An International Energy Bonanza

It's International Week on Industry Focus! On today's Energy and Industrials episode, host Sarah Priestley and Motley Fool contributor Jason Hall walk listeners through a plethora of interesting companies to check out, from infrastructure management to an oil producer and more. Mexican cement and clinker company Cemex (CX -1.11%) is down pretty significantly after the global recession, but could be poised for great long-term growth.

French oil giant Total (TTE 1.72%) is making some savvy business moves in Saudi Arabia, as well as investing heavily in solar. Bermuda-based Brookfield Infrastructure Partners (BIP 3.35%) seems poised to benefit in a major way from the ever-increasing demand for better infrastructure. Tune in to hear more about these companies -- their highlights and risk factors to consider -- and a few other picks, too.

A full transcript follows the video.

This video was recorded on May 17, 2018.

Sarah Priestley: Welcome to Industry Focus, the show that dives into a different sector of the stock market every day. It's Thursday, the 17th of May, and you're joining us during a theme week where we're talking about foreign stocks. I'm your host, Sarah Priestley, and joining me on Skype is Motley Fool contributor and all-around nice guy, Jason Hall. Jason, how are you doing?

Jason Hall: Hi, Sarah! I've been on the show more in the past several weeks than the entire history of the show before that.

Priestley: I was going to say, I don't know what you've done to deserve this punishment. [laughs] But, I appreciate it.

Hall: No good deed goes unpunished, I guess.

Priestley: Jason, this week is a theme week here on Industry Focus. We're a U.S.-based podcast and we talk about the U.S. stock market, so we decided to change things up by focusing on international stories. Why? Because there's a whole world of stocks out there, and no portfolio is truly diversified without at least some international exposure. That's why they have me on the team, I'm the team's international exposure. Every day, the hosts for their respective shows will be covering international stocks or themes within their segments. Jason, you and I have decided to go big or go home, I believe, is the expression. We're covering quite a few companies today.

Hall: Yes. It could be going out of control, it's so big. I'm counting on you to keep this reined in, Sarah. No pressure.

Priestley: [laughs] That's always dangerous. So, yeah, we'll be giving you a whistle-stop tour of some stocks operating in areas of energy and industrials that we're bullish on the general trends that they operate in. That includes infrastructure, renewables, and even an oil and gas suggestion in there, too. 

Most of the companies we're discussing are listed on the U.S. exchange via ADRs. So, some background on ADRs before we start, they are American depository receipts. These are receipts held by U.S. Bank that represent stock in a foreign firm. They trade on the U.S. stock market in dollars, and it simplifies the process. They have a different reporting requirement, so that's something to be aware of, but it's just an investing product that helps U.S. investors buy shares in foreign companies.

On our whistle-stop tour today, we'll first be talking about infrastructure. Any regular listeners know that Jason and I are both bullish on the rise of global infrastructure spending. Jason, I'm not speaking out of turn or speaking for you there, am I?

Hall: No, not at all. I feel that my views are being represented appropriately.

Priestley: [laughs] So, the first company is one that, Jason actually brought this stock to my attention at the end of last year. I've subsequently done a lot of homework on it. I actually pitched it a month ago on a show with Taylor Muckerman, so I probably sound a bit like a broken record, but it's Brookfield Infrastructure Partners, ticker symbol is BIP. 

It's one of the world's largest infrastructure companies. The company is based in Hamilton, Bermuda, and they're listed on the New York Stock Exchange. They really are very much a global company. Only 5% of their revenue came from the U.S. in 2017. They own energy distribution networks, cell network towers, electric lines, toll roads, ports, and even timberland. If you look at a lot of the countries and regions that they're heavily invested in, like South America and India, a lot of these are the next big growth economies, or certainly economies that are demonstrating rapid amounts of spending and infrastructure development.

Hall: Yeah. I think for me, the thesis behind Brookfield Infrastructure Partners is -- it's honestly one of my favorite investments out there. It really is. But something that you and I talked about on other shows, something that drives a lot of the investment thesis I have for some of my biggest personal holdings, is the sheer growth of the global urban population. Over the next decade and a half or so, we're going to add about a billion people. Infrastructure is key to that. I don't think there's any company that does a consistently better job than Brookfield Infrastructure, in terms of really allocating capital really well to good projects and good assets to generate just great cash flows. I'm a huge fan.

Priestley: They have this strategy of acquiring distressed assets, and then they turn them into cash cows and either keep them or sell them. I agree with you. One of the things they do that's so compelling is, it's really these projects that are so vital for the success of an economy and of an area. If you look at ports, even toll roads, you can argue -- I know everybody hates toll roads, but frankly, I saw a Motley Fool analyst present it as, they're selling people time back. [laughs] Which seems like a great way to present it. But it's true!

