Ever since the sharp fall in oil last year, the question has become when investors should buy back into the Big Oil companies. Everyone knows I love a good discount — especially when it comes to stocks — but I’m not interested just yet.
Oil prices have cratered over the last 12 months, recently falling back below $50 a barrel again, and with Iranian supply trickling back onto the market, we’re unlikely to see $90 again for some time to come.
Unless there’s a sudden shock to the system, it’s going to take at least another six months before Big Oil can stop the bleeding, much less get year-over-year comparisons moving in the right direction.
Just look at Exxon Mobil (XOM). This company alone accounts for close to half the sector’s overall market weight. Earnings have dropped 38% over the last two quarters, and few on Wall Street seriously think the trend will turn until Q1 2016 — and those numbers won’t come out for another nine months. Targets have only hesitantly come back in the last few months, but consensus for full-year earnings remains 23% below where the analysts were looking in January.
XOM supported a $103 share price a year ago as everyone assumed the company was going to earn $7.74 per share (so, it was trading at just more than 13 times forward earnings). But since then, earnings targets have plunged to $4.45, which might argue for fair value closer to $60 on a constant multiple basis. Here at $80, the stock now trades at a relatively rich 18 times the current target, which makes it cheap in absolute dollar terms but extremely expensive relative to its historical comfort zone — and no bargain compared to the market as a whole.
Across the sector, even worse stories play out.
Much like XOM, we’re looking at 67% coming out of energy earnings over the current year — not expectations, but an outright evaporation of two out of every three dollars the industry earned in 2014 — and that’s just on the big end of the business.
Given that kind of pressure on the “E” side of the profit/earnings calculation, it’s no surprise that multiples are blowing out to a nightmarish 39 times forward earnings on the large-cap side and a completely unsustainable 80 times earnings in the mid-caps. Drill any deeper (so to speak) and you’ll see smaller stocks bleeding cash outright for the second year in a row.
Any downside in the energy market raises serious questions for sustainability among the most heavily indebted players in the field. On average, companies in the sector are carrying a ratio – assets in hand divided by debt obligations coming due in the next year — of only 1.2. I see a few dozen stocks with less than half the cash they’ll need to pay their bills. With earnings for many declining purely on an operational basis, we may well see at least one high-profile default in the near term. Until the default shadow lifts, the risk of a second contagious backlash against the sector is simply too high for me to consider buying in.
Looking forward, I see the inherent challenges of $50 oil rapidly becoming apparent. I see a lot of stocks where earnings are falling or flipping from profitability to an outright operating loss — probably half of the independent exploration and production names are in this sad category — and a lot of others that are going to have significant trouble when their debts come due. At first glance, I’d say one in six companies in the sector have both strikes against them now, which should tell you everything about the contagion risk right there.
Not a single global oil company has both a strong balance sheet and growth. The big drilling names are in even worse shape when it comes to too much leverage and not enough cash coming in.
Within the broad oil services and equipment group, some interesting opportunities are emerging, but as yet there’s nothing I’m interested in.
Hilary Kramer is the editor of GameChangers, Breakout Stocks Under $10, High Octane Trader, Absolute Capital Return and Value Authority. She is an accomplished investment specialist and market strategist with more than 25 years of experience in portfolio management, equity research, trading, and risk management. She has extensive expertise in global financial management, asset allocation, investment banking and private equity ventures, and is regularly sought after to provide her analysis on Bloomberg, CNBC, Fox Business Network and other media.
