Oil Isn't the Only Commodity That's Crashing. What Does It Mean for Your Portfolio?

Job cuts have begun for some oil companies as they attempt to bring margins to a normalized number. And as stock prices drop for oil, renewable energies seem to have little to no relation to these numbers.

On this episode, our analysts will tell you what they'll be looking for over the next month as earnings are announced for the energy sector.

A full transcript follows the video.

Sean O'Reilly: Peak negativity has arrived in the oil industry -- or has it? On this energy edition of Industry Focus.

Greetings, Fools! I am Sean O'Reilly, joining you here at Fool headquarters in Alexandria, Virginia. It is Thursday, Oct. 15, 2015, and joining me are the absolute best people I could possibly spend my afternoon with: Tyler Crowe and Taylor Muckerman. How's it going, guys?

Tyler Crowe: We've been giving him a hard time for about 20 minutes while we've been setting this up. He needed to get that one out. It was a little sarcastic.

Taylor Muckerman: Filling in a little later in the afternoon than normal.

O'Reilly: Yeah. Headquarters gets busy. I do have a question about this peak negativity that's creeping into the industry. Do we know if liquor sales have increased markedly in the Houston Metropolitan area?

Crowe: My guess is probably yes. If you look at what's been going on. I wouldn't say liquor. Liquor is one of those higher-margin things and a little more expensive to get a bottle of liquor. I'm guessing the really base, really cheap beer. That's going to be the real thing going on in Houston right now.

If you look at some of the job cuts that have been going on in the area right now...

O'Reilly: The 200,000-person job cuts?

Crowe: Yeah. The head-count cuts that we've seen across the energy sector. I wouldn't be surprised if sales of very cheap beer brands are doing quite well.

Muckerman: You guys can find out in a couple weeks for us.

O'Reilly: We will. We're going there next week. Actually, on that note -- this was not planned – if you have any questions you would like us to ask the energy companies we'll be talking to, just broad questions, feel free to email us at [email protected].

Crowe: We will be speaking with National Oilwell Varco, DistributionNOW, and Vanguard Natural Resources. We're trying to get with Kinder Morgan, although we're still having some scheduling issues with them. We'll let you know pretty soon.

O'Reilly: Did you guys hear the joke about the oil man that walks into the bar?

Muckerman: I did not.

Crowe: T. Boone Pickens told this joke. I've heard this one.

O'Reilly: Oil man walks into the bar and says, "Get me a Jackie D." The barman says, "Don't you mean a Jack Daniels?" The oil man goes, "Not when you know him like I do."

Muckerman: T. Boone Pickens... he's seen it all.

O'Reilly: Yes, he has. Peak negativity is here. What does this mean, Tyler? Does it mean everybody is an alcoholic like we're insinuating now, or is it actually economic-based?

Crowe: No. This is more of a Wall Street thing. When you look at stocks, there is the translation between the company itself and the stock ticker that you and I can buy on the open market. When I say "peak negativity," it's looking at how people view the outlook of what's going to happen to the stock over the next year, 18 months.

O'Reilly: The stock is actually people's assumptions about the future.

Crowe: Right. When you're making your investing decisions, somewhere in that balance there is your expectation, the company's prospects, and your return. If you're looking at something in the energy sector two or three years ago, you thought your returns were going to be enormous because shale was booming, everybody was growing.

O'Reilly: Everybody was going to be a billionaire.

Crowe: It was going to be amazing. Nowadays, expectations are: "Man, I hope this company doesn't go bankrupt." At least for a small set of those.

O'Reilly: I definitely noticed this over the past six months because I'm one of the energy/industrial analysts on Fool.com. I'm regularly in Capital IQ looking at the forward estimates out to the end of the decade for the bigger oil names out there. They've gone down a lot. Taylor, have you seen that with Canadian companies?

Muckerman: Yeah. It's just about the same thing up there. I don't think they've pulled back as much as they've needed to because there is such a shortfall in oil prices in Canada, even compared to the United States. You don't see as bright of a future in the near term for these oil sands companies.

It's so much more expensive to produce, and I think once they get some pipelines going that they've talked about up in Canada, to get oil to the East and West Coast to their refiners and for export, I think you could see the oil sands have that decade-long bright future. In the near term, I don't think they have the same outlook that U.S. producers do.

O'Reilly: This article was put out on The Wall Street Journal saying that we've hit peak negativity in the energy sector, and the analysts took that as a bullish sign. Why is that? Is it just the rearview-mirror symptom?

