In this week's episode of Industry Focus: Energy, we take a broad look at the recent past and future in the energy space. What subsectors have done the worst in the last 10 years, and which have done the best? Should investors expect that to change in the 2020s? What does the Saudi Aramco IPO mean for the industry, and what does it mean for individual investors? Are we due for more or less M&A activity in this space, and who's most likely to make a move? How could a political sea change affect energy companies? Plus, stay tuned for some energy stocks to watch in 2020, investing New Year's resolutions, and more.
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This video was recorded on Dec. 18, 2019.
Welcome to Industry Focus, the podcast that dives into a different sector of the stock market each day. I'm your host, Emily Flippen/I'm Jason Moser/I'm Nick Sciple/I'm Dylan Lewis, and today we're talking Financials/today we're talking Consumer Goods/Wild Card Wednesday/and we're talking Energy/and today we're talking Tech. Let's dive in!
Nick Sciple: Today is January 2nd [audio was pre-recorded on December 18, 2019], and it's our 2020 Energy preview show. I'm your host, Nick Sciple, and today, I'm joined by Motley Fool contributors Jason Hall and Matt DiLallo via Zoom. How's it going, guys?
Matt DiLallo: Doing great.
Jason Hall: Hey, doing really good. It's good to be on. Matt, it's been a while. Haven't been on an actual voice-to-voice chat with you in quite some time. I'm excited.
DiLallo: Yeah, probably since October 2018, right before the oil market crashed.
Hall: Hey, let's kill the oil market again!
Sciple: Yeah, last time we did one of these roundtable shows, as you mentioned, I think it was last September or October of last year, when we had the writers' conference here at Fool HQ. [laughs] As Jason called out, we basically hit the top of the oil market, and folks, it really fell from there.
Today, I want to talk off the top of the show, the state of the energy industry. You look back over the past decade, it's been a wild ride for the energy markets. If you look at the S&P 500 Energy ETF, it's up 9% over the last decade. The first half of the decade, you're up 75%, 80%, as the beginning of the shale explosion took place. But valuations have really come down significantly. Just a couple of weeks ago, there was a report from Bank of America Merrill Lynch out saying that Apple is now bigger than the entire S&P 500 Energy subsector. As we look at the energy market today in the context of what's been a wild past decade, what do you think is the current state [of the] energy market today for investors?
DiLallo: I'll start off with that one. It's been tough. If you look at it, you could have done better in a CD than the energy sector, which is just mind-blowing, considering how much energy we use every day. A lot of that boils down to, companies have been really bad at investing their capital. However, I think that's changed a lot, and I think that's why it's pretty attractive. Pipeline companies are just so cheap right now. They're really doing a good job of getting good returns on their projects. Renewable yieldcos are another thing that I like. So infrastructure, I think, is really exciting, looking forward with energy.
Hall: This is Jason. I'll agree with Matt, within the confines of, you're talking about particularly oil and gas, the companies that have predictable revenue streams. Pipeline companies, definitely. There are a lot that look really, really cheap. And there's catalysts for growth there too. if you look at some of the new oil and energy plays, trying to connect markets to supply, he's right. And it definitely carries over to renewable yieldcos. You've got a lot of really good infrastructure and capital asset management companies that have figured out where to make money in renewables. The companies whose prospects are still tied to commodity prices -- I'm looking at you, independent oil and gas explorers and producers -- they just seem to destroy capital, and I don't think that their prospects are necessarily, as a category maybe ... But, I think the problem is picking the winners. So, I think for the most part, investors should continue to avoid those pure plays in the E&P sector. Look at companies that have predictable revenue streams.
Sciple: Sure. To your point on the E&P sector, we've seen a number of writedowns. Just in the past week -- we're recording this in the middle of December -- we saw Chevron take a $10 billion writedown on some of its natural gas assets. You teased this, and maybe I want to pull the thread on this a little bit more -- there's been a lot of pessimism, negativity around the E&P players -- Chevron is a fully integrated player -- particularly around these independents. Do you think that pessimism really is warranted, and we're seeing a sustained period where those companies aren't going to be able to perform in today's environment?
