2018 is almost upon us. This week on Industry Focus, we're looking back at some of the biggest stories and headlines from the last year, and how they changed and didn't change their sectors.
In today's Energy and Industrials show, hosts Sarah Priestley and Taylor Muckerman talk about the slew of bad news that plagued Uber at the top of the year, Volkswagen's enormously costly emissions-testing lawsuits, and how General Electric's (GE 0.36%) CEO seat change has led to some huge shake-ups in the company. They also talk about Tesla's (TSLA +4.07%) upcoming semi-truck, United Tech Corp.'s (UTX 0.64%) acquisition of avionics and interior maker Rockwell Collins, OPEC's extended production cuts and Saudi Aramco's pending IPO, and more.
A full transcript follows the video.
This video was recorded on Dec. 21, 2017.
Sarah Priestley: Welcome to Industry Focus, the show that dives into a different sector of the stock market every day. Today, we're talking energy and industrials. It's Thursday, the 21st of December. I'm your host, Sarah Priestley. Today, we're going to be taking a look at what happened in 2017 in the energy and industrials segment. Joining me in the studio is Motley Fool premium analyst Taylor Muckerman. Taylor, thank you for joining me today!
Taylor Muckerman: My pleasure!
Priestley: How are your holiday preparations going?
Muckerman: I'm about there.
Priestley: Really?
Muckerman: Yeah, I think I'm done.
Priestley: I'm very impressed. [laughs]
Muckerman: I just have to get my old man a gift. That's it.
Priestley: They're always the hardest to buy for.
Muckerman: Yeah, he has pretty much everything he wants, and he's particular.
Priestley: Yeah. My dad pretty much gets a shirt or a jumper every year. Poor guy. And now he's going to know what he's getting this year, if he listens to this.
Muckerman: He'd better listen to it.
Priestley: Well, I can safely assume that he won't, so we're good. Busy year for everybody in 2017. Lots of attention-grabbing headlines. The first thing I wanted us to talk about isn't strictly in our segment, but I thought it was worth mentioning. The Dow Jones Industrial index reached a staggering new high this year. For the first time ever, it grew 5,000 points in one year. There's 30 stocks in the Dow across all sectors, but a few of ours -- Boeing, Caterpillar, Chevron, Exxon, DowDuPont -- up. GE, Merck, 3M, down. So, overall, we're doing pretty good.
Muckerman: Yeah. We're talking about some of the biggest companies in the world. Interesting to see that there's some overlap between these companies in Merck, healthcare; the sector has been doing OK. It's down. GE, I think it might be the worst performer of the Dow. I have a positive outlook for that company, though, in 2018. But Chevron, Exxon, they had to bounce from a very low low in 2016 and 2015. There was very little room to the downside for them, especially with oil prices stabilizing and even climbing this year. Boeing, continuing to surprise everyone with greater and greater aircraft contracts. Caterpillar also riding the coattails of higher oil and also some higher mineral prices.
Priestley: Excellent. You mentioned oil prices. There's also been a seemingly business-friendly president, too, which gave stocks a boost at the start of the year. But oil prices from their 2014 lows are back up to, some people are suggesting almost $60 a barrel is within reach. What do you make of the oil price moves this year?
Muckerman: It's been a much better year than the previous few. You've seen shale come rolling back. U.S. is producing, again, at record levels, and forcing OPEC to extend its production cuts. Russia joining along with that. So, pipeline disruptions both in the U.S. and internationally for various reason, also helping boost the price of oil. Long-term, still questioning the investment thesis over the next decade, but certainly in the coming months into years, there's some bright spots with shale, offshore oil becoming a little bit more cost-effective. If we can continue to put pressure on the Middle East, signs are good for U.S. oil producers and pipelines and service companies, especially the petrochemical sector that's benefiting from cheaper natural gas and cheaper oil and really booming on the Gulf Coast.
Priestley: Absolutely. I think shale had their best quarter since the crash last quarter, so really good signs. Honestly, this has been a great shake-up for the industry in terms of lowering the cost per barrel of extraction, too. As oil prices go up, hopefully they're going to enjoy better and better margins on those.
