Update September 11, 2015: The consensus on Schlumberger’s (SLB) $14.8 billion bid to buy Cameron International (CAM) is that it’s a call by Schlumberger on a bottom in the oil sector. If it were that justifies the 56% premium that Schlumberger has offered in the deal.
But I’ve got an alternative and less hopeful take. I think the deal testifies to Schlumberger’s belief that capital spending budgets in the oil sector have a lot further to fall—and that to stand any chance of grabbing a bigger piece of this smaller pie, oil service and equipment companies that to be able to offer services and equipment that will help oil producers wring more costs out of their capital spending.
That’s exactly what the acquisition by the world’s premier oil service company of a great oil hardware company promises. Cameron is the world’s largest provider of surface wellheads, the set of values that sits on top of an oil well and controls the flow through the well from the oil reservoir. Schlumberger and Cameron have an existing joint venture so the two companies have a good idea of how to combine Schlumberger’s engineering and digital mapping services with Cameron’s hardware. (Unlike the proposed deal that would combine the second and third oilfield services companies (Halliburton (HAL) and Baker Hughes (BHI) this deal isn’t likely to face extensive review by the Justice Department because Cameron sells hardware while Schlumberger sells services.) The Schlumberger/Cameron joint venture, OneSubsea, was set up in 2012 to offer better performance at a lower cost than offered by hardware and service companies operating independently. I think it’s safe to say that the joint venture worked well enough so that Schlumberger wanted to buy all of Cameron at such a substantial premium. (Credit Suisse projects that OneSubsea will see growing revenue in 2015—not exactly the typical oil sector story. One reason the price was so high is that Cameron, unlike most of the oil sector, hasn’t been pummeled. Shares of Cameron are down just 10.57% for 2015 through the close on September 11 and up 29.07% over the last year. The stock’s September 11 closing price of $64.47 isn’t all that far below 5-year high of 2014 $74.33 set on August 29, 2014.)
Schlumberger’s logic in this acquisition is based on continued pressure on capital budgets at oil producers. A big oil company executive recently told an industry conference, Credit Suisse reported on September 11, that the oil industry currently requires $70 billion in cash flow to grow production. But pressures on oil companies to lower costs could see that number fall to $50 billion over the next few quarters. Over that time period, then, oil service and oil hardware companies are looking at a shrinking market. To grow revenue and profits oil service and hardware companies will have to win a bigger share of a smaller pie by enabling oil producers to reach their lower cost targets.
Schlumberger has a history of acquiring joint partners—as in the 2010 deal for Smith International. I think that gives investors reasonable confidence in Schlumberger’s ability to integrate two companies and deliver the numbers they’ve promised Wall Street. The deal, according to Schlumberger, is expected to be accretive to earnings in the first year after closing and to generate $900 million in cost savings and other synergies in the first two years after the deal closes in the first quarter of 2016.
Besides all these reasons for likely this deal, I think it confirms that Schlumberger is holding to its historic discipline of buying when its sector is in the dumps in order to pick up market share at the top of the cycle. There aren’t many cyclical companies that are so sure of their judgment that they’re willing to spend big at the bottom of the cycle. Diesel engine maker Cummins (CMI) comes to mind, but not very many other names. Both Cummins and Schlumberger are in my long-term Jubak Picks 50 portfolio.
(My apologies that everything is running late today but I’ve managed to acquire my first autumn cold in the last few days.)
For the last two posts on my free JubakPicks.com site I’ve looked at the increasing–and increasingly disconcerting–evidence that Chinese financial regulators might be at sea when it comes to figuring out what to do about the bear market in Mainland stocks.
Support prices by direct purchases. Stop direct buying and let prices find their own level–with boost from interest rate cuts. Back to direct buying but only after 2 p.m. in Shanghai and only for the biggest stocks. Arrest anyone who might try to analyze stock prices or who runs a brokerage.
Does this stew sound like it might make investors and traders nervous?
And, of course, China’s meltdown isn’t the only source of worry and volatility in today’s markets.
On Monday and Tuesday on my paid JubakAM.com site I took a look at oil. First, in my Sector Monday Part 1 post I worried that despite a 27% jump in the price of crude in three sessions, oil stocks were going nowhere. That, I suggested, indicated that investors didn’t see a change in oil sector fundamentals that would support a bottom in the sector and a sustained recovery in oil prices. In other words, Monday was a bounce. Then on Tuesday after crude fell by 7% to 8%, I looked at how the end of summer driving season and a big increase in maintenance shutdowns at U.S. refineries could result in a big increase in crude inventories in the weekly oil and oil products report due from the Energy Information Administration on Wednesday, September 2. We’ll know tomorrow and I’d say there’s a very good chance that the short sales that got taken off by traders as West Texas Intermediate moved up from $38.24 a barrel on August 24 to $49.20 on August 31 will go back on as traders bet on a retracement of much of the the recent gains in oil prices.
That’s what I’m working on at my subscription JubakAM.com site–I think there’s some value to you in passing on the direction of my thinking about the market on that site. Hope so anyway.
