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3 Takeaways From the Energy Market This Quarter

By Tyler Crowe, Matthew DiLallo, and Bob Ciura - Aug 29, 2015 at 10:05AM

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There is always something new to learn, and here is what we learned this past quarter.

Normally, following the markets on a daily basis is a bit of a slog. For the most part, you won't see many major changes from quarter to quarter that are really worth investing your time into. However, every once in a while there is something new that can be gleaned from looking over all those finanical statements and press releases.

So we asked three of our energy contributors to give us a takeaway or a lesson that they learned after reviewing this past quarter's results. Here's what they had to say. 

Bob Ciura: My takeaway from all that happened in the energy market last quarter was this: Don't chase sky-high dividend yields. As stock prices across the energy sector collapsed, dividend yields soared, particularly in the upstream MLP space. For example, Linn Energy (LINEQ) sported a 20% yield as recently as a few weeks ago, but high yields like this often turn out to be nothing more than a mirage.

Sure enough, Linn recently stated its intention to suspend its distribution at the end of this quarter. Suspending the distribution may be the prudent thing to do for Linn's investors, since the company can use the savings to pay down its $10.9 billion mountain of long-term debt. Nevertheless, the decision to suspend the distribution was followed by a steep decline in Linn's unit price, proving to be a disastrous double-whammy for investors who bought based on its huge dividend yield alone.

There are other upstream MLPs that currently offer extremely high yields, like Breitburn Energy (BBEPQ), which sports a 22% yield. To be sure, Breitburn has not suspended its dividend like Linn has. But with two distribution cuts already under its belt and the prospect of $30-per-barrel oil, it's very hard to see Breitburn sustaining such a huge yield.

The key takeaway is not to get lured in by extremely high dividend yields, which often turn out to be warning signs of danger to come.

Tyler Crowe: For quite a while I have understood that the gross profits for pipeline companies were protected by contracts that isolate them from the ups and downs of commodity price swings. What I had perhaps not fully grasped was how that affected the income statement on a quarterly basis. I think a great way to explain this is to look at the quarterly results of Enterprise Products Partners (EPD -1.21%). Based on the headlines, you would think that the company had a really rough quarter, since revenue declined more than 25% compared to the same quarter last year. Looking past that number, though, you can see why this is misleading.

Enterprise Quarterly Financials (in millions) Q2 2015 Q2 2014 % Change
Revenue $7,092.5 $12,520.8 (27.5%)
Total operating costs $6,292.2 $11,636.5 (45.2%)
Operating income $800.3 884.3 (9%)

Data source: Enterprise Products Partners earnings release.

Even though the company states that its gross operating income is mostly fixed, it doesn't mean that the company's revenue is. Rather, revenue and costs of goods sold move in tandem. What's even more surprising about these numbers is that if we exclude non-cash charges such as depreciation and writedowns, gross operating margin and distributable cash flow came in higher than in the same quarter last year. 

What this goes to show is that the headline numbers that get put out there for certain companies may not tell the whole story, and so investors looking at companies in this space need to dig into the financials much more than looking at the revenue and net income results, or they might be missing the bigger picture. 

Matt DiLallo: This past quarter I probably reviewed about two dozen energy-related earnings reports and conference calls in depth. While the price of oil was clearly on everyone's mind, there was one other theme that kept replaying, which was the dramatic reduction in costs companies have captured over the past year. That's leading to improving margins and helping to mute some of the impact of the weaker oil price.

Most energy companies I reviewed reported having captured a double-digit year-over-year reduction in operating costs. This reduction is coming via a combination of layoffs, lower costs for commodities like power, and an overall deflation for costs and services. The net result of these lower costs is an uptick in the margin earned on each barrel of oil equivalent produced, which is muting some of the downward pressure on cash flow as a result of weak commodity prices.

On top of that, energy companies are seeing an even more significant reduction in the cost for drilling new wells, especially horizontal shale wells. In many cases, these reductions are upward of 25% per well and are coming from a combination of service price reductions from oil-field service companies as well as from efficiency gains, as drillers are drilling and completing wells in record time. The net result of these cost reductions has enabled drillers to drill more wells for the same capex spend.

The takeaway here is pretty clear: Oil companies are starting to mute some of the sting from low oil prices via cost reductions. As a result, they are improving their earnings per barrel while also gaining more production from the same capex dollars. While this won't completely mitigate the sting of low oil prices, it is helping many companies to keep their heads above water as the downturn rages on. 

Bob Ciura has no position in any stocks mentioned. Matt DiLallo owns shares of Enterprise Products Partners and Linn Energy, LLC. Tyler Crowe owns shares of Enterprise Products Partners and Linn Energy, LLC. The Motley Fool recommends BreitBurn Energy Partners and Enterprise Products Partners. 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.

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Stocks Mentioned

Linn Energy, LLC Stock Quote
Linn Energy, LLC
LINEQ
Enterprise Products Partners L.P. Stock Quote
Enterprise Products Partners L.P.
EPD
$26.98 (-1.21%) $0.33
Breitburn Energy Partners LP Stock Quote
Breitburn Energy Partners LP
BBEPQ

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