Muckerman: Yeah, you're seeing a few companies now get into AI and big data analysis to really help boost these wells. We're moving away from technology advancements under the ground; we're now talking about supercomputers. BP says they have the most powerful computer, maybe, in the world, analyzing data. So definitely some room for growth on that side of the business, and that will continue to hopefully lower the cost per barrel, and make the supply size out there continue to grow. Not necessarily great for the producers, if they continue to lower their cost, and you continue to produce more and more and more as demand begins to flatline or maybe strength, but certainly good for consumers in the long run, you would imagine.
Priestley: Absolutely. And one headline that's been fairly recent has been OPEC, as you touched on their announcement in November, that they would extend to the oil production cut. Some accredited the oil production cut with hoping to keep prices up, and it's definitely contributed. Were you surprised to see that they extended?
Muckerman: No, not at all. Basically, I expected that, as reliant as these countries are on the price of oil being high, they still need to do everything in their power. Shale bounced back harder than I think any of them expected, and we haven't seen that let up. The rig count is still far lower than it was at its peak in 2014, and yet we're producing at record levels. So yeah, I think that production cut was necessary for them and could be extended even further beyond the June or July date that they've set so far.
Priestley: Yeah, definitely, if Saudi Arabia has its say, too. Their IPO of Saudi Aramco next year is probably going to depend a lot on the price of oil. So one very inflammatory company this year has been Uber, really divisive. It's been a big year for Uber. They've had lawsuits that they settled in January. They've been kicked out of London. In June, the founder and CEO, Travis Kalanick, resigned amid pressure from investors over the sexual harassment, discrimination, and corporate misconduct allegations. So it's not a public company, so we don't really have a great deal of clarity over the ins and outs. But this just seems to be a shocking shakeup for this budding company that plans to IPO in 2019 now.
Muckerman: They are going to IPO? I didn't hear that.
Priestley: Apparently.
Muckerman: Apparently?
Priestley: This is rumor. Look at me, spreading rumors. [laughs]
Muckerman: That's OK; we can dip a little fake news into the Industry Focus show. I mean, I think they might have missed their boat in terms of peak IPO market value. You see more and more companies trying to get into the rideshare. Lyft is growing in customer satisfaction, maybe even more so than Uber was at its peak. GM and other car companies are getting into the rideshare business. Slowly, but you imagine, they can move fairly quickly if they realize that it's a business they can succeed in. And they're doing it with the potential for driverless cars, much like Uber had hopes for. So everyone is competing on this playing ground now. Personally, I think Uber might have missed the boat for peak IPO market cap.
Priestley: Yeah, I think you're absolutely right. It's difficult to get over allegations like this.
Muckerman: Yes.
Priestley: Another headline that I had completely forgotten about until we did a show recently, but the United Airlines flight. David Dao, the passenger on the flight who was forcibly removed from the plane after the airline asked four passengers to leave so they could accommodate United staff, who needed to be transported for work. So this was a shocking story, and it led to a tirade of all these other stories coming out. Anything the airlines did for a while didn't seem to be enough. But it raised a lot of questions about the practice of overbooking. Airlines execs were pulled before Congress. Though no fine was levied, it has changed a lot of policies with regard to overbooking. So, interesting, an interesting consumer stance against a widely consolidated industry. I mean, consumers don't have much choice. I have to fly a lot, so I know that really, there isn't much between them. So this was kind of an interesting opportunity for consumers to really air their grievances, but it did raise a lot of very serious questions. The stock, though, declined about 1% on the news. By the end of the next month, it was down about 4%. But just one month later, in May, it was back up 12%. [laughs] So people's memories are short, apparently.
Muckerman: They are. It seemed like, in 2017, you weren't a cool kid on the block unless you ripped a passenger off an airplane, because basically every airline did it. I think it was the power of social media, and then it was also the power of overexposure. People were like, "Oh, well, we've seen that before." In some cases, it was the passenger's fault, so it diluted the shock and awe of what was happening with that. Another industry that's benefiting from low oil prices. I know they're all hoping that OPEC continues to flounder in its efforts to boost the price per barrel, because they're all now price competitive. You see Spirit Airlines is an airline that's being hurt by that, because they were one of the no-frills airlines here in the United States and always had the lowest price, or tried to. And now that these big guys that still keep, they don't charge for every bag, they still hand out some food and water on the plane, because of low oil prices and their scale, they can now compete with price with a company like Spirit. So definitely an industry that hopes the price per barrel stays where it is, or maybe tracks a little bit lower.
