Many oil companies have been slashing capital expenditures in the face of depressed oil prices, so what does that mean for the future of oil supply?
While oil and gas are still the main focus of energy commodities, solar power is quickly gaining popularity. With backlogs and scheduled installs rapidly increasing for SolarCity (NASDAQ:SCTY.DL), one oil company is cutting back on its production and exploration, leaving some investors hesitant to stick it out through the tougher times.
A full transcript follows the video.
Sean O'Reilly: We're talking big oil earnings on this energy edition of Industry Focus.
Greetings, Fools! I am Sean O'Reilly, joining you here from beautiful and really hot Alexandria, Virginia. I am joined today...
Tyler Crowe: Pretty sticky, too.
O'Reilly: Pretty sticky. We're staying indoors all day. To my left here is Tyler Crowe, to my right is Taylor Muckerman. How you guys doing?
Muckerman: Very well. How are you?
Crowe: Pretty hot and sticky.
O'Reilly: We're on video now, so I should do that.
Muckerman: Yeah. That way we can be animated. It makes sense.
Crowe: Lots of hand gestures and I'll get up and do jumping jacks later.
O'Reilly: Halfway through the show? Like a seventh-inning stretch kind of thing?
O'Reilly: Awesome. Today, we're talking about the earnings results of a few oil majors, followed by the short- and long-term implications of cost-cutting by those oil majors. Before we go, we will hopefully be answering a few listener questions. Let's get right into it.
Interesting earnings as of late out of Total S.A. (NYSE:TOT) They are French, as I recall, Tyler.
Crowe: They are very French.
O'Reilly: Very French. As opposed to not quite as French?
Muckerman: As opposed to Quebec. That's kind of French, but not quite as French.
Crowe: This is really French. This is actually To-tal, if you're really going for the nice French.
O'Reilly: I took French in high school, so now I feel bad. They actually reported a pretty decent profit: $2.97 billion, down just a bit from the same quarter last year, where they earned $3.1 billion. This isn't the first time we've seen an integrated oil major benefit from current low oil prices because of their refining operations.
How does this compare to BP and Exxon? Were you guys impressed? What did you guys think?
Crowe: I haven't seen Exxon report yet, because they report tomorrow. We'll see how that compares there. The one thing I saw in Total's earnings that was possibly the most impressive thing was its production growth.
O'Reilly: Was it 13%?
Crowe: 12% year over year. When you look at a company the size of Total, to grow 12% and to grow it in profitable production -- because upstream earnings only declined 50% compared to BP, where we're looking at 80% or 90% declines in upstream earnings.
Muckerman: Same as Shell.
Crowe: Yeah. We're bringing on profitable production and to bring on that much that is profitable, that's huge. It's growing downstream earnings five times compared to last year. It was just a great quarter for them and showed the implications of several seeds they planted many years ago with new refineries in Saudi Arabia, cost-cutting across Europe, where it had weaker refining operations.
O'Reilly: This actually served as a big contrast for me with BP across the English Channel over in England. They reported a gap loss of $3.6 billion, but that was mostly due to Deep Water Horizon settlements and lower oil prices. Had they not been doing that, would they have performed just as well? What did you think?
Muckerman: I don't think they would have performed just as well. It seems like they had focus in too many different directions and they're still trying to recover from that. They sold off most of their downstream operations, so they're pretty much a pure producer. To watch them and Shell lose 80% on the EMP side of the business...
O'Reilly: Not so good.
Muckerman: When oil was only down 50% to 60% -- what's going on there? That's a big question I'll have.
O'Reilly: They didn't have as good of production growth either.
Crowe: Not even close. I don't think anybody is ever going to make 12% growth in the big oil space when you're that big. For Total to do that, it's absolutely phenomenal.
O'Reilly: Did you guys catch where it was? What region?
Crowe: No. A little bit all over the place. They had several deepwater projects. I think there was one in Russia, one off deep shore in Angola; not one giant project. It was the culmination of three or four projects all coming on line within the past 12 months. The funny thing was -- as you were mentioning Shell being weaker as well -- with their earnings release they just announced that they're going to be doing somewhere [around] $50 billion worth of asset sales because of the recent downturn in oil.
O'Reilly: That's walking around money.