The company has had a bit of a rough start to the year, I think because they've always presented return on equity as their big objective. Their big goal is to create a long-term ROE of 12-15%. And I think their ROE took a little bit of a hit in 2017, but this year looks strong. Is that right, Jason?

Hall: I actually only just started scanning through their filing. It was a decent year. I think, from a cash flows perspective, it might have been a little bit better than the GAAP earnings. One of the things that their CEO has talked about more and more over the past few quarters is, it's getting a little bit harder, and it's kind of a cyclical thing, it's a little bit harder to find the same stressed asset opportunistic buys that the company has made in the past, and they're starting to look more at investing in organic growth and expanding the assets that they retain. 

So, I think to a certain extent, we might see a little bit of an effect over the long term as it invests more money in expansion, because those projects do tend to take a little bit longer before they generate a return. You buy a company, it can be accretive to earnings as soon as the deal closes. But when you're taking two or three years and building up a project, you're investing that capital and not getting any return before it goes online. So, that could just be a little bit of a shift in the way the company is focusing on investing for its future growth.

Priestley: Yeah, absolutely. But we're both still really bullish on this company, so definitely, if you're listening and you like the sound of infrastructure development, certainly give them a look. 

The second stock we're going to talk about, this one is an ADR, its ticker symbol is VALE and it's called Vale SA. You'll see the ADR in parentheses after the stock in your brokerage. They're headquartered in Rio De Janeiro, Brazil. It's a $72 billion market cap materials and mining company, so it's a big company. It's one of the largest logistics operators, also, in Brazil. Vale is the largest producer of iron ore and nickel in the world. 71% of 2017 revenue came from iron, 9% nickel, 8% is other, which includes fertilizers and other such, and then copper and coal. 

The company is up 70% over the last 12 months, 18% year-to-date, and this is because a lot of iron stocks have been doing incredibly well because of rising demand or such strong demand from China. China is the world's largest steel maker, and you've seen that come to the fore in the press recently with all these tariff conversations. They buy the most seaborne ore from anybody else in the world, and demand looks like it might start to level off soon. 

So, the near-term outlook looks good. That's probably why we've seen the stock price increase. But, the commodity is expected to level off, because you're going to have some contraction in demand from internally in China, and then, also, the increase in the availability of scrap, which is something we don't really think about, but the more that they've produced means, now, the more that they can probably recycle.

Hall: Yeah. I think that's important. For example, in the U.S., Nucor, the largest U.S. steel maker, is also the largest recycler in the U.S., because they use steel and iron scraps. So, that's really important to mention.

Priestley: And it squeezes the demand on both sides, almost. 41% of revenues came from China, so it's not a small point at all. It's definitely a risk to bear in mind with this stock. They also compete in this arena with Australian miners who obviously can save money on shipping. I think it's $17 a ton to ship from Brazil, and it's about $7 a ton from Western Australia because of the proximity. Vale is mitigating this somewhat. It has its own fleet of ships called Valemax ships, and it's expanding that fleet. So, they're certainly making all the right moves to reduce that Australian advantage. 

But, I would certainly suggest people do their own homework on this and look at the forecasts. It's not a precipitous decline in demand that's being expected. And also, specifically look at infrastructure manufacturing development in the other high-growth economies that the company operates in, because fundamentally, the company is looking in such a much better shape than it has for years.

Hall: Yeah, absolutely.

Priestley: They had attempted previously -- Jason, you're probably way more familiar with this than me -- they were trying to diversify away from iron into other mining commodities, and they overpaid (unclear 9:24), so they overpaid at the peak of these commodity prices.

Hall: Yeah. I know the term "diworsify" has been thrown around. And historically, it's been when the company tries to conglomerate itself. This was, the idea they had was great, to stay within the core mining things that they're good at. But the timing was just terrible, and it didn't really work well. 

I think the big thing, if you look at, iron prices bottomed in the beginning of 2016. We're talking, iron ore prices fell like 70% from the peak in 2010, 2011. And they rebounded. They're up about 60% since the beginning of 2016. So, that's played a big role in its recovery. But, really focusing on that core iron business and staying a low-cost producer, really, that's the most important thing, in addition to understanding the global forecasts, understanding its cost structure, and how well it manages being a low-cost ore producer, is really important to any thesis behind Vale.