Hall: To some degree, I think absolutely. The independents -- for those of us that went through 2014, 2015, 2016, and watched oil bottom in the $20s, and then this new emergence of capital discipline that we saw in the year and a half or so after that, kind of felt optimistic that maybe this sector of the market, these guys that live and die by commodity prices, maybe they finally have it figured out. But, here we are three years later, and guess what? They're still hammers, and everything they see is a nail. It's all about drilling more wells as being the solution. Again, it proves that it's not a sustainable answer. You can't blow through capital when commodity prices are rebounding and expect to be in a position to do when commodity prices don't necessarily hold up.
But, with that said, you look at the SPDR E&P ETF, ticker XOP, it's down like 29% year to date. It might be at an all-time low. If it's not at an all-time low, it's very close to it. I can't help but wonder if maybe taking a basket approach and buying that index ... if there's not some opportunity. But it's just such a hard business to make money in, especially with so much secondary gas being produced from oil drillers. I'm not sure. It just really scares me away from that segment.
DiLallo: I agree with a lot of what Jason said there. It's been just so tough to pick winners in the sector. They just burn through capital like crazy. However, it's been interesting to listen to how managements have changed their tune the last couple years. There's been this talk about how much free cash flow they can generate. They're starting to use that in shareholder-friendly things. A lot of them have started paying dividends. They're doing share buybacks. I really like that. I think that's a big positive. As more companies get on board with that, I think that'll be a positive for the sector, because they're really shifting away from this drill, baby, drill thing to, "Hey, let's try to make our investors some money." A lot can grow at a decent rate plus generate free cash flow in the $45- to $50-a-barrel range. As we're recording today, oil is around $60. So, they're making a lot of money. It's just, it hasn't boosted their stock prices yet. It'll be interesting to see if that starts happening as they buy back their shares. That's why I'm optimistic, especially on the lowest-cost producers. I think they could really make investors some money.
Sciple: Yeah, I think it's something that we'll continue to follow here, certainly. The 2010s were the first real full decade that shale was involved in the energy markets. In the first part of that period, you can see how the markets were very much focused on growth and "how can I show increased production year over year?" As both of y'all mentioned, as you see focus turn more toward cash flows, maybe we'll see some consolidation in the sector. The environment has definitely changed when it comes to the need for profitability and the focus on getting those costs down.
Another important story that we're seeing materialize this year, but it's been talked about the past several years, is the Saudi Aramco IPO. I mentioned off the top of the show how the S&P 500 Energy sector is now smaller than Apple. Well, Saudi Aramco by itself is around $1.7 trillion today, so, bigger than Apple. This company just came public. We don't have a ton of information about it. What should energy investors be aware of with this business? How significant is this IPO for the sector and for energy markets more broadly?
Hall: Matt, do you want to go first on this one?
DiLallo: Yeah, I'll take that. I think it's a good thing for investors that Saudi Aramco's public, because they've been able to manipulate the market behind the scenes, and they won't be able to do that so much. Now they've got a different class, for lack of a better word, to answer to, which is investors. Now whether they'll run their business for investors or run their business for the Kingdom of Saudi Arabia remains to be seen. But if they don't, they're going to have a lot of upset people that bought into this IPO. I think they might keep a lid on their production, and that should boost oil prices. I think it's a net positive for the market.
Hall: I agree. I think it's a net positive for the market in terms of potentially getting a little more information about the gorilla in the global energy room, there's no doubt about that. But I think I can answer Matt's question that remains to be seen about how Saudi Aramco is going to manage this business. It's going to manage this business -- this is my prediction -- exactly the same way it has. The Kingdom of Saudi Arabia is still by far the biggest investor. Will always be the biggest investor. And I think that it will not blink to do things that are still in the Kingdom's best interest if they're not in shareholders' best interest.