Priestley: Yeah, absolutely. Year to date, it's worth mentioning, United are down. But this is more on strategic concerns. But it raises a lot of questions. There's a lot of unbundling going on with what used to be the higher-tier packages, so you have competitors coming in now like WOW Air, Icelandair, who are unbundling. So, no, you don't get your checked bag. You don't even necessarily get carry-on luggage. There's no TVs. There's no snacks, and all those kinds of things. And I think United really botched its rollout of basic economy fares, and that's led to a lot of questions about the long-term viability of how competitive they can be, when you have these new entrants in the market.
Muckerman: They did kind of receive a boost recently. I believe, in the last couple of weeks, the Trump administration retracted a regulation set in place by President Obama where airlines were forced to disclose baggage fees when you're buying the tickets. So that is now no longer the case. So they can hide a little bit more of the cost while you're searching for the flight. Obviously, you have to disclose it when you're buying the ticket. But it makes searching for flights a little bit more complicated.
Priestley: It's interesting. We all need to learn to pack more lightly. [laughs]
Muckerman: Yeah, eventually, you're going to pay for your bag no matter what, because it's becoming industry-standard. So yeah, either pack more lightly, or even maybe ship some things to where you're going. It might be cheaper.
Priestley: The next headline we've had this year is United Tech Corp. bought Rockwell. Aerospace supplier United Technologies bought avionics and interior maker Rockwell Collins for $140 per share, $30 billion total, including debt. That was about a 17% premium on those shares. They're creating a new segment called Collins Aerospace Systems. This is the company's words -- they said, "Together, Rockwell Collins and UTC Aerospace Systems will enhance customer value in a rapidly evolving aerospace industry by making aircraft more intelligent and more connected." But basically, the consolidation of these companies, they both make parts for Boeing and Airbus. It's mostly been driven by the fact that the airplane manufacturers are squeezing suppliers so much on cost right now, and they're really trying to move away from the high-margin aftermarket parts and services industry that really keeps these companies going. I know a similar situation is happening in oil and gas, too. A lot of these price cuts are being felt further down the stream, and you're seeing more and more consolidation of the smaller players. It's an interesting story at play. It'll be interesting to watch how that works out.
Muckerman: Yeah, that sector as a whole was kind of a hotbed for big M&A this year. Like you said, definitely interesting to see how it plays out and if they're forced to sell any of these smaller bits and pieces to make that deal work. But $30 billion, that's no joke. [laughs]
Priestley: So one thing that we may have all forgotten about is the Volkswagen emissions scandal. The carnival started in late, I believe, 2015, but it came to a head in January of this year. The U.S. Department of Justice announced $4.3 billion in criminal and civil penalties and arrested six Volkswagen executives for their alleged connection in the emissions scandal. So Volkswagen owns about 70% of the U.S. passenger-car diesel market and got into hot water for cheating on its emissions tests. Basically, the way that they did this was, they installed software in the cars. So it was about half a million diesel cars in the U.S., 10.5 million worldwide, and it basically allowed the car to be fully compliant with federal emissions levels when it sensed that a test was in operation. But when driven normally, it reverted back, and that permitted heavy nitrogen oxide emission into the atmosphere. It's kind of a scary thing to happen. Six executives arrested for this. [laughs] It's serious.
Muckerman: Yeah, they got away with it for a little while. Somebody was smarter than most of the inspectors for a while.
Priestley: And the stock's rebounded since all of this kicked off. It's up 14% year to date. It's still below the pre-scandal levels. But, again, it just shows you, Toyota has had their scandals in the past --
Muckerman: With the brakes, yeah.
Priestley: Yeah. Companies have bounced back from issues like this. I was surprised to see the arrests and civil penalties for this. But I guess that's how serious it was.
Muckerman: Yeah. I would be interested to see, if this happened to a U.S. car manufacturer, if they would have levied the same penalties and arrests.
Priestley: That's interesting.