Priestley: Yeah, absolutely. And management has been slowly taking steps to remedy their overburdened balance sheet from these acquisitions. We're seeing this a lot with mining companies, they're getting stricter on their investments. So, they're saying, "We're committed to investing mainly in world-class assets with a long life and low cost." And it sounds like something that you should take for granted as a mining company, but really looking at the rest, actually, it's strangely not. [laughs] 

Hall: They all say that! They all say it, but it's seeing how well they do it. Looking into the earnings reports every quarter, seeing what management says, read the transcripts of their earnings calls, read what management says. Compare it to, is their conversation changing? Are they talking about their successes, or are they talking about how now they're moving the goalposts because they weren't successful? That's where you can find out if they're doing what they say or not.

Priestley: Yeah. We've talked about, the ore prices have come up. Currently, the valuation of the company reflects that, its P/E is a little rich. I think it's 16X. This company is one that I would mainly put on a watch list for some people, because the commodity that they deal in is just going to be so pivotal for a lot of the growth projections that people are anticipating.

Hall: Yeah. I think it's especially worth considering, if you think about the "trade war" right now with the U.S. with the tariffs on steel makers and China being singled out, China's steel production far exceeds its internal consumption. I mean, it's so far beyond what they actually consume, it's kind of ridiculous. So, the concern is, how much of China's consumption has been artificial, in terms of demand? And, how could that potentially affect Vale's ability to retain real market share? And a lot of it depends on what the Chinese government decides to do with its policy, in terms of supporting its steel industry.

Priestley: Yeah, absolutely. The next company I wanted to talk about is Cemex. Its New York Stock Exchange ADR ticker is CV. We were debating before we started this show how to pronounce it. I YouTube-d it, [laughs] as with everything in the modern age. It said Cemex, I'm really sorry if that's wrong. It's the second infrastructure suggestion that we're talking about today. It's headquartered in San Pedro, Mexico. 

Cemex is a mid-cap company in the construction and materials sector. It's the third-largest cement company in the world in terms of installed capacity, and the largest concrete company, and the world's largest trader of cement and clinker. Clinker is those lumps that you see in cement, which are pretty pivotal to keeping things stuck together.

Really fascinating company, in the way that they operate. They're heavily tied to construction in five regions: Mexico, U.S., Europe, South America, Asia, Middle East, and Africa. The global financial crisis pretty much decimated demand for cement, so they were down 31% in the last 12 months; 23% year-to-date, and their performance reflects this extended downturn, and also nervousness around the construction activity in Mexico. But, predominantly, big projects, like government-driven projects, such as the City Airport, which has become a contested issue in the presidential election. However, what I think people are missing with this company is that the majority of demand in the Mexican market, which drives about 25% of sales for the company, is retail. That just blew my mind.

Hall: I was really surprised, when we were talking before the show. I was really surprised by that.

Priestley: Yeah. Retail is 65% of the market in Mexico. 35% of that is self-construction. And Cemex just dominates that market. They have Construrama stores throughout Latin America. I probably mispronounced that.

Hall: I'm not even going to try. But, I'm guessing that has to be a much better margin business than the industrial supply side.

Priestley: Yes, absolutely. It's 25% of sales, 40% of EBITDA. A lot of people are focusing on this government infrastructure spending, which, yes, it definitely would be a growth driver for the company if they secured that in the region. But it's certainly not necessarily their bread and butter. And because they can really dominate that local market, it's a low-value, high-weight commodity, so it has this really high barrier to entry for competitors, and they have a fantastic distribution network.

Hall: They have such a scale advantage in that market, that's a huge advantage.

Priestley: The U.S. accounts for 25% of sales; Europe, 25% of sales. It's government and corporations that are the big buyers here. We all know the infrastructure promises that are being made in the U.S. Similar ones are being made in Europe. It's facing all these cyclical 50-year turns of, these roads need to be widened, especially in high-growth cities like London. So, yeah, I think it's kind of an off-the-wall suggestion, maybe. It's worth looking at, definitely worth doing some research.

Hall: I think it's kind of like Vale to a certain extent. It's a bit of a commodity product. It's a company that has a big scale advantage, it's in a lot of the right geographies. And it could definitely be part of that long-term urban population growth, that same story. But I guess it always depends, it gets back to, when is the infrastructure spending going to happen? So much of its spending is tied to big government projects and that sort of thing.

Priestley: Yes, absolutely. For a lot of these companies that we're talking about, the commodity focus, if this was my portfolio, it would definitely be a very small allocation, just because, as Jason said, you're at the mercy of the commodity. And we all know that that's incredibly cyclical on this show, probably more than other shows. [laughs] 

The next company we want to talk about, Jason, is one of your pitches. I don't know a ton about the company. They're a pure-play wind farm turbine maker, Vestas, is that right?

