Save for early punk rock and a few obscure power pop bands, I’m not a huge fan of ’70s rock-n-roll. Rooted as a blues band in the late ’60s, the Steve Miller Band grooved into the ’70s and managed to crank out a few catchy radio mega-hits that are still staples of classic rock radio to today.
Ok. You know where I’m going with this, don’t you?
When stocks rally big time, I can hear the “Hoo! Hoo!” vocal hook of the SMB’s “Take the Money and Run” in my head as valuations get pushed to what I consider silly levels.
I’m hearing it now as I look at a few stocks in the oil sector.
Black gold has been on an absolute tear since the beginning of 2016. After a merciless pounding thanks to the one-two punch of a strong dollar and a global supply glut, oil has rallied 46% to nearly $54/bbl from its basement low of $37/bbl.
Is there any room left in the oil rally? Maybe. OPEC members recently reached an agreement to curb production by 2% with the goal of creating price stability and curbing the surplus. On the domestic front, rig count in the United States has fallen, keeping with OPEC’s production dial-back. Despite these efforts, analysts are calling for $60/bbl for crude on the top end. So, at $54/bbl, there’s a bit of an upside but it would seem as if the train has left the station.
One of the direct beneficiaries of the recent recovery in oil prices has been oil giant Chevron Corporation (CVX).
Those bold enough to buy shares below $80 have enjoyed a more than 50% run with a 3.62% dividend yield that pushes the total return well over 60%. Cue the Steve Miller Band hit.
But while there is little doubt that Chevron is one of the highest quality plays in the energy space, the stock has gotten way ahead of itself. At around $119, the stock trades with a forward P/E of 90. The company is expected to deliver earnings per share (EPS) of $1.34 for 2016, 42% short of 2015 EPS of $2.46.
While 2017 estimates call for EPS of $4.55, it’s a hard row to hoe. The company has crawled back from the oil crash admirably. But the company had negative free cash flow of around $16 billion last year and is expected to experience the same for 2016.
Chevron has committed to capex spending of $20 billion and to raising its annual dividend, but negative free cash flow makes keeping these promises difficult.
That said, there is still value in the energy space and investors should maintain exposure to the sector….