Bottom of the Cycle Alert -- Time to Check Out Offshore

Oil is a cyclical industry, but offshore's been left out of this current oil updraft. Luckily for them, there are plenty of signs that's about to change. In this week's episode of Industry Focus: Energy, host Nick Sciple and Motley Fool analyst Jason Hall tell investors what they need to know about the offshore market before getting in. Find out what offshore drilling involves (roughly), why this industry isn't recovering with the rest of oil, why a turnaround could be coming soon, plus some investing advice about three of the biggest players in the space -- Transocean (RIG 2.16%), EnscoRowan (VAL), and the beleaguered Seadrill (SDRL) -- which really doesn't seem to be recovering from bankruptcy all that well.

To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. A full transcript follows the video.

This video was recorded on June 6, 2019.

Nick Sciple: Welcome to Industry Focus, the podcast that dives into a different sector of the stock market every day. Today is Thursday, June 6th, and we're discussing offshore drillers. I'm your host Nick Sciple, and today I'm joined by Motley Fool contributor Jason Hall via Skype. How's it going, Jason?

Jason Hall: I'm very good! I ran a 10K over this past weekend, set a personal best. Came in below a 9-minute mile, so I was pretty happy with that. Feeling good! For 42, I'm happy!

Sciple: Nice! It was my girlfriend's birthday over the weekend. We went out to dinner, spent some time in the city. Went to the new spy museum, checked those sorts of things out. It was a good time.

We had some other interesting news over the weekend. Jason, we'll just hit this off the top of the show. The SEC has changed their regulations now to allow alcohol sales in football stadiums. We both graduated from SEC schools. What has been your reaction to this huge change?

Hall: I think it's important to note that since this is primarily an investing podcast, in this case, we're referring to the Southeastern Conference. The dominant football conference, and kind of the dominant basketball conference to a certain extent, in terms of overall talent. I think it's really interesting. Most of these schools have had the ability for like the super-wealthy donors who have their little private boxes, they can bring in their own alcohol anyway. But the thing is, I don't think most of the schools are just going to throw in taps and start having general alcohol sales. I don't think that's going to happen. We'll see. It's another source of money. They can get more money to fund their men's diving programs with by selling alcohol and generating extra revenue. Is that the idea?

Sciple: Yeah, I guess that's the vibe. For football, I feel like folks are going to go to the football games, no matter what. And we already have donors. I know at the University of Alabama, we have donors that can pay the big amount of money for club seats, and they can bring their own in. But this change has been talked about for a while, and it's come in place. It is interesting, at Georgia, you see some of the money-generating moves they've made, they're going to charge folks $25,000 for the privilege to purchase alcohol at these games any place where you cannot see the field. What are your thoughts on that $25,000 cover charge for six or seven home games a year?

Hall: That $25,000 isn't just for the booze, isn't just for access to that specific area. It's part of getting into a specific group of donors. They have to be a part of that group of donors, I can't remember the name of it off the top of my head. Basically, it's all the money they're using to fund all of their big capital investments. They're building a new tennis facility, they built a new end-zone facility with new locker rooms, and a new visitors area for recruiting. There's a few people that are going to do it, but no, I think it's dumb. I really do. There's been a lot of backlash from both your regular Joes like you and me that don't just have an extra 25 grand to throw at their alma mater just to get a bumper sticker for that specific little alumni group or whatever; but also from the people that are contributing at that level saying, "Hey, we're getting thrown under the bus by everybody else for this thing that we weren't even a part of that we also think is dumb." I don't know. It comes across like they're pretty out of touch with what the alumni and the fans actually want. What do you do?

Sciple: Yeah. We'll see how things play out. It's getting that little bit of nugget that makes it feel like college football season is coming up. I think we're under 100 days until the season. Fun to have a little bit of discussion.

