The price of oil is very sensitive to economic and political factors. While the ongoing Russia-Saudi Arabia oil price war has caused the price of crude to plummet, long term investors know that extreme price fluctuations are part and parcel of oil markets..
There is no doubt in my mind that demand for oil will return to normal levels once the coronavirus crisis is resolved and world economies reopen.
Thus, I see the current slump in oil price as a great opportunity to pick up undervalued stocks to hold for the long term.
Here are 3 oil stocks I’m watching.
Marathon Petroleum Corporation (Nasdaq: MPC) is specialized in refining, transporting and selling oil. The company operates the largest refining system in the USA, with 16 refineries and a crude oil production capacity of more than 3 million barrels per day.
MPC also sells gasoline, diesel and merchandise through convenience stores it owns and operates. Its retail segment has roughly 3,900 company-owned and operated convenience stores across the US and more than 1,000 long-term supply contracts for direct dealer locations.
Here’s the breakdown of its EBITDA by segment: 41% refining and marketing, 41% midstream segment and 18% retail segment. This means the company is reasonably diversified.
CORONAVIRUS AND OIL PRICES
The coronavirus crisis caused MPC stock to drop along with the overall market, plunging from $60 in February to $25 in April. The subsequent crash in oil prices is not helping MPC’s 2020 financial outlook as the company needs $50/barrel to generate substantial profits. If oil remains under $30 a barrel for the foreseeable future then the company’s short term prospects are bleak as it will break even at best.
That being said, I believe MPC’s financial situation allows it to survive even with a low oil price. From 2016-2019, it doubled its Revenues ($63bn to $123.9bn), Net Income ($1.1bn to $2.6bn), EBITDA ($4.3bn to $9.2bn) and Operating Cash Flow ($3.9bn to $9.4bn) and tripled its Free Cash Flow ($1bn to $4bn).
The immediate issue is that MPC will not produce any excess cash as long as oil prices remain low. 2020 might well be a disappointing year in terms of profits but the company’s survival is not in question.
SUSTAINABLE DEBT BURDEN
MPC has non-current liabilities of $40bn and its Debt Ratio is 0.57, which is in line with the industry average.
However, the drop in oil prices has forced the company to take on additional debt to raise short term liquidity: MPC recently priced its $2.5 billion unsecured senior notes offering consisting of $1.25bn principal amount of 4.5% notes due 2023 and $125bn principal amount of 4.7% notes due 2025.
MPC plans to use the offering’s proceeds to “repay amounts outstanding under its five-year revolving credit facility, prefund the repayment of other indebtedness with near term maturities and for general corporate purposes“.
I’m not a fan of companies loading their balance sheets with debt, but this is necessary to ensure the company can survive these turbulent times.
MPC pays an annual dividend per share of $2.32. This represents a very attractive yield of 9.40% and the company has raised its dividend for the past 8 consecutive years.
The current payout ratio of 58% is rather high. The company’s decisions to take on debt and defer 2020 Capex projects in order to raise liquidity will help offset the decline in revenues caused by the drop in oil prices.
The current oil slump will test the company’s short term resolve but I believe it is well positioned to bounce back when oil prices recover.
VERDICT: The company’s earnings are due to be released soon so risk-tolerant investors should buy the stock now while its under $30 but risk-adverse investors should wait until publication of results. Either way, I believe this stock could be a good long term hold.
ExxonMobil (Nasdaq: XOM) is one of the world’s largest oil corporations and one of the biggest publicly traded companies in the world. Formed in 1999 by the merger of Exxon and Mobil, it is the largest direct descendant of John D. Rockefeller’s Standard Oil.
ExxonMobil is an industry leader in all facets of the oil and natural gas business. It has significant upstream, chemical, downstream and natural gas and power marketing operations and it markets fuels and lubricants under four brands: Esso, Exxon, Mobil and ExxonMobil Chemical.