Crowe: Yeah. That makes it funny because they just bought BG for about $50 billion. It almost looks like they turned this entire thing into a chop shop. They took the two together, plucked out the parts they really wanted, and now they're going to jettison a whole bunch of it afterward.
O'Reilly: They just had great earnings, but then they announced these asset sales and they're laying off 6,500 people.
Crowe: We also need to be very careful when we say a company has an earnings beat. When you have oil down this low -- the hurdle wasn't very high.
Muckerman: We talked about it on MarketFoolery a couple weeks ago, how the expectations for energy were worse than they've been in a long time. a) Because it's a tough economy; b) just because it's a terrible time for oil right now. I don't think there's any excuse.
O'Reilly: Moving on from the oil majors to something a bit smaller. Big news out of one of the bigger MLPs. LINN Energy (NASDAQOTH:LINEQ) announced earnings and MLPs are famous for paying out dividends. They're cutting theirs completely. Any thoughts?
Crowe: I am very ambivalent about this.
O'Reilly: You're not saying "meh," are you?
Crowe: No, I'm not saying "meh." This is a big deal for this company. Part of owning master limited partnerships as a unitholder is you're looking for a cash payment and if you're not getting one, it voids the point of owning this one in the first place. Especially for someone who may be a little later in their investing period. Someone either coming to retirement or in retirement looking for that income stream. This invalidates the investment thesis for LINN Energy.
Perhaps someone like myself, I am a shareholder in a bit of a different position because I look at this to say, "This really stinks. I'm not getting a distribution anymore." The one shining thing I keep coming back to with this company, though, is, it is actually a cash-flow-positive company in terms of generating cash.
O'Reilly: Factoring in the hedges, of course.
Crowe: Yeah, factoring in the hedges -- after its capital expenditures. It's a very good operator in that sense. By taking this distribution away -- they just mentioned they bought back about $600 million worth of its debt this past quarter, at a 35% discount, no less, because people are betting against their bonds right now.
Muckerman: They're getting a little nervous.
Crowe: It actually looks like they're maybe going to use this time to clean up their financial statements. If they can get that to work, from a long-term perspective, that actually makes a lot of sense.
Muckerman: Yeah. I was pretty shocked. Then you think there's going to be some selling. It's down 17%, but there are different mutual funds they have in the MLP space -- dividends, mutual funds, they'll probably have to trim their holdings to get that out of there. For me, as a long-term shareholder, if the company is willing to cut a dividend and has a good blueprint in front of it to figure out what it's going to do with that savings, I'm all for it.
Dividends are never guaranteed. I'd rather the business stay liquid than get my dividend until the company goes bankrupt or has to go private. I think it's a worthwhile cause as long as they are able to pay down that debt, maybe buy back some stock at these low prices, and grow by acquisitions. Hopefully, they can put some of that cash toward a new line of business as well.
O'Reilly: Taking a little step outside the energy and oil space, the last company I want to talk about in terms of earnings was everyone's favorite, Elon Musk's sponsored enterprise SolarCity. They actually had great revenue growth of 67% year over year, but that didn't help the bottom line at all. They actually lost $1.61 per share compared to $0.96 last year.
You probably know what I mean here, but is this going to be one of those companies that grows but continues to lose more and more money. Like they'll make it up on volume even though they lose a couple bucks per unit.
Muckerman: Yeah, it's not done yet. They said the loss this quarter is going to look even worse in the coming quarters. Their marketing and expenses are a lot higher, so margins have crimped down a bit, but they're growing. They're starting a small-business solar business that they just announced a couple days ago. Their business is growing at record pace quarter over quarter.
I'm not going to compare it to Amazon because that's a pretty lofty goal as a shareholder or company in general, but they are pouring their money back into the business at a record clip and they're growing vertically and horizontally in terms of integration. I'm a shareholder, and I'm willing to wait out a few more years of losses as long as they can continue to grow. They have record installations, record backlog; the top of the funnel looks great.
O'Reilly: Awesome. Any insights, Tyler?
Crowe: The one thing you can keep drawing to that's an encouraging sign in this is that its cost per watt is still being managed quite well. They saw a slight uptick this past quarter in terms of sales because sales are just growing that fast. They're trying to build an immense amount of infrastructure very fast. To do that, it's going to take more sales staff, more installation staff; if anything, that's my one concern with this company. It's the law of large numbers.