But let's now move on to our main topic for the day. As I said off the top of the show, it's going to be offshore drillers. Just to give you some numbers for context on the size of this industry, about 37% of global oil production comes offshore, about 28% of global gas supplies. This is an industry that's really been lost in the woods a little for the past few years since oil prices declined in 2014. But it looks like there are some signs that things are going to pick back up. Jason, 10,000-foot view, what are we seeing today in the offshore market? How have things evolved over the past few years since oil prices declined?

Hall: If we go back to 2014, oil prices were still well over $100 at the middle of the year. I think that was the all-time capex peak for E&P, 2014. Of course, oil prices started falling in the second half of the year, fell sharply through pretty much all of 2015. By early 2016, the headlines were "The Death Of Oil." I think Brent crude was in the high 20s. West Texas intermediate crude, this is the big U.S. benchmark, I think it hit like $22 a barrel, or some really, really low number. All along that way, offshore spending continued to fall and fall and fall. Offshore is really expensive to develop. Oil company cash flows were getting slammed because oil prices continued to fall, and they had to cut somewhere, and offshore was one of the biggest places they cut. I think last year, we still saw a continued little bit of a decline with the major E&Ps offshore.

But spending overall has started to really recover this year. We're still less than about half where we were in 2014 in terms of that offshore spending, but it is starting to recover. I think a big thing that's happened too over that time is, the drillers that we're going to talk about, the industry has gone through a ton of turmoil. There's been a lot of scrapping of these old rigs that just weren't cost competitive at lower prices, rigs that couldn't operate in the environments where all producers want to develop resources. There's been a ton of fleets acquiring one another, a lot of merger and acquisition activity that's happened.

So, from a fundamentals perspective, the industry is a lot healthier than where it was. The trajectory looks right in terms of spending does continue to increase by the producers. But if you were to look at the stock prices, you would think that this is an industry where they're going to ask the last guy to turn off the lights on the way out the door. It's really ugly if you've invested in this sector at all over the past four or five years.

Sciple: Sure. And this is a sector that is traditionally very cyclical. When you have a cycle that was particularly rough, in these past few years, when you had oil on the high end, got up to $150 a barrel, then plummeted all the way down to the 20s, that really left a lot of producers in a situation where they were unsure about the future of oil prices. And as you mentioned, when you invest in an offshore oil rig, it's going to take several years to go from your initial input of capital to getting money out on the back end. And if you don't know what oil prices are going to be on that back end, it's really tough to make that allocation decision.

However, over the past several years, we've seen oil prices seemingly stabilize in this mid-50s and mid-60s dollar range. We've seen some breakeven levels. As you mentioned, we've got some new investment in new rigs, really modernizing our fleets. We've seen the breakeven levels for offshore come down. Whereas in 2016, we saw breakevens in the $64-a-barrel range, which for a long period of time, you'd be underwater, there's just no sense making an investment now. We've got some estimates from Rystad Energy saying that breakeven is now in this mid-40s- to low-40s-dollar-a-barrel range, which in this current pricing environment, makes offshore a profitable investment. Whereas before prices tick back up, they may not have been.

Hall: Let me give some context on that, too. That early-2016 period you're talking about, where it was in the 60s, you go back a few years before that, it was in the 70s, easily. So in early 2016, let's say February 2016. Average breakeven was $64, is what they were saying. Again, I said it, oil was selling for in the 20s. $20 barrels. You're looking at, you spend $64 to produce something that you could sell for less than $30. That's how ugly things were back in 2016. Fast forward to now, oil is in the 50s. You can produce it in the 40s. So you can make money. It's a massive, massive shift in the past two and a half, three years.

Sciple: Right. And as we've seen investment in offshore wane over time, the ability of the global oil market to replenish oil supplies as they come off -- so, you have a well that is drilled over time, the production of that well decreases over time. What we've seen as investment dollars into new production have dwindled over time, we've seen the replacement rates continue to come down, which has reached us to a point where we're only really replacing the barrels that come off the market at about a one-for-one rate with the new ones that are coming onto the market. So we need new investment to create new supply to continue driving the market forward. And that's where we're seeing this cycle for offshore turning around.

