SOME ENERGY DIVIDENDS MAY BE AT RISK

Transcription

1 SOME ENERGY DIVIDENDS MAY BE AT RISK By Ivan Martchev, Investment Specialist at Navellier & Associates, Inc. Co-authored by Louis Navellier, Chairman and CIO of Navellier & Associates, Inc. Some of the best performers in the October stock market rally were energy stocks and they are rapidly unwinding those moves with the oil price barely holding at $40/bbl last week. One possibility for the October rally in energy stocks was a short squeeze which may be identified by looking at a list of the best performers and seeing notably shrinking sales and earnings for 2015 as well as declining estimates for The most important question to many energy companies and their investors is why is oil declining? 600K 400K 200K 0K $ CLZ15 - Crude Oil WTI - Daily OHLC Chart Mar 14 May Jul Sep Nov Source: Stockcharts.com. Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary. Jan 15 Mar May Jul Sep Nov K 400K 200K 0K It takes time to develop the high-cost shale capacity in the US. In the case of shale, oil can cost $40 to produce and that cash cost can go much higher, to over $100/bbl. It also takes a lot of debt financing to make this shale expansion happen. Faced with the Damocles sword of bond coupon payments, shale companies have been jamming more and more sand down oil wells in order to increase output in a lower cost way in order to keep making those bond payments.(see Bloomberg s article US Shale Drillers are Drowning in Debt, published September 17, 2015). 7.5M 7.0 Enter Sandman Oil drillers are increasing the sand they use in fracking to boost output and survive low prices Proppant Pounds Per Well Q Q Q Q Q Q Q Q Q Source: Primary Vision Inc. Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary. NEM Q Q Q Q Q Q Q Q Q Q3 2015

2 But as Bloomberg recently reported 1, In the past year, U.S. oil producers used 83 percent of their operating cash flow to pay for debt service, according to the U.S. Energy Information Administration. A year ago, it was less than 60 percent. Since it is difficult to obtain new debt financing with such a shrinking interest coverage scenario, the present dynamic suggests a wave of bankruptcies and dividend cuts. This results in the absurd situation where lower oil prices mean more production, which later on means lower oil prices 2. Sooner or later this negative feedback loop may end as there is only so much sand an oil company can shove in an oil well before it runs out of money to make bond coupon or dividend payments due to a declining oil price. I think the oil price can decline much further, possibly below $20/bbl. Now that the U.S. has made a massive investment to increase oil output by nearly 60% over the past five years, global demand is weak and, in my opinion, getting weaker. China, with its voracious appetite for commodities, is causing quite the turmoil in Asian and Latin American economies as its economy decelerates courtesy of a busted real estate and stock market at a time of record debt overhang in the Chinese economy, approaching 400% of GDP if one adds shadow banking leverage estimates from reliable sources like the Brookings Institution 3. This resembles the Asian Crisis in where record financial leverage in Asian economies created quite the economic downdraft as capital flight set off a banking system domino effect and a series of currency devaluations. China is so big now that with a GDP that is likely to reach $11.2 trillion at the end of 2015 using estimates from the IMF and the Economist Intelligence Unit 4, the previous Asian Crisis may end up paling in comparison. China is likely to drag down many trading partners in Asia and Latin America via its reduced demand for manufactured imports as well as most major commodities, the most important of which is oil. 12,500 U.S. Field Production of Crude Oil Thousand Barrels per Day 10,000 7,500 5,000 2, U.S. Field Production of Crude Oil Source: U.S. Energy Information Administration. Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary. I conducted an experiment last weekend by taking a popular energy ETF like ishares U.S. Oil & Gas Exploration & Production (IEO) and plugging it into a Navellier dividend grader tool that uses cash flow coverage and all sorts of other metrics to come up with a grade for many IEO component dividends from A to F. Since the IEO ETF has Oil and Gas Exploration and Production 69.8% holdings but Oil & Gas Refining & Marketing 27.1% with a tiny bit of