You started two or three years ago where they were going from 20 to 40 megawatts per quarter in terms of development. Now we're going from 130 to 180 megawatts deployed. If you look at their guidance, they're going to have to double what they've done in the first half of the year.
We're looking at a huge ramp-up and eventually that large-number law will probably catch up to the company. That's my one concern: that they're not going to be able to staff themselves quick enough and get enough people on board to cover the demand they actually have.
Muckerman: It's funny because in all their press releases they say "We are hiring" on every single press release. They have a link to their jobs page.
O'Reilly: That's got to be a good sign.
Muckerman: The latest one was where they announced that they're going to do the small business solar systems and it said at the bottom "We're hiring; click here."
Crowe: Another encouraging sign: megawatts booked. Not stuff they actually installed, but megawatts booked. It's actually even greater than what was installed this quarter. I think it was almost double. It was 300-something megawatts of total booked installations.
Muckerman: They're looking at close to a gigawatt this year of installed solar power.
O'Reilly: We could power up a DeLorean with a time machine.
Muckerman: I think so.
O'Reilly: What was it?
Crowe: 1.21 gigawatts.
Muckerman: You guys have better memories than I do.
Crowe: Now we've just got to get that house up to 88 miles an hour.
O'Reilly: We're going back to the future and then we'll go to the future and hopefully the Cubs will win the World Series.
O'Reilly: No, never. Before we move on, I want to make everybody aware of a very special offer for all of our Industry Focus listeners. If you found this discussion informative, and you're looking for more Foolish stock ideas, Stock Advisor may be the service for you. It is our flagship newsletter started more than 10 years ago by Motley Fool co-founders Tom and David Gardner.
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Moving on, we're talking about the short- and long-term implications of cost-cutting by oil and gas majors. I don't think I'm stretching anything by saying that the oil majors that we're talking about are some of the biggest industrial enterprises on planet Earth. They're enormous. They're talking about cutting their budgets 50%. Where does this leave us in the short term? Everyone is talking about the oil glut and all this, and where does it leave us in five years? I don't see the world needing less oil.
Muckerman: Yeah, it's not going to need less oil. That's the big worry from a lot of people. Even OPEC is saying because of this, in the next 10 to 20 years, we're going to be in a world of hurt and you'll see oil prices come back to where they were, possibly even higher. If you look at producers, they are dependent on future production.
When I look at them cost-cutting this much, that's a pretty worrisome sign as an investor. For some of the energy service companies, I think cost-cutting will allow them to come out even stronger because they're going to be lean and mean and they don't have to go out and find new fields. That's the energy producer's job.
When they come out of this like a Halliburton or Schlumberger, all of these companies talking about cutting employees, saying that cost-cutting was the reason why they beat estimates and why they're still doing so well during this downturn. They're not selling machines, letting go of a few employees that aren't going to be needed over the next year or so, but hiring is a lot easier than going out and finding oil.
I'm confident that they'll be able to hire back some of these employees unlike an Exxon or a Shell or someone – and other big producers -- that aren't going to be looking for oil for the next year or so. That takes time.
Crowe: One other thing... one of the earnings conference calls that I really liked to listen in on when discussing a lot of this stuff is Core Laboratories (NYSE: CLB). Their CEO had some really interesting comments on this. They have contracts with the largest oil and gas producer in the world, Saudi Aramco, all the way down to the really small independent ones that we have in the United States.
So they have a very all-encompassing...
Muckerman: The mom-and-pop shops with one or two wells, even.
Crowe: Some of the things he was saying on the call, David Demshur who's their CEO, was that we're seeing the cuts in a lot of these budgets we're seeing today, but he's more focused on the shifts in how that spending is actually being proportioned out rather than the cuts. A lot of these companies are going away from doing the exploratory capital spending right now and focusing all their efforts on development and saying, "Let's get these things online so we're not spending any more money."
Muckerman: And lowering the cost.
Crowe: Lower our cost to capital that we have and get these things pumping and generating some sort of cash flow for us, even if it's marginal, because oil prices are lower. This has some larger implications if we look further down the road. If you're someone like BP and you're really cutting back today on your exploratory budget, what's going to happen seven, eight, nine years from now when fields that are discovered today are on the clock for when they should be coming online?