On the back half of the show, Jason, we'll talk a little about some companies we like specifically. Any last thoughts on this broader market for offshore before we move on?

Hall: I think it's important to understand the greater context of what's happened that's caused offshore to be so much slower to recover than I think a lot of investors, including myself, initially expected. One of the big ones is shale. That's primarily onshore. You think about the Permian Basin in Texas, the Eagle Ford Basin in Texas, and some of the other SCOOP/STACK plays. The bottom line is that it costs a little more to produce that oil, but if you're an oil producer, and you want to get some return on your cash, and you know what oil is selling for today, and you know you can produce shale right now at a higher breakeven cost, but you can literally start generating cash flow within a few weeks of drilling a well, vs. an offshore project, which might take 5 or 10 years to come online, even if the breakeven is lower, in the environment that these guys have dealt with over the past three years, since oil bottomed in the 20s, and has recovered, but been quite volatile, it's a pretty easy decision. If I'm a capital allocator at an oil producer, I'm going to focus on shale right now because the predictability of generating cash returns is really powerful.

Now, I think one of the things that's changing is, the bigger producers -- you've got the national oil companies, you got the Saudis, who actually have a pretty large amount of offshore oil, you have some of the African countries that have a lot of offshore oil. They have much larger scale of resources, and they can plan long term because their cash flows over time are a little more predictable. So I think that's one of the things that's going to drive offshore in terms of thinking about the greater context. Because that oil is still so important, while shale has been the swing, I think the offshore plays, because of the predictability of their long-term cash flows, that's why we're going to continue to see that upswing in investment in offshore.

Sciple: Yeah. Last thing on shale, the decline rate on shale is much more significant. You can get that investment out of the well much quicker, but it will pay you dividends over a much shorter period of time. So, the shale movement of continually drilling more wells and inputting more capital can work to a point. But as interest rates move up, or as the pricing environment maybe doesn't cooperate, that can be a cycle that is difficult to continue over time. Whereas that long tail of offshore provides a little bit more stability and sustainability over a long period of time. Obviously, both of these methods are going to play their roles in the market, but there's no silver bullet that can fix all the problems.

Hall: Yeah, that's kind of the point.

Sciple: OK, Jason, now let's talk about some of these offshore drillers and what's going on with their businesses. First, let's talk about Transocean, ticker RIG. That's really easy to remember. Transocean over the past several years has really been repositioning and modernizing its fleet, particularly targeting these harsh, ultra-deep-water environments for offshore drilling. What can you tell us about Transocean, Jason?

Hall: I think Transocean's really impressive to look at in terms of where the company was at the peak and how it's managed its way through the downturn. If we go back to the Deepwater Horizon event, Transocean was the operator of the drilling vessel on that event. That happened a decade or so ago. The point is that the company managed through that crisis. Things started looking better. Then, next thing you know, you're dealing with the oil crash in '14. And when that happened, the company had a ton of older vessels, had a lot of debt, but it also had a pretty decent cash balance. The company was really quick to cut its dividend back then and start preserving cash. Management did a really good job of scrapping older vessels quickly, and continued to scrap more and more vessels over the past few years. But at the same time, the company did a really, really good job of divesting assets. I think they sold Borr Drilling, its entire jackup fleet. That's a pretty recent thing that happened. And then it's made a couple of really big acquisitions to acquire more harsh environment ultra deepwater vessels that are going to be in demand over the next decade or two, because that's where the biggest offshore plays that are going to need to be developed are.

To me, it's the most impressive company coming through the downturn, in terms of repositioning its fleet, managing its balance sheet, the debt. Its debt came down. It's come up a little bit after a couple of the recent acquisitions. But it's still a very manageable debt load compared to the value of the assets that it owns, its drilling vessels. The company has a ton of deep connections across the industry in some of the hottest plays with some of the biggest producers. Those are things that really play to its advantage in terms of being able to leverage that fleet and continue generating positive cash flows as the recovery continues.