The coronavirus has caused Exxon stock to fall to a 10-year low. As one of the most integrated and diversified oil majors in the world, it is capable of weathering the current crisis and bouncing back strongly once its resolved.
MASSIVE REVENUES AND STRONG CASH FLOW
Frst, it’s important to remind ourselves of the fact that ExxonMobil’s finances are staggering. The company has dips in performance every one in a while but overall the trend is towards greater revenues and profits:
– 2019 Revenues of $255bn is up 16.9% from $218bn in 2016
– 2019 Net Income of $14.3bn is up 83.3% from $7.8bn in 2016
– 2019 EBITDA of $39.8bn is up 29.6% from $30.7bn in 2016
– 2019 Operating Cash Flow of $29.7bn is up 35% from $22bn in 2016
– 2019 Free Cash Flow of $5.3bn is down 10% from $5.9bn in 2016
MO’ LEVERAGE MO’ PROBLEMS?
Evidently, ExxonMobil’s biggest problem is the $99.6bn of long term debt. Worse, Barron’s reports that if Exxon is to maintain its dividend despite the current market conditions, 2020 Capex will have “to be funded with balance sheet capacity”, which translates to even more debt. It is expected that Exxon will soon declare that it will cut its 2020 Capex to $25bn from a projected $33bn, but this will not be enough.
Thus, Exxon decided to raise $9.5 billion in a mixed shelf offering of debt securities. There will be a mix of short and long term maturities, with the nearest maturity date being 2023 and the furthest away being 2051.
Exxon will use the proceeds for “general corporate purposes” but has also earmarked funds for paying short term liabilities, working capital, acquisitions, capital spending and other opportunities.
Is it reasonable for Exxon to add to its already sizeable debt?
Exxon is taking advantage of extremely low interest rates. Some say they are actually playing it smart by raising capital at near-zero interest rates. This is basically free money.
Credit rating agencies Standard & Poor’s and Moody’s don’t appear overly worried either. They both slightly lowered Exxon’s credit rating and issued a Negative outlook but the company retains its above-average investment-grade status.
Its sheer size, diversification and stable cash flows mean it is in no immediate or even long term danger of insolvency.
GENEROUS AND RELIABLE DIVIDEND
ExxonMobil pays a yearly dividend of $3.48, which represents a yield of 8%. This is extremely high for any company but Exxon has a long history of generously rewarding its shareholders. Having raised the dividend for the past 37 consecutive years, the company is a very well established dividend aristocrat and is very proud of this status.
Exxon may very well defy expectations and raise the dividend again. Even if the increase is modest, this would bolster investor confidence and potentially send the stock soaring.
That being said, the current payout ratio of 103% is too high and suggests the dividend is close to being unsustainable: In 2019, Exxon paid out $14.6bn in dividends when its Net Income was only $14.3bn. If they want to maintain the high dividend payment, which they will, Exxon will have to find ways to reduce costs and boost profitability even further.
I like ExxonMobil’s dividend and if they guarantee its payment then this stock is a strong buy. You can expect reasonable capital gains once the stock recovers but the main reason to buy and hold Exxon is for the reliable dividend income stream it provides.
VERDICT: Risk tolerant investors should buy now but prudent investors should wait until Exxon officially confirms its dividend to buy in.
Energy Transfer LP (Nasdaq: ET) is a company engaged in natural gas and propane pipeline transport. ET describes itself as one of the “largest and most diversified midstream energy companies in the country with more than 90,000 miles of pipelines traversing 38 states” and a workforce of nearly 13,000 employees.
Its Investor Presentation claims that roughly 30% of the US’ natural gas and crude oil is transported through its pipelines. It also states that the company has great earnings diversification, with no single segment contributing more than 30% of its adjusted EBITDA. Lastly, it says that the “vast majority of margins are fee-based with low commodity price sensitivity“. This last aspect will be crucial to the company’s performance during the current oil downturn.
