For traders that just happened to catch the bottom in oil stocks, life is good. After rapidly turning around what was looking like an awful start to the year, the benchmark Brent Crude Oil index is up 25% year-to-date.
While virtually all oil stocks have been lifted by the industry tailwind, independent explorers and producers have seen the most gains since late-January. That’s not particularly surprising, given their more speculative profile. But how long can independent oil stocks last?
Just by pure technical performance, the signs aren’t encouraging. After jumping to a strong 23% lead in April, the following month only produced an 8% gain. This is just shy of the average 9% move seen in February and March.
Of course, near double-digit growth isn’t anything to scoff at, especially considering the pedestrian blue-chip benchmark SPDR S&P 500 ETF Trust (SPY). That said, investors would prefer rising momentum going into the summer season — typically, the strongest quarter of oil stocks.
It is also worrying that the broad markets haven’t given us a good read. For example, SPY is flat over the trailing 52-weeks. Essentially, this suggests that nothing ground-breaking has occurred to justify optimism towards oil stocks. In addition, the University of Michigan‘s Consumer Sentiment Index between January through April is down 5% from the same time period one year ago.
That’s hugely problematic as unfavorable economic conditions had a negative impact on oil stocks in 2015. According to the U.S. Travel Association, spending by international tourists in the U.S. declined last year — the first time we have seen negative rates in five years. One of the sectors hurt the most was in foreign patronage of U.S. airliners, where sales dropped 11% from 2014.
The main culprit was a stronger dollar relative to foreign currencies. This also confirms that oil demand isn’t as inelastic as economists believe.
Add to this the volatile nature of independent oil stocks, and you have a recipe for a perhaps uncomfortably eventful summer. Here are three companies that are flashing warning signs.
Dicey Oil Stocks to Toss Before Summer: ConocoPhillips (COP)
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Houston-based ConocoPhillips (COP) has been on a tremendous roll, gaining more than 35% after hitting bottom around the middle of February.
But since that explosive rally, it’s clear that the technical performance of COP isn’t what it used to be. From mid-March onward, COP formed three distinct peaks, with the middle one jutting out above the other two. That may be an early warning sign of a head-and-shoulders pattern, which has a bearish implication.
It’s hard not to think pessimistically given the poor fundamentals of oil stocks. To its credit, COP management has made efforts to stop the bleeding, and there’s evidence that it’s having an effect. For example, ConocoPhillips’ profitability margins are in the upper half when compared to oil stocks specializing in exploration and production.
However, top-line sales in 2015 were down 44% from the prior year. More cost cuts will be necessary for COP to become profitable again.
One factor that should be watched closely is the quarter-over-quarter sales growth for COP versus the QOQ growth in market value for the Brent Crude index. The correlation since the fourth quarter of 2014 is very strong at nearly 90% (as seen in the image above). In other words, wherever Brent Crude goes, so too does COP. That’s good news if Brent continues to rally; not so much if it fails.
At this point, COP stock is a coin toss. Though it’s strong among independent oil stocks, there are other opportunities that engender much more confidence.
Dicey Oil Stocks to Toss Before Summer: Marathon Oil Corporation (MRO)
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Another exploration and production specialist, Marathon Oil Corporation (MRO), has enjoyed an even bigger run than ConocoPhillips.
Since hitting bottom in late-February, MRO stock virtually doubled in market value. However, there are indications that the party may be quickly coming to a close.
Last month, MRO dropped 3%. In addition, shares are charting the same worrying head-and-shoulders pattern seen in COP. Declining volume levels since the initial rally also threaten the likelihood of long-term sustainability.
Fundamentally, the symptoms from the long oil rout are taking their toll on MRO. Revenue loss in fiscal year 2015 was the worst among the featured oil stocks at -48%.
Adding to the concern is the fact that in recent quarters, there’s no marked improvement in sales deterioration. That will prove particularly challenging because profitability margins for MRO are middle of the ground against other oil stocks.
Because of its financials, MRO isn’t quite as coupled to the rally in Brent Crude as is ConocoPhillips. There’s a 77% correlation between Marathon’s QOQ sales versus Brent’s market gains, which is definitely strong, but noticeably less than COP. This is mostly due to the fact that as Brent pushed higher from late January to March, Q1 sales for MRO dipped 52% against the year-ago level.
In many ways, MRO is just like COP stock — except worse. Obviously, that wouldn’t make for a compelling buy argument.
Dicey Oil Stocks to Toss Before Summer: National-Oilwell Varco, Inc. (NOV)
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Companies involved in the production and exploration areas aren’t the only oil stocks that are having trouble.
Equipment and services provider National-Oilwell Varco, Inc. (NOV) is also feeling the pain.
After jumping nearly 40% between mid-February until the end of April, things quickly became ugly for NOV stock. For the month of May, shares lost 5% of their value. NOV is also stuck in a consolidation pattern.
There’s really no telling where it might end up, considering how choppy NOV has been this year.
One thing is clear: NOV shareholders have been steadily exiting their positions each time a spike-rally has occurred. They don’t seem to have much faith in the longer-term picture, and the financials justify this pessimism.
Although its 31% sales loss in fiscal year 2015 is the most favorable among the three oil stocks, revenue growth for NOV has consistently grown negative in recent quarters. To be fair, NOV does have a stronger balance sheet relative to debt levels. However, that’s an awfully risky bet to place based on one statistic.
More telling is the relationship (or lack thereof) between NOV sales and market growth in Brent Crude. The correlation is only 22% — too weak to make any scientific assertion. Unlike MRO and COP, the correlation between oil’s broad rally and NOV is only technical in nature, and very sporadic at that.
While a rising tide lifts all boats, NOV simply has too many holes in its hull.
As of this writing, Josh Enomoto did not hold a position in any of the aforementioned securities.