With that said -- Matt, I don't want to speak on your behalf here, but I think you probably agree with me. I don't think this is an investment that retail investors should consider. I don't think there's enough upside. I don't think there's enough value. I don't think there's enough downside protection, when there are plenty of appropriate investments that you can make that would give you great returns or income or whatever your focus is.
I do like the fact that it's there, that it can maybe give us a little more information. But I don't think it changes anything about what Saudi Aramco does or why it does it.
DiLallo: Yeah, I agree, Jason. It's interesting to watch but not something that I would put my money in.
Sciple: To both of y'all's points, this is a company that I think should be the poster child for political risk when it comes to investing in a company. The Aramco example highlights something that's broader to the energy sector, how intertwined the energy industry can sometimes be, with both government policy and regulation. I think today, we see that in no more apparent way than concerns about climate change, and what actions the government should take along those lines. We just saw Greta Thunberg from the climate strike be named the Time Person of the Year. We saw the EU announce a new Green Deal this past week. And, we see the 2020 election coming up this year. From the perspective of an energy investor, what will you be paying attention to on this policy/government side of the market when it comes to your investments?
DiLallo: One thing that I've noticed that companies are already talking about is the possibility of fracking bans on federal lands. Some of the candidates on the Democratic side have said that they would institute moratoriums on granting permits and things like that. That's one of the things that's weighed on the U.S. E&P sector, because a lot of these companies, especially in places like the Permian Basin, a lot of that's federal land that they've leased. So that could impact their ability to grow. It would shift where they can grow. They might not be able to drill the highest-return wells. So that's something that could definitely weigh on the energy sector, a candidate with one of these policies coming to the forefront later this year.
Hall: Yeah. I think that's definitely the big one, if you want to call it a macro thing. That's definitely a macro thing. I think a smaller thing that's pretty important, but I think it has a bigger material impact on certain smaller companies, is alternative fuel tax credits. Some of our listeners are probably aware of something called the tax extenders. It's this bucket of tax credits that historically, over the past decade or 12 years, tend to get renewed close to the end of the year, every single year. And every once in a while, they don't get renewed, and then they get renewed again, and they grandfather in the period that wasn't covered, and then they get extended for two or three years.
Anyway, alternative fuel tax credits have an outsize benefit for companies like Clean Energy Fuels, a small natural gas-for-transportation company. For somebody like Clean Energy Fuels, this tax credit wasn't in place this year, 2019. If it gets reinstated and made retroactive for 2019 and all of 2020, the company would probably get a cash tax return just on this one credit that would be enough to pay off all of its debt. The company's been working to clean up its balance sheet. Made a lot of progress, but to be able to say, "Hey, we have no debt, and by the way, we've got an extra $50 million in cash" would be a pretty powerful thing. So, that's one thing that I'm watching. I think you'll see more push for that if there's a Democrat in the White House, and maybe Democrats took a little bit more position in Congress. We'll see what happens in November.
Sciple: Yeah. Jason, to your point on tax credits, as well, we're seeing starting in 2020, the solar investment tax credit starts to sunset. We see, starting in 2020, Tesla and GM will be the first EV makers that will see their federal tax credits start to roll off. And there has been talk several times extending those tax credits that's been done in the past. That would be another significant tax credit to follow this year, particularly as EVs and solar become a bigger and bigger part of the future of energy.
As we move on to talk about some themes of the energy market that folks should pay attention to, I have a few questions to ask you guys about. First off, what's one thing you think that people get wrong about the energy markets or about investing in energy?