STRONG REVENUE GROWTH
ET’s recent financial performances are encouraging:
– 2019 Revenues of $54.2bn are up 44.5% from $37.5bn in 2016
– 2019 Net Income of $3.5 bn is up 251.75% from $995m in 2016
– 2019 EBITDA of $10.5bn is up 162.5% from $4bn in 2016
– 2019 Operating Cash Flow of $8bn is up 135.29% from $3.4bn in 2016
– 2019 Free Cash Flow of $2bn is up $6.6bn from -$4.6bn in 2016
ET’s overall growth is very impressive. I’m really like companies who are growing their revenues and profits by triple digits. This suggests that the stock price has plenty of upside. I especially like the fact that the company became Free Cash Flow positive in 2019 and I expect them to remain so in the coming years.
The most worrying aspect of ET’s Balance Sheet is the $51 billion of long term debt. This figure represents a staggering 94.4% of total revenues.
ET is pursuing an ambitious strategy of borrowing to simultaneously invest in growth and pay generous dividends to its shareholders.
Over the 2016-2019 period, ET spent more than $30bn on Capex, $5bn on acquisitions and $6.6bn on dividends. ET financed these operations by taking on debt, issuing senior notes, selling assets, issuing preferred stock and forming joint ventures.
The good news is that ET is finally starting to lower its Capex. ET expects its long term Capex run-rate to be roughly $2-$2.5bn a year, compared to $5.9bn in 2019, $7.4bn in 2018 and $8bn in 2017. If ET can consistently maintain its Capex below $2.5bn, this will free up plenty of cash flow and give it greater financial flexibility.
Lastly, ET is making massive yearly debt repayments: Debt payments of $20bn in 2019, $28.9bn in 2018, $31bn in 2017 and $24bn in 2016 show that ET is committed to honoring its obligations.
Total ET insider ownership is 14.5%:
– CEO owns 11.9 million shares worth $136m
– Board of Directors owns 2.3 million shares worth $17m
– CCO owns 178,000 shares worth $2m
– CFo owns 78,000 shares worth $668k
– COO owns 53,000 shares worth $375k
Significant insider ownership is a very good sign because it means that management has a vested interest in seeing the company succeed.
A VERY GENEROUS DIVIDEND
As mentioned ET pays a very generous dividend of $1.22 per share, which currently represents a yield of 18.83%. The dividend was raised every year from 2007-2018 but was not raised between 2018-2019. This is not overly concerning given the incredible yield.
However, the total payout ratio is high and needs to decrease. Growth companies should not have payout ratios above 50% – especially if they are highly leveraged – and ET still has a long way to go to ensure that it can sustain its dividend. This should happen as Capex decreases and frees up more cash to lower the overall leverage.
Thus, I don’t mind if the dividend remains stable even for the next 3 years. This would be in the company’s best interest and increase its long term resilience. I am of the belief that dividend investors should prefer long term dividend security over short term high dividend payout gratification.
ET’s stock price crashed hard during the 2015-2016 stock market selloff. and it has a long way to go to return to its previous levels. The selloff was justified given the economic context of the time and the company’s high debt burden. At nearly $40, the company was definitely overvalued.
Recent financial performance suggests the company’s best years are still ahead. Further, given the high yield, capital gains are not the main purpose of investing in this stock. An 8% dividend yield is a great return and I don’t mind simply collecting the dividends DRIP-ing them back into the stock to boost my dividend payments even more.
I like ET’s growth and success at reaching its objectives. ET has made the bold decision of financing growth and dividends with debt but there is light at the end of the high leverage tunnel.
The next 2-3 years will be crucial and management has already proven that it can deliver its promises.
VERDICT: Investors interested in purchasing this stock should try to buy in under $7 if possible but any price under $8 is a good entry point given the amazing dividend yield.
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DISCLAIMER: This is not financial advice. Do your own research before investing in any asset. At writing, author holds shares of ET and may initiate long positions in both MPC and XOM.