<THE DRIP PORTFOLIO>
Touchstone Friday
Plus, what's next?
by Jeff Fischer ([email protected])
Paris, France (Dec. 18, 1998) -- We burnt off Thursday's hours by summarizing where the oil industry has been and where it might be going. Our conclusion: more consolidation, continued fluctuations in oil prices and demand, and overall, continued uncertainty for the long-term -- much more so than with a pharmaceutical or beverage company. None of this is surprising. Industry leaders still offer many strong points that make them attractive, and many of them, as Brian showed us three weeks ago, have beaten the market over the long term.
Over the past two weeks, Brian covered the upstream dynamics of the oil industry, meaning exploration and production -- or E&P. On Tuesday, Brian provided an overview and considered what made companies profitable in this segment. We took a look at Return on Equity and Return on Assets. Next week, I'll begin to consider the downstream operations of the industry, better known as refining and marketing. We'll call it R&M (not to be confused with the Rule Maker Portfolio, although that port does own two oil giants).
I'm certain that in this segment of the industry we're going to discover that, as with upstream operations, there are mainly two factors that determine how profitable equally efficient oil companies are: 1) oil prices, and 2) oil supply. Of course, these two are very interrelated and are also intertwined with oil production in relation to oil demand. If we could take these variables out behind the barn and shoot them, we would. But we can't. Oil prices -- like a sly coyote -- will always be stalking our investment farm. Oil supply, as predictable as a rabid dog, will always be one step ahead of us, running through the forest with its tongue hanging low and its eyes lolling (picture Saddam's head on the torso of a running dog in the night).
What're ya gonna do? No. I already said that we can't shoot anything. Market uncertainty comes with investing. We accept this and we remember our goals: invest in reasonably predictable market-beaters that possess a sustainable advantage in a lasting and growing industry, one which we understand.
We'll do our best to understand the variables in the oil industry. Oil prices and oil supply are "brother variables" when it comes to analyzing their impact on oil investments. Both are contingent to a large degree on oil demand and OPEC. OPEC controls 75% of the world's known black gunk reserves. If it shut itself down (assuming it could), oil prices would soon double. Then triple. Then keep going. However, even OPEC can't currently do much about today's prices (it can't agree to slow production much), nor can it do anything about the world's lagging demand for oil. Instead, it's hoping to add more countries.
The secretary-general of OPEC is Mr. Rilwana Lukman Skywalker, of Nigeria (Okay, I added the "Skywalker"). He recently shared that three of the world's largest non-OPEC oil exporters -- Oman, Russia, and Mexico -- might join the 11-member OPEC clan. This would help the cartel combat low prices. The more countries under OPEC's popup tent, the more it can sway influence.
Beyond oil, the rest of our week was slick. (Throw a rotten tomato at your screen now!) On Wednesday, Brian presented a great opportunity and went so far as to label it. Be certain to see that column if you lack Foolish knowledge about 401(k) plans. On Monday, George Runkle continued his excellent look at "franchise businesses," using Home Depot (NYSE: HD) as an example. George will return in January to present part three of this highly Foolish topic.
Our Next Investment. For our January 1999 investment (blow the horns for the new year), we're sending $100 to buy more Mellon Bank (NYSE: MEL). It'll be sent this weekend, but it will take about 10 days to arrive because I'm in France. Why am I here? Since the Drip Port launched, I've received many e-mails from military Fools who are overseas. They're always saying, "It takes my check much longer to arrive sending it from this U.S. Air Force base in Germany," for example, "so can you please let us know sooner what you're doing each month?"
In response -- although we don't advise you to simply copy our moves -- we thought it'd be nice of us to run the Drip Port from France for our overseas Fools. So there you have it. Every baguette I eat, this new laptop, my enormous phone bill, the Renault I bought: it's all being done for our overseas Fools. They now have as much time as the Drip Port. Our check goes out tomorrow. (If you live in Australia or Japan and are still unhappy, just send us an e-mail. Brian will head right out.)
The Next Two Weeks: Brian and I will continue our oil study next week, but the week after next -- the final one of 1998 -- we'll review our investment performance for the year. We'll see how each of our companies stacked up. Dale will even return to give us a one day review and look-ahead for Mellon Bank.
This Week's News. On Thursday, Johnson & Johnson (NYSE: JNJ) announced that it will acquire a dermatological skin care business from S.C. Johnson & Son (no relation, just a creepy coincidence), which is a private company. S.C. Johnson owns a leading skin care brand called AVEENO. In skin care, Johnson & Johnson already owns Neutrogena and sales growth in this division has been rapid, rising from $220 million in 1995 to over $300 million this year. Neutrogena sales are estimated to hit $340 million in 1999. Skin care is a $47 billion retail industry, so J&J isn't even a gnat on this cow yet.
Also on Thursday, in news that impacted S3 (Nasdaq: SIII) more than Intel (Nasdaq: INTC), the relatively small chip maker announced a 10-year cross licensing agreement with our most successful investment. Along with the deal, Intel is purchasing warrants for S3 shares. S3 is the world's second-largest supplier of 2D, 3D, and graphics accelerator chips for desktops, among selling other products.
Any comments or questions, please visit the Drip message boards linked in the top right of this page. Have a Foolish weekend!
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