Muckerman: I think it was -- those earning revisions were down to one or two standard deviations from the mean. You don't see it very often if you look at the history that they've provided in the chart. If you're a mean-revision kind of guy, he's saying this is the time to start looking at the market because you don't see it dip down below where it's at very often. If it does, it's almost an asymmetrical bet that it's going to bounce back up.

Crowe: One thing you have to take into account when we talk about negativity, it's normally looking at an analyst's outlook on a company. It would be "buy, sell, hold, outperform, and underperform." You'd put some price targets on something and call it a day. If you look at the trends that you normally see with these things, analysts are very good at being late to the game when it comes to these types of things.

You'll watch a company's stock drop by 70% because of debt issues. Then all of a sudden there's the underweight.

O'Reilly: Then I'm ready to sell.

Muckerman: Then it's outperform just down to neutral. Eventually it will be down to sell, and that's when you see...

Crowe: Exactly. I think the thought was that revisions down have been coming in pretty heavy, but it almost seems a little late to the game. If you look at stock prices of a lot of companies, they've already fallen immensely. To some degree, you could say they have adjusted to our current oil market.

To see all these revisions coming now might be saying, "People are going to be bearish from here on out" -- when it could be possible that an uptick in oil prices could send things back up again, despite the bearish sentiment.

Muckerman: The cyclicality when you get to peaks and troughs is very momentum-driven. If you see the tide turn when the negativity is this high...

O'Reilly: Well, everybody's sold now. That's when bottoms come in. Everybody will sell now. OK. Before we move on to discussing a possible slowdown in renewable energy; I wanted to point our listeners to a newly redesigned focus.fool.com.

There you'll discover a special offer to join The Motley Fool's Stock Advisor newsletter for all Industry Focus listeners. All loyal IF listeners have access to a special discount on Stock Advisor that works out to $129 for a full two-year subscription. Just go to focus.fool.com to take advantage of this offer. Once again, that's focus.fool.com.

Moving on to our second topic of today's podcast, we've got: Could we see a slowdown in renewable energy? Long story short, renewable energy financing is hitting a snag. That's in part because the drop in energy prices in the oil market and natural gas market makes renewable energy less competitive. Tyler, do you think this is fair?

Crowe: Yes and no. Here's my thought on it: Yes, in the sense that, for some reason, solar stocks have a tendency to correlate with oil prices. On its face it makes absolutely no sense whatsoever because oil and solar have very, very little in correlation with each other. Oil is predominantly a transportation energy source, which some use in petrochemicals. I think in the United States less than 1% of electricity generation comes from oil, specifically.

You could say it's much closer tied to natural gas, and natural gas has been very low, but if you look at the cost of energy produced, solar is in the range of cheap natural gas right now to the point where that argument doesn't really hold a lot of water. The reason that renewable energy financing is starting to see some issues is the development of things called yieldcos.

For people who don't know what yieldcos are, they are a specific type of company that are set up similar to a master limited partnership in the energy space, where it basically owns assets that pay a steady cash stream. It's not going to grow through research and development or anything like that or capital expenditures for organic growth.

Instead, it will buy projects that are financed earlier by developers.

O'Reilly: These companies like SolarCity are using yieldcos to raise...

Crowe: SolarCity, no.

Muckerman: They've got the financing directly from -- they're issuing bond-like issuances to get the yield from those. They're basically selling the future cash flows of their residential solar installations. The folks that are having these installed on their roofs are committing to 15, 20, even 30 years to pay them a certain monthly amount and then SolarCity is turning that cash flow back around and selling it as a bond.

O'Reilly: They're using these to raise billions of dollars.

Muckerman: Yeah, quite cheaply. I think without a lot of the risk that you're seeing with these yieldcos, though.

Crowe: Some very popular yieldcos are set up by energy companies, one's called Energy Yield, you also have Terraform Energy (TERP), and Terraform Global (NASDAQ: GLBL) -- both set up by SunEdison (SUNEQ). Basically, what these things are is... they're set up to buy utility-scale projects from these developers like a SunEdison. They will take on large forms of debt or issue equity to finance them because they're not actually building them over time.

They're making a big lump payment all at once and then sending out the cash flows afterwards. The problem for these companies is they use stock issuance as a major form of capital. With prices declining as fast as they have, it becomes more expensive from a cost to capital perspective, to actually finance these projects.

O'Reilly: You're issuing at the bottom.

Crowe: Yeah, you're issuing at the bottom. It's more diluted. You have to issue more shares to raise the amount of capital you want and it makes it more expensive. Therefore, it's that much more difficult to finance things. Yes, they could probably do it with debt, but then you run into the issue of issuing too much debt and getting yourself in trouble with too much debt.