And, of course, there’s an ulterior motive: If you decide that you’d like more detail on those posts, I’m hoping that you’ll subscribe to my site at JubakAM.com for $199 a year. (By the way, you can get a full refund during the first seven days if you change your mind for any reason.)
Exxon’s dividend is up to 3.75% and latest quarterly report says dividend is safe even at current oil prices
Update: August 3, 2015. Dividend income investors don’t buy ExxonMobil (XOM) because it pays the highest dividend in the market or in the oil sector. They buy it—and I bought it for my Dividend Income portfolio on May 21, 2015—because it pays a relatively high, safe yield.
How does that trade off look after a truly horrible second quarter earnings report delivered on July 31? Exxon shares fell by 4.6% after the company reported its worst quarterly profit since 2009. Earnings of $4.2 billion, or $1.00 a share, were down 52% from the $8.8 billion or $2.05 a share reported in the second quarter of 2014.
As of the close on Friday, July 31, shares were down almost 13% for 2015 and 17% for the trailing 12 months. Shares were down 9.2% since I added Exxon to my Dividend Income portfolio.
Actually the trade off still looks pretty good. Thanks to that punishing drop in share price Exxon’s dividend yield as climbed to 3.68% from 3.35% at the time of my purchase.
And despite the huge drop in earnings, Exxon doesn’t look to be in any danger of turning cash flow negative or of having to cut its dividend. In fact on July 29, the company voted to maintain its quarterly dividend at 73 cents a share after raising its dividend to that level on February 6 from 69 cents a share. (The record date for Exxon’s most recent dividend payout is August 13.)
That’s because even after seeing earnings cut in half Exxon earned $4.2 billion in the quarter. And the company’s cash flow besides being really hefty shows plenty of room for reductions that don’t touch the dividend.
For example, cash flow, a more important measure than earnings for seeing if a company might need to cut its dividend, came to $8 billion in quarter that ended on March 31. Capital spending came to $6.8 billion. The company used another $1.8 billion to buy back shares and spent almost $3 billion on dividend payouts.
For that quarter Exxon grew cash by a bit less than $600 million.
Can you see how easy it would be to reduce cash outflows in order to preserve the dividend?
How about reducing capital spending? Capital spending was down 12% in the first half of 2015 and was down 16% in the second quarter from the same periods in 2014.
Or how about reducing stock buybacks in the quarter by $500 million from $1 billion?
Exxon’s ability to offset a crushing drop in oil prices with increased earnings from its refinery and distribution business also adds to the safety factor for this stock. What are called downstream earnings—that is earnings from refining oil and then selling it through gas stations–rose to $1.5 billion in the quarter from $831 million. That wasn’t nearly enough to offset the $2 billion decline in earnings from the company’s upstream business—oil production—but it sure doesn’t hurt an oil company to have a sizeable business that makes more money as oil prices fall.
Shares of ExxonMobil fell below $80 a share on Friday, July 31, to their lowest level since 2012. And there’s certainly a good chance that shares will move lower in the current quarter since crude oil prices have moved lower than they were in the second quarter. Supply growth from OPEC and the end (probably) of sanctions against Iran are likely to increase supply in coming months. West Texas Intermediate, down to $47.12 a barrel on July 31, could retest lows from $40 to $45, although analyst projections still see West Texas Intermediate closing the year at $60 a barrel or better.
But at $60 Exxon’s dividend is safe and the company has room to defend the current dividend at $45 as long as the market doesn’t get stuck at that level far into 2016.
Morningstar currently has a one-year target price of $98 on the shares. Standard & Poor’s is projecting $90.
Me? I wouldn’t mind seeing short-term dip that brought the yield up to 4% or more since, as I read Exxon’s cash flow, the company has plenty of powder available the ability its dividend. (On Monday August 3, shares of ExxonMobil fell another 1.45% and the dividend yield climbed to 3.75%)
Not something I’d say about a lot of companies in the oil and gas sector.
Update: July 28, 2015. Statoil (STO) reported second quarter results today (July 28) that beat consensus estimates on both earnings (NOK3.15 a share vs. the NOK1.62 consensus) and revenue (NOK138.5 billion vs. NOK124.8 billion analyst consensus.)
That doesn’t mean Statoil has found some way to magically sell oil for a higher price than competitors. Second quarter earnings may have exceeded analyst estimates but they still fell 27% year over year.
What’s the secret to the Norwegian oil company’s relative success at a time when oil continues a collapse from $108 a barrel in January 2014 to a July 28 close at $53.15 (for European benchmark Brent crude)?
Statoil’s quarter is a checklist for what an oil company has to do right these days to stand a chance of navigating a plunge in oil prices that still has a while to run. (Statoil is a member of my Jubak Picks portfolio. The position is down 36.4% since I added it on May 10, 2012. )
First, Statoil announced a further cut to its capital-spending budget to $17.5 billion for 2015. That’s down from $20 billion in 2014 and a projected budget of $18 billion reported last quarter. At the same time as the company continued to cut capital spending production climbed with second quarter production, adjusting for asset disposals, up 7% year over year.