Muckerman: And they're not growing production now as we speak. What's going to happen when they don't have anything in the pipeline, when their reserve replacement ratio is plummeting?
Crowe: Everything for them always looks like a giant funnel. Up at the exploratory level, you have all these projects up in the air and then three or four years later they've designed them, figured out how to implement, and then it gets down to the construction procurement. You get even smaller lists of projects that are going to be profitable. If you're cutting that section of the pyramid down smaller, the actual results you'll get in that 10-year time horizon is going to be very short.
Muckerman: It's the exact opposite of what SolarCity is doing right now.
O'Reilly: Very good. If you are a loyal listener and have questions or comments, we would love to hear from you. Just email us at IndustryFocus@Fool.com. Again, that's IndustryFocus@Fool.com. As always, people on this program may have interests in the stocks that they talk about, and The Motley Fool may have formal recommendations for or against those stocks. So don't buy or sell anything based solely on what you hear on this program.
Before we leave, I wanted to hand off a couple of listener questions that were emailed to us. I'm sure they'd love to hear what you guys have to say.
Richard wrote in and said, "I'm a petroleum engineer and I like to follow energy stocks as well as world oil headlines. I'm a big fan of your energy podcast, but, unfortunately, it is only weekly. What are the three top places to follow oil and gas news on the Internet? The Platts Oilgram Newsletter, for example, is incredible, but it's $3,000 a year and I'd rather not fork over $3,000. What do you guys use to follow industry news?"
Muckerman: A quick news aggregator is FuelFix.com. I think it's part of the Houston Chronicle. It's down there in the heartland of oil and gas in our country. You can go there and they're like a Huffington Post for energy articles. It's just the news side of things. If you want data, EIA.gov is an easy turn-to for me.
Crowe: Yeah, it's free as well. In terms of a news aggregator, one I really like as well is Rigzone.com. It's a really good one. They also have a lot of instruction...
O'Reilly: Was that made in the last few years? That sounds very...
Muckerman: No, it's been around for a while.
Crowe: Yeah, it's been around for a while. One of the other great things about it is there are a lot of how-tos and instructions. Like, "What is this piece of equipment?" It not only gives you an idea of the news, but it also gives you a better understanding of the entire industry and how things work. EIA has always been a really big one for me as well. Aside from the generic press releases from the companies, why not get the news straight from the horse's mouth?
O'Reilly: Awesome. The last one relates to LINN Energy, which we talked about earlier. They obviously just cut their dividend and a gentleman name Nick Blackman wrote in: "Do you guys think MLPs like LINN Energy will be at a default risk in the near future? I see no way that they keep their already-reduced dividend intact." He was right and as their hedge becomes more of an issue next year, I think LINN has hedged about 60% next year compared to 90% this year. They have $10 billion in debt and an inability to make acquisitions with equity due to their reduced share price. What are your thoughts? Are they a default risk?
Muckerman: I'll default to the shareholder.
Crowe: As the shareholder, I would say, because they have good operations -- they are able to generate cash from their operations -- and since they've actually suspended their dividend, it does give them an opportunity to whittle down that debt a bit.
I'm not completely sold on it either way right now. Like you said, the hedging thing is a big question. What happens within 12 to 18 months in terms of oil prices?
O'Reilly: Do they at least break even on a cash basis with oil at $50 or $60?
Crowe: That's not in their reporting. I haven't been out to their wells recently to tell you.
O'Reilly: OK. So we need to book you a plane flight then?
Crowe: Yeah. If you guys want to fly me out to Oklahoma and I can take a tour...
Muckerman: We'll wait until the summer is over.
O'Reilly: All right. Cool. Well, Tyler, Taylor, thanks for joining us. Thanks for listening, everybody, and Fool on!
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Taylor Muckerman owns shares of Core Laboratories, Halliburton, and SolarCity. Tyler Crowe owns shares of Core Laboratories, ExxonMobil, LINN Energy, LLC, and SolarCity. The Motley Fool recommends Core Laboratories and Total (ADR). It recommends and owns shares of Halliburton, SolarCity, and Amazon. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.