Sciple: Sure. If we look out into the future, Transocean has the best backlog in its industry. I believe it's $12.1 billion. They call that out as being 4 times its next largest competitor. We've talked about how they modernized the fleet to really put their assets in a position where they'll be in demand going into the future. When you see that backlog, is that just evidence that that thesis has really played out for the company and set themselves up going forward with lots of contracts available?

Hall: Yeah, I think it is. You have to be a little bit careful with the backlog. You need to understand what the backlog means. At this size, it's a good number, but you really want to understand what it means in terms of the day rates it's able to get from its vessels. In other words, what is that backlog going to generate in terms of free cash flow? That's an important thing to understand about it. And I think for the most part, this is a company that has done a really good job with that. It's not signing long-term contracts at stupid, cheap rates. A good number of its lower-day-rate contracts are shorter-term. They're for a couple of wells, maybe they're for a year or less, or in some cases, maybe for a couple of years. What that means is that management has done a really good job of being disciplined, generating cash flows to cover operating expense as much as it can, but also not handcuff it in this current environment, to not be able to participate as rates increase, as we start seeing some tightening in the global fleet of drilling vessels, so that it can really leverage the rates as they go up.

I think in general, it's done a good job with its backlog being -- it's a big number, but it's also a big number that's not restrictive in terms of what it could generate in terms of profitable day rates going forward.

Sciple: Right. And if you look at this backlog, it appears as though the company has legitimate prospects going forward. People are contracting its services. However, if you look at the pricing for the company, it's trading at 34% of its tangible book value. Historically, it's traded maybe 7% or 8% above that tangible book value. So when you look at what the market is pricing this company, that it's worth less than even the assets that it carries on his books, is the market too negative on Transocean, and maybe on the industry more broadly as well?

Hall: I think so. But you have to be a little bit careful with the book value metric. It's one that I've actually used a lot as a baseline for drillers over the past few years. Here's why you have to be careful with it. No. 1, even a fleet like Transocean's there's still going to be some scrapping activity going on. If it carries a rig on its balance sheet for $200 million, that rig might not necessarily have any economic value. If it's 15 or 20 years old, if it's sitting in a shipyard somewhere in some of an idle status, the company may be better off, instead of paying to maintain it and keep it idle, just go ahead and scrap it. Eliminate its operating costs. And if it does that, it has to write off that $200 million in value that it's carrying. That is a ping off the book value. So, part of what you're seeing is, that 32% of book value, roughly, that it's priced at right now, is because the market does expect that there's going to be some continued writedown of those assets.

Frankly, I think Transocean's book value, realistically, probably should be double the current multiple. Maybe even higher. 1X book value is really not too much to ask for. But you go back to, again, 2014, when oil prices started to fall, these books values fell sharply. In the past half decade, all of the offshore drillers have looked really cheap by that metric.

Now, if you look at cash flows, it's a different story. Transocean looks a little bit expensive based on its price to cash from operations, which is a good metric for cash profits, a good proxy for that. But that's partly because of some timing things. It just acquired Ocean Rig late last year. A lot of the vessels it acquired from Ocean Rig are not under contract, which made it really a prime opportunity to buy those vessels, but its cash flows have taken a bit of a hit the past quarter or so because of that, and that could continue.

What I'm watching with Transocean right now is, I want to see how quickly they can integrate that fleet, drive out any costs they can, and then start putting those vessels back to work so they're generating cash flows. I think it could take some time to do that. I think on balance, the risk-reward, if you buy shares right now, you have to be willing to sit on them, sit on your hands for at least three years, two or three years, to really let the market continue to turn and to continue to improve before you're necessarily going to see those book values start to really recover. But I think there's a tremendous amount of upside in the valuations that Transocean trades at today.

Sciple: Sure. Last thing before we move on to other companies. I've looked at several of these as we prepared for this episode. You look at Transocean's fleet, their exposure to these deep-water in-demand industries. Would you say, of the companies we're going to look at today, Transocean's probably best in class when it comes to offshore drillers; that if you need to buy something in this space, this would be at the very top of the list?