DiLallo: I'll take that one. One of the things that's been surprising to me to learn over the years is, it's not driven by fundamentals as much as I thought. Sentiment plays this big role in how well oil stocks perform. We've seen that this year. The U.S. oil benchmark WTI is up like 27% right now; however, oil stocks have underperformed. One of the big ETFs that follow oil stocks is actually down this year. That's different than what we've found in the past. There's been this big dislocation in recent years of fundamentals and sentiment. A lot of that, I think, is driven by the fact that it's been so hard. Things have underperformed for so long that investors have given up on the energy market in total. And it's not just retail investors. We've seen the capital markets, it's almost impossible for oil companies to issue stock or to get new debt at good rates. There's just been this huge change in sentiment that's made it really difficult for the market to operate. That's just not the way it's always been. That's something that investors really need to learn. Even though oil prices are up doesn't mean oil stocks will go up.
Hall: Yeah, I'm going to chime in on that. Just to further show some numbers to prove that out, the Oil and Gas Explorer and Producer ETF, XOP, it's probably finished 2019 down 15% or 20%. I think it'll probably end up down like 35% from the high that it hit early this spring. West Texas crude is going to finish the year up between 25% and 30%. Again, the companies that directly benefit from higher commodity prices as a group, sentiment. Their stock prices as a group are going to be down double digits while commodity prices are up double digits. That's it.
But I think the other part of it, too, and I think this ties to it for me, is, a lot of investors view renewables as this panacea that's going to kill fossil fuels over the next decade or 20 years. Certainly, I think the oil industry is dying. It's just not dying yet, and it won't die quickly. We're talking about, it's going to take 30 or 40 or 50 years for the oil industry to "die." Renewables are just a bare fraction of the global energy market. And even as they grow and become a bigger fraction, oil and gas are going to remain a dominant, dominant way we power the world.
I think none other than Bill Gates is a pretty big proponent of nuclear energy for those reasons. I think he also points out the needs for industrial energy, and how there are parts of the industrial chain that are going to continue to produce massive emissions no matter all the other pieces of it. Nuclear can and probably should be a big part of that no-emissions power. So yeah, I think you're probably right.
Sciple: All right, next segment. Do either of y'all have a bold prediction about the energy market for 2020?
DiLallo: I do. There's been a lot of mergers and acquisitions in the energy market in the past couple of years, but I really think that 2020 is going to be the year that we see a ton of mergers and acquisitions. But I think what's going to be different is that we're not going to see these huge mega-premium deals. Earlier this year, we had Chevron bidding on Anadarko and then getting outbid by Occidental, and this huge debacle. I think we're going to see a lot of what we'd call a merger of equals, where there's no premium deal, straight up stock for stock. The reason being is, these companies just need scale to drive down costs, and the only way they're going to do that is to join forces. So I think we're going to see a ton of mergers.
I've got some that I've been keeping my eye on. I really think they'd be good fits. So, my bold predictions for this are, I think Devon's going to buy Marathon Petroleum. Diamondback Energy is going to buy Concho [Resources], and then ExxonMobil, I think, is going to make a big buy and merge with ConocoPhillips.
Hall: You're not messing around, Matt. You're stepping out there.
DiLallo: He said bold.
Hall: It is, it is. Of those, honestly, I think ExxonMobil buying ConocoPhillips might strike a lot of people as, "Whoa, that's crazy," but that's actually a really good fit. I think it really is a really good fit.
I'm going to go in a different direction. I'm going to be bold. I'm going to say offshore drillers will finally be a great investment in 2020. [laughs] I think they almost have to be, though, to be honest with you. I'm bottom-fishing a little bit there.
But, seriously, my bold prediction is going to be that Tesla grows its solar business in 2020, and then it takes market share from SunPower, Vivint, and Sunrun. For the uninitiated, those are the biggest residential solar installers and commercial solar installers in the U.S. I think Tesla is going to grow that business and it's going to take market share this year.
Sciple: The next segment is, what are y'all's...I don't want to say your top picks, because that's always tough. But what energy stock would you be most excited to own going into 2020?
