels of oil and NGLs, all in Canada. In addition, Devon will get 1.6 million acres of undeveloped leases in Canada. The purchase nearly doubles Devon's natural gas assets and leaves the company with 1.2 trillion cubic feet of gas and 117 million barrels of oil after the acquisition.
The planned acquisition is also positive from an operational viewpoint as Northstar's operations appear to complement Devon's existing Canadian operations. Devon will merge its existing operations in Canada into Northstar's operations, and Northstar's current management will operate the merged Canadian operations. After the acquisition is complete, Devon's assets will be split evenly between the United States and Canada.
DCR plans to meet with Devon's management in order to complete a thorough review of the transaction and to evaluate the company's financial objectives. The priorities for the use of cash and management's acquisition strategy will need to be analyzed in order to assess its impact from a debt service perspective.
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