Hall: Yeah, I think so. When you're talking about equities, there's always a risk of permanent capital loss of some level. But this is a company with close to $2 billion in cash. It doesn't have any near-term debt maturities that really put it at any risk. Because this is a very capital-intensive industry, these companies almost always carry a significant amount of debt, so its ability to manage that debt is important. But between its general cash liquidity, access to tap some revolving credit, it has tons of capital available to it, and it should swing back to positive cash flow, I would imagine, sometime in the next couple of quarters. So I think this is definitely the one that has the least amount of risk and a pretty decent amount of upside from here. For sure.

Sciple: Sure. So, moving on, we're going to talk about EnscoRowan, ticker ESV. When you look at their fleet, it differs somewhat from what you're looking at from Transocean. They're more tied to the jackup type of rig than Transocean is, more focused on the deepwater. Can you talk about, when you look at those differences in fleets, what that means from the company from an operational point of view and what they may be exposed to that Transocean is not?

Hall: It's an interesting story with EnscoRowan. If you go back to 2017, Ensco and Atwood Oceanics merged. Ensco had a little bit stronger financial profile. It merged with Atwood Oceanics. Atwood had a great fleet, small fleet of really high-spec, primarily floaters. That's semisubmersible and floating drill ships. Didn't have a ton of backlogs. Anyways, those two companies merged. A lot of financial strength came out of it. But again, the offshore market was really slow to bounce back. So the decision was made to merge with Rowan just very recently. This actually closed in April. Rowan's strength is jackups. That's where this big fleet of jackups comes from, Rowan has a very large fleet of those, has a really solid backlog. That's where that joint venture with Saudi Aramco comes into play. So it's a really interesting now hybrid, because you get Rowan's strength on the jackup side, and this massive customer with the joint venture with Aramco. And then, from the Ensco legacy side, it actually still has a pretty focused fleet of floaters, really, especially semi-submersibles, that can operate in harsh environments. And the expectation is that the harsh environment semisubmersibles are going to be one of the stronger day-rate growth, market-tightening, high-demand segments of the offshore market over the next five years. I think it's a combination of a pretty predictable amount of cash flow that it should get from the Rowan side of the business that it acquired, and then opportunity to really grow its cash flows from the harsh-environment drilling and production that should be really starting to grow over the next four or five years.

It's another company that's got a really good liquidity situation. They just released a presentation that broke down some of their pro forma information. The financials that both companies reported for Q1 was before the merger, so they were separate financials. It's got about $1.5 billion in cash and short-term investments, which is really strong. Again, doesn't have any real near-term maturities in terms of its debt. So over the next four or five years, its capital situation should remain pretty good.

It's much smaller than Transocean, but, again, it doesn't have anywhere near the backlog. A big part of that is because those jackup vessels just don't get the day rates that you do from the floaters that are such a big part of Transocean's backlog. But again, I really like it in terms of a little bit smaller player, really good opportunity for upside. If you look at a lot of the book values in different screeners that you might use out there, you see a 20% to 25% book value. I don't know how accurate that is. And until we see consolidated financials, it's probably trading a little bit closer to the same kind of valuation that you're seeing from Transocean. But, also, I like Ensco a lot. I actually bought shares somewhat recently of RIG and Ensco both.

Sciple: Are you more bullish, then, on the ultra-deepwater, harsher rigs than you are on the jackups? Does that exposure to jackups maybe make Ensco a little bit less attractive? Or does that presence with Aramco really make it a special case there, that they have such a powerful client with them buying up their supply?

Hall: I think it's a good situation. In general, a heavy jackup fleet isn't necessarily the best situation to be in. But, yeah, the Aramco relationship, that joint venture, is really good. A lot of its jackups are newer, and it has a program to buy a lot more newer jackups that are going to drive down those costs. You can buy a jackup for $60 to 80 million. You want to buy a semisubmersible, you're going to spend triple that, easily. You buy a drill ship, you can spend $500 million. Those vessels are very, very expensive. It takes a lot of capital, takes a lot of debt. Debt means leverage, interest expense, all that kind of stuff, and the market's going to start recovering.