Muckerman: Because certainly, no bankers were arrested for what happened in the great financial collapse, or very few Enron executives were punished like that. Interesting to see that go down. But consumers, as we talked about with the airlines, very short memory, because Volkswagen, still, in the first half of 2017, was the second largest automaker by volume in the world, falling slightly behind Renault-Nissan. They had previously been the first, but they're still No. 2, and not very far behind, with Toyota falling in third place. All of them selling over 5.1 million vehicles in the first half of the year.
Priestley: Wow. That's a lot of cars. [laughs]
Muckerman: That's a lot of cars. The debate rages if we are at peak car in terms of the cycle. But you still see a lot of old vehicles on the road, and the good times keep on rolling for them.
Priestley: The next headline is definitely in your wheelhouse. TransCanada abandoned two pipelines, and they also got a win at the Keystone XL, or, arguably, on paper, at least, they got a win. But they abandoned the Energy East and Eastern Mainline projects. What was the reason behind that?
Muckerman: Continued in-fighting with the regulators in Canada. They're basically like, we'll just take our oil south. They decided to continue the fight with TransCanada with the Keystone XL, because they already had the southern leg approved and in action. They were really in need of and wanting to connect that so they could supply the southern leg with that excess oil coming out of the oil sands. They got it approved. They have to change course slightly from what they had originally estimated once they reach Nebraska. That's going to require some renegotiations with folks in the state to acquire the land use rights. They're still debating on whether or not they want to proceed. A lot of folks out there believe that the billions that they've already spent and the time that it would take isn't really a hindrance, so most likely will attempt to move forward with this pipeline and give another avenue of escape for that oil sands.
And people might think, why are they trying to move so much oil out of Canada? Because Canada doesn't really need it. They export most of their fossil fuels, in terms of natural gas and oil, to the United States. So that would really be a nice boost for them. Of course, if oil prices fall back, oil sands will continue to suffer. You've seen a lot of big names that sell out of oil sands. Suncor, the largest integrated oil company in Canada saying they're going to pump the brakes on their own oil sands production and start returning cash to shareholders. So who knows if the Keystone XL pipeline is really all that necessary in the long term, but right now they feel that it is.
Priestley: And a lot of that is going down to the refiners on the south --
Muckerman: On the Gulf Coast, yeah. It's connecting the oil sands to a major hub in Oklahoma, Cushing, where the WTI price of oil is set. And then, the southern leg goes from Cushing to the Gulf, where predominantly all of our refining capacity is, outside of a few midcon refiners and some refiners out of California.
Priestley: The next headline, we kind of touched on this already, it's something I definitely have a vested interest in, is GE. GE is one of the country's biggest employers, one of the country's most widely held stocks. Its power division supplies over 30% of the world's energy. So this is not small change that we're talking about with this company.
Muckerman: I'd say it's too big to fail, in that category.
Priestley: So in August this year, Immelt, the previous CEO, was replaced by John Flannery, the incoming CEO. The company has been in an awful cash crunch. It's really just incredibly irresponsible, I feel like that they have got to the situation they're in. Flannery is making moves. He cut its dividend to save about $4 billion a year. It's gone from about a 4.7% yield to a 2.4% yield. They're cutting businesses, transport division, light bulb business, potentially coming out of their Baker Hughes (BHGE +1.32%) merger, relinquishing stake there. That was a Baker Hughes GE company. So overall, just a plan to simplify GE and refocus on the core areas: aviation, healthcare, and power.
This quote from John Flannery I really like. He said, "I'm not trying to run the company for the reaction on Monday or Tuesday or Wednesday of this week. We have a long-term plan. We have a lot of work to do. We're reinventing ourselves many, many, many times." So I feel this is kind of a very Foolish story, potentially, because it's such a long-term vision. People are talking five to 10 years. It's a huge ship to try and turn around. It's not going to happen overnight. What do you make of this story?
Muckerman: I foresee some dividends and share buybacks in the future, once they start to parse out some of these other business lines. You mentioned Baker Hughes and that tie-up. That basically took the place of Halliburton's attempt to tie up with Baker Hughes. I think they have to wait a little bit longer than the other divisions. All the other divisions they announced they want to sell, they can move forward with that whenever. But I think based on the regulation and the deal terms, they have to wait a little while in order to parse off the Baker Hughes portion of their business. But that's certainly on the chopping block almost as soon as it was announced that it went through, just a few months later. Very interesting there, reducing the exposure to natural gas and oil, even though they are the largest natural gas turbine manufacturer for power purposes in the United States and the world. I'm also a shareholder of GE. I assume that's what you meant when you said you have a vested interest.
