The energy industry has been one of the most stable of any for investors over the last century. Oil, coal, and natural gas dominate the industry, and demand is as predictable as it gets.
But over the past decade, there have been some technological advancements that have upended energy as we know it -- and will continue to do so. With that in mind, here are six energy-related stocks from which investors should stay far away.
Image source: Getty Images.
Big oil is in big trouble
ExxonMobil (XOM 0.57%) and Royal Dutch Shell (RDS.A) are two of the biggest companies in the world by market cap, but neither is well-positioned for the future. Their businesses focus on oil and natural-gas extraction, refining, and sales in a world where every major automaker is investing billions of dollars to develop vehicles for a post-fossil-fuel world.
We haven't seen the impact of electric vehicles, buses, and semis on oil consumption yet, but we know it's coming. What's amazing is that ExxonMobil and Royal Dutch Shell aren't preparing themselves fast enough by de-leveraging their balance sheets and diversifying their capital spending. In the past five years, Royal Dutch Shell's long-term debt has more than doubled, and ExxonMobil's has more than tripled.
XOM Free Cash Flow (TTM) data by YCharts.
One of the biggest reasons debt rose in recent years was because both companies are clinging to their beloved dividends. That led to billions in cash flowing out of the company each year, even when free cash flow generated by the business didn't cover the payout. As oil rose above $60 per barrel the oil business generated enough cash to cover dividends and pay down some of that debt load, but they need high oil prices to cover all of their existing expenses (including the dividend) and that may not be guaranteed long-term as shale production rises and EVs become a real force in the market. None of these trends are good for big oil, and that's why I'm avoiding ExxonMobil and Royal Dutch Shell at all costs.
The disruptor with long odds
Tesla (TSLA -3.40%) arguably is doing more to push a post-fossil-fuel world than anyone, disrupting the big oil companies I've mentioned above. But that alone doesn't make it a great buy for investors.
By any measure, Tesla is burning through billions in cash, all in hopes of building an electric-vehicle (EV) and energy-storage giant that will be highly profitable someday. The problem is that products keep being delayed and there's little evidence today that Tesla has the engineering excellence to make world-class electric vehicles at a competitive price once the rest of the industry catches up.
TSLA Cash from Operations (TTM) data by YCharts.
As delays hit Tesla, competitors like General Motors, BMW, Volkswagen, Porsche, and others are perfecting their electric-vehicle concepts and manufacturing processes. This year alone, Audi and Jaguar will enter the EV market with SUV competitors to the Model X, and Hyundai, Kia, and GM will battle the lower-price Model 3 with the Kona, Niro, and Bolt, respectively. In 2019, Volvo, Porsche, and others will get into the EV business, increasing competition even more.
Tesla is a disruptive force in energy and auto manufacturing. But it's also a manufacturer that has to be able to make products profitably to stay ahead of competitors that can simply pivot to EV technology and leverage their existing manufacturing expertise. It's this manufacturing side of Tesla's business that has me worried, and given the company's cash burn, I'm avoiding this stock at all costs right now.
Old-school utilities are in trouble
Speaking of disruption, no industry may be in for more disruption in 2018 -- and be less prepared for it -- than U.S. utilities. Solar, wind, and energy storage have changed the utility business forever, making old power plants obsolete, and even giving consumers the ability to produce and store their own energy -- power they've never had before. Three companies with massive power-plant businesses that will be very difficult to shift to new energy sources are Duke Energy (DUK -0.12%), AEP (AEP 0.83%), and NRG Energy (NRG 0.60%).
Duke has been trying to shift away from coal and electric-power production to more renewables, regulated utilities, and natural-gas distribution. But the company has just 2.9 GW of renewable energy assets compared to 49.3 GW of total generating assets, hardly a major shift in the business model. On top of that, its utility is facing flat demand and customers eager to produce their own electricity in sunny southern states.
AEP is another power producer that's seen the writing on the wall but may not be making a transition away from fossil fuels fast enough. After disposition of four coal plants in Ohio, the company still will have 42% of its power-generating capacity in coal and another 30% in natural gas. Renewables account for just 19% of capacity, a number that needs to change rapidly to stem growing losses in fossil-fuel power generation.
The most confounding power producer in the U.S. today is NRG Energy. The company went from being an early mover in renewable energy, buying some of the most groundbreaking assets in wind and solar over the past decade, to focus on fossil fuels. Earlier this year, the company agreed to sell most of its renewable-energy assets and is doubling down on fossil-fuel power plants. It's literally going back to the old world of energy, and that's why I won't be anywhere near this stock.
Energy is changing quickly, and Duke Energy, AEP, and NRG may not be changing fast enough.
Disruption is coming to energy
It's not likely that all of the companies I've mentioned will collapse or be disrupted into oblivion, but I think the deck is stacked against all of them. The energy industry is getting cleaner and will move more quickly than it has in over a century. Companies that can't adapt will eventually fade away, and that's something investors need to think about more than ever in the energy industry. I’ll be adjusting my portfolio accordingly, selling shares of AEP that I own when our trading rules allow it.