3 holdings in transportation and storage, the results were quite telling as to how refining dividends were doing relative to E&P dividends. While our database does not have a grade for every XOI component, it was able to produce grades for enough of them to illustrate some important points. A few years ago, we saw a wave of de-integration in which ConocoPhillips (COP) spun off Phillips 66 (PSX) and Marathon Oil (MRO) spun off Marathon Petroleum (MPC) all of which happen to be in the IEO ETF. Surprise surprise, COP and MRO get dividend grades of F while the ugly duckling refiners no one wanted back at the time of the spinoff PSX and MPC get a grade of A. This is much bigger than the COP and MRO situation and extends to the whole refining sector where refiners show the healthy cash flows to maintain their dividends while E&P companies show deteriorating cash flows that sooner or later will potentially cause those in a weaker financial condition to cut or eliminate those dividends (with grades D and F in our database). Sample Portfolio of the Navellier Dividend Grader Database as of November 15, 2015 Ticker Company Name Sector Industry APA Apache Corporation Energy CHK Chesapeake Energy Corporation Energy XEC Cimarex Energy Co. Energy COP ConocoPhilips Energy CVI CVR Energy, Inc. Energy DK Delek US Holdings, Inc. Energy DNR Denbury Resources Inc. Energy DVN Devon Energy Corporation Energy EGN Energen Corporation Energy EQT EQT Corporation Energy HES Hess Corporation Energy HFC HolyFrontier Corporation Energy MRO Marathon Oil Corporation Energy RRC Range Resources Corporation Energy TOTAL PORTFOLIO GRADE Market Capitalization Dividend Grade Four Quarter Div Growth Twelve Quarter Div Growth Estimated Div Growth Consecutive Quarterly Dividends Div Yield Current F D B D F D D N/A N/A F D B F F C D D F F N/A N/A F F C C F D N/A F F D C D F F F F F D F A F D A F F F F C F C C D F D D F D Source: Navellier & Associates. Tables are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary. Looking at the relative stock charts if MPC: MRO and PSX:COP, you can see how the price of oil expands margins for refiners but shrinks them for E&P companies. My conclusion is that ExxonMobil (XOM) and Chevron (CVX) are much better off as more balanced companies for refusing to de-integrate the way COP or MRO did. De-integration realized absolutely no shareholder value for COP and MRO as by spinning off their refiners both became much more leveraged to the price of oil, which can decline dramatically as we have recently witnessed. This is the only conclusion that I can reach with the data presented here.

4 MPC:MRO Marathon Petroleum Corp./Marathon Oil NYSE $ 13-Nov-2015 Open 3.18 High 3.20 Low 3.12 Close 3.12 Volume 0 Chg (-1.54%) Source: Stockcharts.com. Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary. Since I don t think the price of oil is done falling as there has been no decline in production as demand growth has deteriorated, I think we are about to witness a wave of bankruptcies and dividend cuts in the energy sector. It may not be Conoco and Marathon Oil cutting dividends, although it is possible, but rather smaller and more leveraged producers. This is why my advice is to stay away from rising yields in the energy sector due to falling shares prices. Yields seem the highest before they get cut. Ivan Martchev is an investment specialist for institutional money manager Navellier and Associates. The opinions expressed are his own. Navellier and Associates holds no positions in any investments mentioned in the article. Ivan Martchev and Louis Navellier personally do not hold any securities mentioned in the article. This is neither a recommendation to buy nor sell the securities mentioned in this article. Investors should consult their financial adviser prior to making any decision to buy or sell the above mentioned securities. Investing in non-u.s. securities including ADRs involves significant risks, such as fluctuation of exchange rates, that may have adverse effects on the value of the security. Securities of some foreign companies may be less liquid and prices more volatile. Information regarding securities of non-u.s. issuers may be limited. Past performance may not be indicative of future results. Important Disclosures The preceding commentary is the opinion of Ivan Martchev, Investment Specialist with Navellier & Associates, Inc. and Louis Navellier, Chairman and CIO of Navellier & Associates, Inc. This is not a recommendation to buy or sell the securities mentioned in this article. Investors should consult their financial advisor prior to making any decision to buy or sell the above mentioned securities. Dividend Grades are subject to change. The sample portfolio is an example and should not be used to make investment decisions. Navellier may hold some or all of these securities in some or all of its investment portfolios. The sample portfolio and accompanying charts are for informational purposes only and are not to be construed as an offer to buy or sell any financial instrument and should not be relied upon as the sole factor in an investment making decision.

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