Hall: Vestas, right. I think they're Danish. Anyway, they're a pure-play leader in the wind turbine industry. It's an interesting company. A few years ago -- and, my timing, so many of my investments that have done well, I just lucked into the timing. The company had struggled, because selling wind turbines to utilities all around the world, spending is really cyclical. One year could be huge and then the next year is terrible. So, that really affects the demand from one year to the next. And when you're a manufacturer of something like wind turbines, it's very specialized and really capital-intensive. It can lead to really high fixed costs. And those high fixed costs were really a major problem for Vestas for a number of years, if you look at its cash flow statements historically.

But, a few years ago, they brought in a new executive team, new CEO, and they made some changes. They sold off some of their non-core, non-specialized manufacturing to companies that can leverage it better. Then, they're using those third parties to do some of their manufacturing while they still focus on the things that are really strategic to them, like the making of the actual turbine blades, for example, for wind turbines. 

And it's really paid off. If you look at the company's cash flows over the past few years, with a grain of salt, I'll tell you, it's been a generally healthy demand environment for the company in the past few years. But, just in terms of its cash flow, it's improved significantly.

Priestley: Anecdotally, I see wind turbines all over in Europe now, and I'm sure that market is going to be saturated somewhat at some point.

Hall: Well, it's a long time from now. It's still at such a small portion of global electricity production that comes from wind. Globally, I don't even think it's in the double digits, in terms of percentage at this point. So, there's still a lot of room to grow. 

Now, there are some challenges right now. Because of the cyclicality, I think we talked about, last quarter, its sales in North America, primarily the U.S., actual turbine deliveries fell by like two-thirds. It was offset in some of its other markets. So, it's kind of a little bit of a weak cyclical period right now. But, there's also, the technology has gotten better, and the costs have come down. 

So, Vestas' revenues, I think they fell last year by about 3%. Earnings fell a little bit. I think, again, if you look at this from a global growth long-term opportunity, this is certainly one of the companies that, if you're interested in renewable energy, this is certainly a company that you need to have on your list.

Priestley: It's always nice to see a company, when their shares dip, an active buyback. It really makes you feel confident that management also sees those shares as undervalued. 

The next company we want to talk about is French oil giant Total, trading through ADR ticker TOT. It's an interesting company in itself, but it's also interesting for its controlling stake in high-efficiency solar company SunPower, which is an American solar company. Through a subsidiary, they bought 60% of shares and paid a 50% premium for them in 2011. This was kind of before a lot of the growth that we've seen recently in solar. 

SunPower was one of the first solar companies to aggressively pursue utility-scale projects and develop their own solar parks. They had the advantage of making extremely efficient solar panels. They had that advantage with space-constrained residential and commercial markets. 

But since then, low-cost competition from China has really eroded some of those advantages in some markets, and we're starting to see that shake out with the tariff suggestions right now. But, a small part of Total's portfolio, but to me, it's indicative of their forward-thinking attitude. 

Hall: I agree. If you look at Total's results and pull up their earnings from last year, the bottom line is, it's an oil and gas company, in terms of where it derives its revenues and incomes. Its E&P business, that's Exploration and Production, generated the vast majority of its earnings. Operating income last year, its Petrochemicals Refining business, that alone is a third the size of its E&P operating income, but it's 7X larger than what it gets from its Renewables & Power business. 

But, I think it gets back to what you were talking about, in terms of, it's a forward-looking company. Earlier this year, Total purchased a French company, Direct Energy, for about $1.7 billion U.S. dollars. Direct Energy uses natural gas to produce electricity, they retail electricity. That more than doubled Total's ownership of electricity production. 

Again, it's focused on natural gas and renewables. You talked about its expansion into solar with SunPower. There's an interesting thing that's worth mentioning in terms of the solar thing, and why it makes sense for Total to participate in that. Right now, in Saudi Arabia, there's this potentially $200 billion solar energy farm that's in the talks right now. It's going to add 200 gigawatts. That's ...

Priestley: Double.

Hall: Yeah, it's double how much solar was built in the entire world last year! It's a massive thing. And that's Saudi Arabia. That's one of the big oil countries. So, you have Total, an energy company, it does a lot of business with Saudi Aramco, is in a great position. It's already connected to the leadership to these places to talk about renewables. That's a pretty powerful position to be in.

Priestley: They had a great first quarter, as you mentioned. On a forward-looking basis, they're actually a comparably very cheap oil and gas company right now. They announced a dividend increase and repurchase plan, so it's a pretty attractive prospect. 