O'Reilly: That's been the major criticism of these yieldcos. You're basically not guaranteed to get the shares when you need them to build these projects.

Crowe: Right.

Muckerman: These yieldcos aren't necessarily all renewable energy yieldcos. Yieldcos encompass a broad variety of different utilities. Back to Tyler's point where he doesn't think solar necessarily correlates to oil prices. I don't even know if it should be thought of in the same view as natural gas prices. You have to continually buy natural gas. You don't have to continually buy sunlight.

Once you build a solar panel installation, maintenance is the only thing that you need to keep up with, and you have to keep up with maintenance at a natural gas utility plant as well. There's huge advantages. Yeah, it might not be competitive on a price-per-kW now... will be with the initial up-front costs, but the cost savings, without having to buy the fuel to produce the energy, is an immediate return.

O'Reilly: There's a gain there.

Crowe: The one thing I will critique in the way that these are set up, though, is the fact that they do them in these ways where they have to make these large, lump-sum payments all at once. You see this in the master limited partnership spaces where you get the MLP that buys something that's dropped down to them at a lump-sum cost and they have to find all this capital all at once. Share price, interest rates, and things like that can really affect that.

Going forward, rather than just buying a project outright, I would like to see some of these yieldcos' model where they can develop one themselves in house and slowly build it up over time through internally generated capital and doing a little bit of retained earnings. Very similar to, what I would say is some of the better-run master limited partnerships that do keep some capital in house for these development projects and actually use cash generated from operations to pay for things.

O'Reilly: Got it. Before we head out, I do want to go into our third segment, which is: What is the biggest narrative we are all watching this coming earnings season? We're going to be getting a lot of earnings releases over the next month. Tyler, what are you looking at?

Crowe: One thing we've talked about over the last couple shows a bit has been this revision of credit facilities and financing for oil and gas companies. I think one thing that will be pretty prominent in this upcoming revision will be how much companies -- especially oil and gas producers -- have to write down some of their assets.

How much are they going to have to take a hit because they're saying that their oil and gas properties are worth less? I like to watch these because it gives you a better picture over time of how much something is valued. You could look back 12 months ago and look at what they were valuing those properties at $95. Then you could look at them again in April and say, "This is what they were valued at around $60."

Today, what are they valued at? Fifty-five dollars or $45. Having that scale gives you a much better idea of where these companies can lie in that range over time. We're not going to see oil stay wherever it is. It moves, it changes, and to see how much a company can add at that $60 range, how much it can add at that $70 range, can be really interesting to see how successful they're going to be going forward.

O'Reilly: Cool. Taylor?

Muckerman: I'm looking at margins. We talked about job cuts earlier in the show. Other cost-cutting initiatives that have been taking place. The price of oil has kind of flattened out. It's still lumpy, but it's still within the same $40-$50 band. We all know that sales are going to suffer because of that.

I'm looking to see if cost-cutting will help the margins, which will in turn help the bottom line. Until the price comes back, revenue is going to remain fairly flat to down. I'm looking at margins to see if these efforts are paying off now because the sooner, the better.

O'Reilly: On that note, a lot of E&P companies have been talking up efficiency gains over the last year, too. Is that...?

Muckerman: They have, but those are achieved over time, whereas you would imagine that job cuts and budget cuts are going to be more immediate. I want to see if those help because if those immediate cuts don't help with margins, they don't have any other leverage to pull.

Crowe: You can also see that with some oil services companies, too. Their ability to actually command prices for what they do. A lot of services like pressure pumping for hydraulic fracturing is a pretty commodity service. You're just going to go to the lowest service, but companies that have that ability, with something where they have a technological advantage over somebody, or something like that. It would be interesting to see who could actually preserve their margins through some sort of pricing power.

O'Reilly: Do any names come to mind?

Crowe: A name for me -- I know I'm going to be saying I'm a bull too much -- is Core Labs (CLB). They have a lot of proprietary services in terms of well characterization and high-technology products that optimize total reservoir production. Things like that can have a tendency to keep their margins a bit higher.

O'Reilly: Gentlemen, thanks for your thoughts and have a good one. If you are a loyal listener and have questions or comments, we would love to hear from you. Just email us at [email protected]. Again, that's [email protected].

As always, people on this program may have interests in the stocks that they talk about, and The Motley Fool may have formal recommendations for or against those stocks. So, don't buy or sell anything based solely on what you hear on this program. For Tyler Crowe and Taylor Muckerman, I'm Sean O'Reilly. Thanks for listening, and Fool on!