So I guess the best way to describe it is, I like the jackup fleet because of that relationship, because it is a predictable cash flow source that should continue to pay off. But you also have some upside because it does have a nice, smaller fleet of high-spec vessels in the area that I think we're going to see a lot of demand growth, and is probably the most susceptible to tightening in demand, which is good for day rates, which is good for profits for a company like EnscoRowan.

Sciple: Awesome. Going to be a company to continue to follow as they absorb this acquisition, come together, and you can see how the financials of the combined company shake out.

Last company we're going to talk about today is Seadrill. They also have had, I guess you could call it a transaction. They emerged from bankruptcy in July of last year. Equity holders that were holding prior to that point were essentially wiped out, lost 98% of the equity value. However, since they've emerged, what are we seeing from Seadrill, Jason? Is there any sign that there's some light at the end of the tunnel after they've emerged from bankruptcy?

Hall: On previous shows, myself and Tyler Crowe have spoken with you about our...there's a lot of emotion [laughs] that we still have with Seadrill. I was fortunate that I sold a pretty substantial amount of my investment in the company about three years ago. But I did hold some, and it lost 98% of its value. I sold right before the bankruptcy was official, when it was pennies on the dollar, and just washed my hands and walked away and decided I just wanted to sit back and watch.

Essentially what you have is, you have a company with a great fleet. It has a fantastic fleet of, I think it's all floating vessels. I don't know if there's any that are more than 10 years old. It's a high-specification fleet. It has a smaller backlog. It doesn't have a ton of debt that it really has to worry about in terms of near-term maturities. It's working through some really high-interest debt that it's trying to get off of its balance sheet and repurchase. But it's really struggled to generate cash flows that I think investors should be looking for right now. It's burned through a ton of operating cash since emerging from bankruptcy. I think the year-ago quarter, it burned $180 million in cash flow. It did generate positive cash flow at the end of 2018. $33 million in positive cash flow. That's a good sign.

But frankly, you had a company come out of bankruptcy, and on this last conference call, one of the executives was talking about potentially selling off assets, which leads me to believe that this company did not really do a very good job of emerging from bankruptcy healthy and whole. It's one that I continue to watch, because the potential of its fleet seems to be pretty good. But I'm not convinced that the company is where it needs to be. I think I want to see more recovery in the offshore market before I would really be willing to give them a single penny of my money at this point.

Sciple: Yeah. One thing I saw, I was reading through their most recent earnings conference call, and I saw this line from the CEO, and I wanted to ask you a question on it. He said, "Our focus is on backlog quality over backlog quantity, which means at the moment, we're saying no to as much work as we're saying yes to." What are your thoughts on that, given a company that's showing some problems when it comes to keeping their liquidity up? If they have to sell off some assets, they're having some cash issues, what are your thoughts on them turning away business that they could have under these circumstances?

Hall: Yeah, no, I think in general, conceptually, that's probably the right general move in this market. One of the things that has happened, as you've started to see day rates improve, is, we had to go through a ton of consolidation, we had to see a bunch of guys go out of business because day rates had gotten stupid cheap, because people were just saying yes to anything to generate any cash flows that they could. The balance of leverage shifted completely to the side of the producers. There does need to be some discipline. [unclear 32:37], is that the CEO you're talking about?

Sciple: Dibowitz.

Hall: Oh, Anton Dibowitz, the CEO. I believe he's actually leaving the company, too.

But the thing that's important is, the contracts they're saying no to are when a producer throws out a three-year contract that's cash flow breakeven for rig, for example. If I'm in a financial situation as an offshore driller where I can say no to that contract, I absolutely would say no to it, because, a year from now, two years from now, there's a good chance that day rates are going to be 25% higher for that same vessel. So, by saying no, you have the potential to help continue to push the tightening of the supply in that market to push day rates up. It's a little bit of short-term pain that should generate long-term gain overall for the industry.