As you mentioned, Jason, the profitability for them has definitely been upstream, and their shares have been trending up with the rising prices of oil. But, recently, you actually told me -- I'll say, I probably wouldn't have noticed this -- they agreed to buy a 25% stake in Clean Energy. Clean Energy is natural gas transporter. As we've talked about before, natural gas is going to become a huge market. So, definitely another wise move for them, I think.

Hall: I think so, too. I think it's interesting to look at the Clean Energy Fuels acquisition. First, they got a steal for what they paid. But, I think where it's interesting is, Total doesn't actually operate any retail refueling in the United States. But, it has pretty significant petrochemical and refining operations in the U.S. So, it's actually kind of a natural tie-in for them to invest in that segment in the U.S., as a way to look to see that market and drive increased consumption of natural gas. And I think the transportation sector is going to see a real boom.

Priestley: With Total, then, I would really say, look to the long-term future of this company, because it seems to be one that's really taking the impending changes that will come to oil and gas seriously.

Hall: It also has a really strong balance sheet. If you compare it to ExxonMobil (XOM 1.15%) and Shell (RDS.A) (RDS.B), some of the other big majors, it has more cash in short-term investments than ExxonMobil and Shell have combined. That's over $32 billion in cash. And about $55 billion in debt, which is less than Shell and a little bit more than ExxonMobil. But, it has a really strong balance sheet, pays a really solid dividend, and I think it trades for 1.6X tangible book value. That's cheap for a high-quality company. That's a reasonable price.

Priestley: Yeah, absolutely. The last company is also on this natural gas trend, it's TransCanada (TRP 1.16%), ticker TRP. It's a Canadian energy infrastructure company. They have assets in the U.S., Canada, obviously, and Mexico. They operate 40,000 miles of natural gas pipeline. A notable project that they operate is the Keystone XL Pipeline and the Keystone Pipeline system. It also has interests in 20 power generation facilities, mostly in Canada. And, they have significant scale as a midstream company. I kind of like these midstream players, because they're really winners, so to speak, in a lot of respects. A lot of the contracts that they make with the oil refiners or the oil companies themselves are 15-20-year contracts.

Hall: Can you say toll roads?

Priestley: [laughs] Toll roads.

Hall: They're often compared to toll roads.

Priestley: They are.

Hall: That's basically what they do, they essentially charge a toll.

Priestley: It's true, yeah.

Hall: To move things from place to place.

Priestley: So, the reason that I'm particularly bullish on them is their natural gas projects. Five natural gas projects in Mexico, where natural gas shipments are expected to double by 2020, so, not that long. And they've invested over $3 billion with expected returns of $450 million per year, which isn't bad at all. The real bright point for these projects is, they're underpinned by 25-year throughput agreements with Mexican state-owned agencies. And I'm not saying that all of those projects look like that, but it just gives you a flavor for how these companies can operate.

Hall: Yeah.

Priestley: So, yeah. TransCanada, definitely worth a look. I've talked about it before. Apologies for the repetition, but, you know, we're just so global on the Energy portion of Industry Focus anyway. [laughs] 

Hall: Well, so many of the best companies in this space are global companies. Here's another hint: if you're hearing the same company brought up multiple times, it's probably because there's a high degree of confidence in the quality of that business.

Priestley: Yes. I learned my lesson, my contrarian play was GE -- which I actually still really like, but I'm fighting against the tide on that one, that's for sure. [laughs] Jason, have I missed anything? Is there anything that you would like to add for our listeners?

Hall: I think, again, look at the big trends. International exposure is really important. Energy tends to be an internationally traded commodity, so these are levers that effect, even if a company is focused in one area, because energy is international, it can have these effects. But the long-term trends are, we're going to need a lot more energy, we're going to need a lot more distribution of it. Brookfield, with the need of infrastructure assets of all kinds. International investing doesn't have to be risky or dangerous. There are lots of high-quality companies that are easy to invest in for U.S. retail investors. And these are just a few to consider.

Priestley: And if investors are nervous of investing through ADRs or investing in companies that aren't based in the U.S., there are a lot of big industrials and energy companies that, a great portion of their income comes from overseas. Maybe that's another show that we could do some time, Jason.

Hall: Yeah, let's do that next time!

Priestley: [laughs] So, 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 @MFIndustryFocus. Thank you very much to Austin Morgan for patiently producing the show every single week. As always, people on the program may own companies discussed, and The Motley Fool may have formal recommendations for or against stocks mentioned, so don't buy or sell anything based solely on what you hear. For Jason, I'm Sarah Priestley. Thanks for listening and Fool on!