Investing in oil can be a pretty polarizing thing today. Some see it as a massive opportunity to buy shares at a discount, while others see plenty of opportunities to lose a lot of money if companies can't stay afloat in this low price environment.
We asked a few of our energy contributors what they thought about companies in today's market, and whether now is a time to stay away from certain stocks, or if it's time to dive in. Here is what they had to say.
Matt DiLallo: I'd steer clear of BP (NYSE:BP). Sure, it has a very compelling dividend that's currently yielding a tempting 5.7%. There are also rumors that ExxonMobil or some other Big Oil giant might buy BP. The problem with these two apparently compelling reasons to buy is that both are far from a sure thing. Worse yet, BP has problems -- lots and lots of problems.
Let's start with that alluring divided. It's just not safe in a low oil price environment, as BP's cash flows are under pressure by oil prices. That's why Goldman Sachs recently downgraded the stock to a sell and said BP's dividend is one of a handful of oil dividends that will "likely see the largest cuts." https://uk.finance.yahoo.com/news/bp-dividend-risk-oil-prices-112200553.html
The other reason some investors are drawn to BP is its potential as a buyout candidate in a mega-merger. However, that's highly unlikely for the simple fact that the British government has already said it would oppose a takeover of BP. The country wants to have two Big Oil companies after Royal Dutch Shell (NYSE:RDS-A) (NYSE:RDS-B) announced it was gobbling up BG Group. That would seem to effectively quash any attempts to buy out BP at a premium.
On top of this, BP still has legacy issues from the Macando disaster in the Gulf of Mexico. Because of that disaster, the company's balance sheet isn't as strong as its rivals', as BP has the weakest credit rating among the big five oil majors. Many of its other metrics aren't as good either -- its earnings per barrel of oil is the lowest in the group, and its returns, as the chart below shows, are all at the bottom of the barrel, so to speak.
The numbers just don't add up in BP's favor; there are better oil stocks to buy right now.
Seadrill's stock has rebounded almost 50% since April, but the company remains heavily exposed to risk on two fronts: prolonged reduced demand for offshore drilling, and its immense (and growing) debt burden.
When the company suspended its dividend several months ago, management said the roughly $2 billion in reduced annual cash outflows would create a margin of safety while the drilling environment settled. At the time, it was expected that demand would stabilize by the end of 2015, but it's looking more and more likely that it could take substantially longer for offshore drilling activity to increase -- maybe as long as two years.
The risk for Seadrill is compounded by the 15 newbuild vessels the company is on the hook for, and which it has already invested billions of dollars into. These vessels will be entering service over the next 18 months, and so far, only a few are under contract. The risk of as many as 10 of them entering service without an accompanying source of revenue would be disastrous.
Seadrill's current $13 billion debt could grow by as much as $5 billion once all newbuilds enter service, on top of the $2.6 billion in debt at subsidiary North Atlantic Drilling that the company had to guarantee recently.
Seadrill is on track to see both its debt and operating expenses grow, even as offshore drilling demand remains weak and uncertain. Unless you're willing to take on measurable risk, I'd avoid Seadrill for the foreseeable future -- and that comes from someone who owns shares.
Tyler Crowe: Now that my colleagues have soured you on other energy investments, it's my turn to offer some encouragement. If you are looking for a company to buy today, there are a lot of signs that point to National Oilwell Varco (NYSE:NOV) as the one.
I can see the skepticism on your face through the screen. Yes, the company's most recent quarterly results weren't great, with earnings and project backlog seeing decent sized declines. And yes, the offshore rig market -- the lion's share of NOV's revenue stream -- still looks oversupplied with rigs, meaning new rig orders will likely be pretty weak for a while longer. However, these are the sorts of things that happen with a company ultimately tied to cyclical commodities like oil and gas, and those who can look beyond the waves of cyclical markets will see a company well positioned for long-term success in the industry.
First, the company has a dominant market share in rig equipment sales, with more than 80% of floating offshore drilling equipment having the name National Oilwell Varco on it. A standardization program across all of its offerings pretty much ensures any piece of equipment that needs replacement will be coming from NOV.
Second, the company has financials that make most companies in the energy industry jealous. Not only does National Oilwell Varco have a splendid balance sheet -- its net debt to capital ratio is 4.7%, and its $3 billion in cash on hand is more than enough to cover any short-term expenses that might pop up -- it also has superior rates of return for the industry and a history of maintaining EBITDA growth throughout the commodity cycles better than its peers.
Finally, shares of National Oilwell Varco are extremely cheap by today's standards. Price to earnings are at a paltry 9.4 times, price to sales is 0.97 times, and buying shares today is at close to book value. These are the kinds of traits value investors like Benjamin Graham loved, and they suggest you can get a lot of bang for your buck today.