When it comes to Seadrill, I'm just not convinced that, on balance, they're really leveraging their assets in the best way. From an industry perspective, I love that they're saying that. Again, I'm just not sure how much truth to really leveraging their assets in the best way is going on there.

Sciple: Yeah, something to continue to follow. Again, a company that's less than a year out from bankruptcy, still trying to find its way, as apparent by thinking about continuing to sell some more assets.

Jason, before we go away, for folks who want to get involved and maybe buy one or two of these companies and continue to track the offshore drilling industry over time, what are the metrics folks should really be paying attention to -- whether it's an individual company metric or a broad industry metric -- as they follow this investment over time?

Hall: There's a couple of metrics that the companies will talk about that are important. One is the utilization rate. That is the percentage of available revenue-producing days for their entire fleet -- in other words, the percentage of their vessels that are actually working. There's another one that they use, it's called economic utilization. The difference is really important. The utilization rates for these guys are going to be anywhere from mid 50s to the low 70%. The higher that number is, the better, because it means they're generating more cash. The economic utilization is a very different animal, because that is the percentage of working available days that vessels that are actually under a contract are working. Now, it's an important metric, because it's a cash flow efficiency metric. How much are they wringing out of every vessel that's actually under a contract? But it doesn't include the vessels that they don't have under contract. It's really important that you understand both the actual utilization rate for the entire fleet and their economic utilization rate. That's important to know.

You also want to look at two metrics from their balance sheet -- you want to understand, what is their available liquidity from a combination of cash and short-term investments that they can tap essentially immediately. Any debt instruments they have access to, like a revolving credit, that they might be able to tap for opportunistic acquisitions or anything that they might be able to use it for like that. And also, on the backside of the balance sheet, looking at their liabilities, understanding not just how much debt they have, but any near-term maturities that they're going to have to deal with, that they're going to have to come up with the capital to pay off, or that they're going to have to figure out how to refinance, which can be a little bit harder right now.

Now, again, on the operating side, I think an important one to look at is operating cash flow. If you think about GAAP -- generally acceptable accounting practices -- net income, earnings. There can be a ton of noncash stuff in there, especially with all of the acquisitions and mergers and fleet scrapping and all of the things that are happening. A lot of those things are noncash. So, the GAAP net income numbers aren't necessarily a great way to understand what's going on the profitability side. Cash from operations is a really good proxy for cash profits.

Look at the trends. Don't make a decision based on what happened last quarter, or what you're expecting next quarter. Think about the trends over the long term. Those are probably the metrics that I would focus on the most, in terms of identifying the quality of the business.

And then in terms of valuation, think about price to free cash flow or price to cash from operations over a trailing 12-month period to give you some idea. Then, balance that out with the price to tangible book value. Split the difference. And, somewhere in the middle, based on the historical averages, that's going to give you some idea of the trajectory, in terms of, are you getting a decent valuation or not? I think that's basically where I am right now.

Sciple: Yeah, great advice for our listeners! Last thing I'll say is just remember, this industry, like a lot of the ones we talk about on this show, is cyclical over time. Like Jason said, one quarter, or even a couple of quarters, shouldn't determine your investment decision. Just be aware of where we are in the cycle. Right now, it appears we're reaching a cyclical trough and starting to turn back up, so now is a good time to sniff around and kick the tires on some of these companies. We hope this has been a good introduction to that for investors who want to dive deeper.

Thanks so much for coming on the show, Jason! I look forward to having you on again soon!

Hall: Cheers! Thanks so much!

Sciple: As always, people on the program may own companies discussed on the show, and The Motley Fool may have formal recommendations for or against the stocks discussed, so don't buy or sell anything based solely on what you hear. Thanks to Austin Morgan for his work behind the glass! For Jason Hall, I'm Nick Sciple. Thanks for listening, and Fool on!