DiLallo: I've been thinking about Energy Transfer for years and years and years. I'm glad to this point that I haven't bought because it's done nothing but go down. However, for me, it checks all the boxes. It's so ridiculously cheap right now. It trades at 8X its earnings. Most midstream companies trade at 10X-plus earnings. It's so cheap, and it's because it's growing its earnings, even though its stock is falling. It also pays an enormous dividend, 9.7% at this moment. And it generates enough cash to cover that 2X, which is really safe as far as coverage goes. It's a master limited partnership, so they typically try to do 1.2X coverage. So there's a ridiculous margin of safety there. They've done a good job fixing up the balance sheet to get their leverage down. So I think that's a safe payout. I think they might actually start increasing it in 2020, because they're growing earnings. They grew their earnings double digits for the past five years. They're on track for another double-digit earnings growth next year. They just bought SunGroup, which will give them another oil port. They're integrated into oil exports, and I think that's a big market. They have a lot of organic expansion. So I'm really tempted to buy that. I think I will buy that. That's the one that I think has the potential to do extremely well next year.
Hall: It's funny, I think, to a certain extent, Energy Transfer lately has been a product of its past a little bit, in terms of, it's had some challenges that it's had to work through over the years, and then you have this sentiment where it's blocked in as a quote-unquote oil stock. But I think you're right. A lot of times, people see that nearly 10% yield as, "Wow, that's got to be a dividend trap. Something bad's going to happen. I'm not going to buy it, they'll cut the dividend, and the stock will fall 30%. I'm not falling for that, Energy Transfer." But I think you're right. It's an opportunistic chance to buy one of these guys that you buy usually for yield, but you'll probably get some really good capital appreciation because the value is so cheap.
With that said, I'm going to go a similar, slightly different direction. I'm going to go with an expensive renewable energy company, Brookfield Renewable Partners. The stock has absolutely been on a tear. But I think deservedly so, because it's a great company. It's part of that Brookfield group. They know how to manage assets, they know how to invest in assets that make money. I'm going to say this is one that I don't know if I'd necessarily buy today, unless I didn't own it. I think it's worth starting a position today. But I have a ton of it. So I'm going to say that's my "own forever."
If I was going to buy today, my buy now is Tellurian. We did a show not too long ago, Nick, about the LNG exporters, liquefied natural gas exporters. Tellurian is one we talked a lot about. Great management that have a solid operational background from their time at Cheniere. It's got co-founders that are still really involved. It's got great prospects. It's a little higher on the risk scale because they still don't have a business. They're still just in the early stages of planning out and getting ready to build. They're going to have to spend upwards of $30 billion to build this export facility and a couple of pipelines. But they have the right team in place to do it. There's a huge opportunity. And I think after the recent tumble the stock's taken, I think five years from now, there's a realistic possibility this is a 10-bagger stock. Even if it's not a 10-bagger, I think it has a better-than-average chance of absolutely crushing the market over the next 5 to 10 years.
Sciple: Yeah, absolutely, Jason. We discussed when we did that show, maybe a week or two back, you have the management in place there at Tellurian that's done it before, an opportunity before you from a macro point of view that really sets up nicely for them. So you can really see the way things could line up, and it could be a very successful stock.
I think for me right now, I don't know if I have an individual stock pick, but I do think, going off some of the themes that we said earlier about how we think there's going to be continued consolidation in the E&P space, about how energy prices are low relative to the value that these businesses provide, I think companies that are alternative asset managers that are sources of permanent capital are well positioned going forward. We talk about Brookfield Asset Management a lot on this show. Jason mentioned Brookfield Renewable Partners. We talked about the merger between Occidental and Anadarko Petroleum earlier this year, that Berkshire Hathaway was really able to extract incredible terms out of that deal as the capital provider there. You look at how low interest rates are over time, I think you're really well positioned to invest in one of those alternative asset management companies, whether it's a Brookfield or whether it's Berkshire Hathaway or a company we're going to talk about on this show next week. It'll have already been out by the time this show comes out, it's Loews, a company that touches a few of these areas. They have a stake in Diamond Offshore.