Second, Statoil has been able to cut costs—and increase efficiency—so that it is finding and producing more oil even with lower capital spending. Unplanned losses (that is production losses that aren’t the result of planned events such as maintenance but are the result of accidents or weather) have fallen from 12% in 2012 to 5% in 2014. Efforts to increase the percentage of oil recovered from mature and declining off shore fields on the Norwegian Continental Shelf have pushed the recovery factor up to 50% with the company targeting 60% recovery. (Increasing oil recovery is an especially profitable endeavor since the company has already built out necessary infrastructure in the region.) Operating expenses fell an additional 15% quarter to quarter.
Third, Statoil has either been very lucky or very good at finding new oil to diversify its asset base beyond its traditional concentration in the Norwegian Continental Shelf. The company has announced promising finds in the deep-water Gulf of Mexico, off the east coast of Canada, and off both coasts of Africa (Angola and Tanzania.) Statoil has also recently added U.S. shale assets in the Marcellus, Eagle Ford, and Bakken geologies.
All this is backward looking, of course. Looking toward the future, Statoil has potentially lucrative positioning as a major supplier of natural gas to Europe at a time when Western European countries are looking to reduce their emissions of green house gases and to find alternative sources of natural gas to reduce reliance on Russian supplies.
Looking that that same direction, the big uncertainty is whether Statoil can continue to reduce costs and increase production at rates that will enable the company to maintain the current $0.221 quarterly dividend. Right now the company’s payout ratio is running at 80% to 100%, which doesn’t leave Statoil with a huge margin for further drops in the price of oil. In the conference call, the company said that it projects that it can maintain the current dividend payout (for 2015, management said) while reducing the payout ratio. The stock currently yields 5.4%.
As of July 28, looking at the likelihood that oil prices will stay low for a while, I’m cutting my target price to $24 a share by June 2016 from a prior $28 a share. Statoil closed at $16.48 in New York trading on July 28.
Update: April 14. The acquisition of BG Group by Royal Dutch Shell (RDS.A) has grabbed all the oil sector headlines. $51 billion deals will tend to do that—especially when they’re priced at a 52% premium to the pre-deal market price for BG Group. The acquisition makes Royal Dutch the biggest player in the world in the liquefied natural gas sector, expands the company’s presence in Brazil’s pre-salt oil projects in the South Atlantic, and gives Royal Dutch a big presence in waters off the east coast of Africa, one of the world’s most promising new areas for exploration. In short it’s not a bad deal although it is expensive: Credit Suisse calculates that the deal will dilute earnings at Royal Dutch by 10% in 2016, the year the acquisition will close, 5% in 2017, and then 1% in 2018, the year when the acquisition turns earnings positive.
The big deal headlines have overshadowed a series of announcements from Norway’s Statoil (STO) that on a smaller scale promise to continue the transformation of Statoil from a company focused on the North Sea to one with a major presence in the Gulf of Mexico, the Arctic frontier, and the same East African waters that Royal Dutch has just bought into.
For example, on March 30, Statoil announced the discovery of an additional 1 to 1.8 trillion cubic feet of natural gas at an exploration well in the water off Tanzania. That brings the company’s discoveries in the area to 8. I think Statoil’s discoveries, the much bigger finds by Italy’s ENI (ENI), and BG Group’s exploration success in the area has put the natural gas reserves of East Africa over the top. There’s now clearly enough natural gas in the area to make the investment in liquefied natural gas facilities to export LNG to Asia a viable and attractive proposition. Statoil already exports liquefied natural gas from its fields on the Norwegian continental shelf. Now it will be able to export LNG to the highly lucrative Asian markets from fields much closer to those markets.
Shortly after that announcement, Statoil reported another find, this one in the Gulf of Mexico. Statoil, the operator of this well has a 50% interest in its oil production with Anadarko Petroleum (APC) holding a 37.5% interest.
And then, finally, today, April 14, Statoil announced another natural gas find near its Aasta Hansteen field in the Norwegian Arctic. Statoil put the find at 2 billion to 7 billion cubic meters of natural gas. In the last year Statoil has increased its estimates of the size of this field by about 25%.
It’s hard to tell if it’s time to buy Statoil. The company’s total costs are relatively high because of taxes imposed by the Norwegian government and hefty depreciation. That has helped push Statoil’s New York traded ADRs down 26% in the last 12 months, as of April 13, but it also means that Statoil is very highly leveraged to any recovery in the price of oil that takes the Brent benchmark back towards $65 a barrel.
The ADR’s chart looks like it shows a pattern of higher highs and higher lows over the last six months but the pattern isn’t especially strong with the December 2014 high at $18.55, the February high at $19.62 and the ADRs closing at $19.55 on April 14. The dividend yield is 4.84% at the moment but Statoil isn’t covering that dividend from operating cash flow—and won’t until 2016—so it’s not clear how safe it is.
I’ve owned this stock in my Jubak’s Picks portfolio since September 2009 and it is down 14.02% in that time. Certainly I can’t tell you when the plunge in oil prices is over, but I think the odds are good that we’ll finish 2015 near the $65 a barrel level that would work well for Statoil. I am cutting my target price today since I think $37 is a bit ambitious. The new target is $28 a share by October 2015.