Priestley: Yes.
Muckerman: I'm holding, and I have hopes and belief that they're going to turn it around. Might even, who knows, write some puts or buy some more. But yeah, certainly going to have to do something with that cash, and I think dividends and share buybacks will be a part of that. The share is down over 30% year to date. Share buybacks might not be the worst plan with the extra cash.
Priestley: Yeah, absolutely. I bought more and lowered my price point, too, so I'm absolutely invested in this story. I think Flannery has exactly the right idea. He's making very difficult decisions. It's hard to go in and say, "We're now expecting to earn -- " I think they were expecting to earn $1.00-1.07 per share. That's half the goal they had a year ago. But one of the biggest criticisms, and one of the most egregious things that I think you can talk about from the Immelt era, is just the way they approached their financials was very opaque, and they weren't very good at giving guidance at all.
Muckerman: Sure. It's tough, for a business that big.
Priestley: It is, it's true. But I feel like there was definitely some number fudging going on. The way that they worked out cash flow was just so different from any other company. Very difficult to make comparisons. Anyway, just a small point, Volvo, this year, announced that starting in 2019, it will only make hybrid or electric vehicles. Seems amazing. GM also announced that its Maserati brand will be all electric by 2021.
Muckerman: Those two smaller brands, makes sense if you're going to have a hybrid or electric car, you might as well go all in, because that's the direction of the future and maybe you can gain some economies of scale without having to have two separate manufacturing lines with engines and transmissions, which are different, and almost the entire drivetrain. Interesting there. Wave of the future, and you have multiple countries coming out saying that they're going to basically outlaw fossil-fuel vehicles being sold, some countries as early as 2030, a lot by 2040. France, Norway, China even. California wants to do the same as a state. That's the wave.
Priestley: Absolutely. And another big electric maker, Tesla, had a huge year. Elon Musk describes the mass-market manufacturing of the company's lower-price Model 3 as production hell. He was forced to push back shipments by at least three months, and we found out in November that it was caused by a production bottleneck at the Gigafactory. So yeah, big year. They announced a new truck. The semi-truck was announced just last month.
Muckerman: A lot of buyers, apparently.
Priestley: Apparently, yeah.
Muckerman: They're going to be waiting a while.
Priestley: Yeah, I'm wondering to see how much of that is more of a marketing stunt. They bought and repositioned SolarCity. So a lot going on. A lot of money being lost.
Muckerman: Battery factory is online, the Gigafactory. A lot of money being lost. They need a high share price if they're going to continue issuing equity, and to have access to capital. If the share price does decide to turn south, then not only will they lose that lever, but the debt markets might also close up shop on them. This bull market has been great with the higher stock price for them.
Priestley: Yeah, absolutely. The company raised $1.2 billion from common shares and convertible notes this year. They also entered the junk bond market; they sold $1.8 billion of unsecured bonds. Interesting times for them. Definitely want to watch. As always, he's such an enigmatic character, Elon Musk. He makes for great commentating. I think the financial media would have a lot less to say if Tesla wasn't in play.
Muckerman: I just wish we had access to SpaceX, personally. Maybe next year. [laughs]
Priestley: Well, that was kind of 2017 in a nutshell. I'm sure we missed some big headlines, but those were the key points we wanted to touch on.
Muckerman: They were probably fake news anyway.
Priestley: [laughs] Probably. Like my rumors about an Uber IPO. Have a wonderful holiday!
Muckerman: You, too!
Priestley: That's it from us today. If you would like to get in touch, please feel free to email us at [email protected], or tweet us on Twitter at @MFIndustryFocus. As always, people on the program may own companies discussed on the show, and The Motley Fool may have formal recommendations for or against stocks mentioned, so don't buy or sell stocks based solely on what you hear. For Taylor, I'm Sarah Priestley. Thanks for listening, and Fool on!