Hall: By Loews, you're not talking about the home-improvement company Lowe's? The other Loews.
Sciple: Yes, L-O-E-W-S. I think these sorts of companies that have permanent capital and are well-positioned to invest going into the future are a place to look in the market.
Alright, moving away from energy and more toward the new year and investing, as we close out, Matt and Jason, what are your New Year's investing resolutions for 2020?
DiLallo: Well, one of the things that I know I struggle with as an investor sometimes is, I tend to be really risk-averse. That's why I like things with predictable cash flows and high dividends, even though those have tended to have more risk than I expected. I want to be a little bit riskier with some of my energy picks, especially in the renewable side. Renewables is a multidecade trend. So I think, buying renewable stocks this year, even though they've been crazy. Like Jason mentioned, Brookfield Renewables has been gangbusters. A lot of solar stocks are up triple digits this year. However, when you're looking decades out, I think renewables is just going to be the place to go. So with zero-dollar commissions, I want to take advantage of buying renewables and build a basket of different renewables to go with my lower-risk Brookfield position and TerraForm Power and some of those. But I want to add some solar panel makers, maybe some wind turbine type stuff, and just build out a really nice portfolio of renewable stuff to benefit from this long-, long-term trend.
Hall: Yeah, Matt and I were chatting on Slack a couple of weeks ago, talking about Pattern Energy, which recently reached a deal to go private. I've been a big bull on Pattern for the past couple years. The stock's done really well, with some risk. I think the last thing Matt said to me in the email was, eventually he would learn, [laughs] talking about that. So, I want to laud you for taking this approach. And I agree, zero-dollar commissions, such a great way for investors -- I don't think people should use it as a reason to trade more, but people should use it like you're talking about, as ways to build more diversified baskets. You can throw a few hundred bucks. You've got five or six companies you like in an industry, and you don't know which one or two you want to buy, there's no reason now why you can't spread your capital across the entire basket and build some diversity into a sector that you like. And then, also, you don't have to worry about trying to pick the winners and avoid the losers. And I think it can pay off.
Ironically, though, my resolution for 2020 is to make fewer bigger bets. I've always been wanting to spread my capital around. I own well over 100 individual stocks. But as my knowledge and experience has increased, I've identified half a dozen to 10 stocks that I own a little bit of that I really like a lot, and it's time for me to start making some bigger bets. Specifically, I'm looking at renewables, some global infrastructure companies, and some real estate investments, some REITs out there that I really like out there a lot.
Sciple: Yeah, I think those are great things to work on for the new year. For my part, I've become, I guess, more hesitant to invest every month. I've gotten out of the habit of investing a set amount of money every month. I've tried to pick and choose a little bit more than, probably, I should with timing the markets. So, I think my resolution for 2020 is to buy the same dollar amount of stock every month, whatever my thoughts are on the market, whatever I think is the best stock to buy at that time each month.
I do think you guys missed the one big important part of this zero-dollar commissions, and corollary: everybody moving to fractional shares. Robinhood just came out, they're going to allow fractional shares. I can tell everybody I'm a Berkshire A shareholder now starting next year. All our listeners, you can do that, too, and we can make everybody think we're superstars because we own Berkshire A.
For folks who don't know, Berkshire A shares are the ones that share for $300,000 a pop. Unless you've been hanging out with Warren Buffett for a long period of time, you need to be a superstar to be moving those around. But I tell you, as soon as we get access to fractional shares, the first thing I'm buying, Berkshire A shares.
All right, y'all, thanks so much for coming on the show, as always. I hope all our listeners enjoyed this preview show for 2020. We'll be bringing lots more coverage of the energy and industrial markets as much as we can. Thanks for coming on, guys!
DiLallo: Thanks for having me!
Hall: Thanks. Happy New Year to you guys.
Sciple: Happy New Year!
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 Dan Boyd for his work behind the glass. For Jason Hall and Matt DiLallo, I'm Nick Sciple. Thanks for listening, and Fool on!