Mining, Drilling, Natural Gas, and Oil: Stocks to Watch, and Stocks to Ditch

We've got an action-packed program today, talking about everything from company buyout to the potential for company shutdowns to even companies that are looking to split up to create upstream and downstream opportunities. We'll give our insight on which ones to hitch your wagon to, and those you should bury in the pits.

A full transcript follows the video.

 

Sean O'Reilly: We're digging deep into the mining industry on this energy edition of Industry Focus.

Greetings, Fools! I am Sean O'Reilly here at Fool headquarters in Alexandria, Virginia. It is Thursday, Oct. 1, 2015, and joining me today are the indispensable Tyler Crowe and Taylor Muckerman. Gentlemen, how's it going?

Taylor Muckerman: We're not myths or legends anymore.

Tyler Crowe: Yeah. 

Muckerman: We're indispensable.

O'Reilly: Indispensable today.

Crowe: A lot of descriptive adjectives.

O'Reilly: That Jersey is indispensable, too.

Muckerman: It is, yeah. It's Benfica. They won their championship yesterday against Atletico Madrid.

O'Reilly: Sweet. You representing?

Muckerman: I am. I would have worn it yesterday, but I had to wear my St. Louis Cardinals.

Crowe: Win 100 yesterday, I think.

Muckerman: They did, yeah. They clinched the division. Big time.

O'Reilly: Looking good.

Muckerman: Best team in the league.

O'Reilly: Oh my God.

Crowe: Taylor's having the best sports week ever.

O'Reilly: Best sports week ever.

Muckerman: Panthers are 3-0, Benfica's 2-0, and the Cardinals are home-field advantage.

O'Reilly: How's your fantasy team doing, out of curiosity?

Muckerman: Fool Fantasy is 3-0 and my other friend's league is 3-0 as well.

O'Reilly: Cool. All right. You're winning all around.

Muckerman: Yeah. Hitch the wagons, boys! Second half is probably not going to be so rosy. As long as the Cardinals win the World Series, I can go 0 for the next month.

O'Reilly: Don't jinx yourself.

We've got a bunch to talk about today, including more divestitures and the merger between Baker Hughes (BHI) and Halliburton (HAL 0.34%), and Alcoa (AA) splitting into two separate companies.

First, as part of our "woes in the mining industry" segment, Glencore (GLNCY 1.03%) is looking to make some asset sales. Tyler, are you interested in doing a little shopping for some cheap mining assets?

Crowe: Right now? Probably not.

O'Reilly: Buy at the bottom, Tyler!

Crowe: Here's the thing. When you say that to me as an individual investor, I have to be looking at the companies that I would be buying.

O'Reilly: Yeah, or you could just go raise $400 million.

Crowe: Yeah. Just, out of nowhere. What's going on is, Glencore, as everyone has seen in the market as of late, has been the poster child of the troubles of the mining industry.

O'Reilly: Stock is down by 60% or more.

Crowe: More than that. I think it's down 70% for the year. So far they have slashed dividends, made some major capital expenditure cuts, and they're looking to cut their net debt rate by about $10 billion in the next 12 months, in a way of shoring up the balance sheet. One of the ways that they're looking to get there, about half of it can be done with no dividend and some capital expenditures.

They can get about $5 billion there. They need to get the other $5 billion from asset sales. Here's the problem with selling assets in the commodities business.

O'Reilly: At the bottom.

Crowe: They are quite possibly the least valuable they have been in the past seven to 10 years. This is something that you see across mining and all these other materials and anything that is a cyclical industry. You see these companies buy at the top, at their peak of pricing, and then they're stuck with them down here and trying to sell.

Glencore bought Xstrata back in 2013 at a pretty frothy price. I think another great example is Cliffs Natural Resources. In 2011, they bought Consolidated Thompson for $5 billion.

O'Reilly: It's all gone. Correct me if I'm wrong.

Crowe: Yeah. It's all gone. Every $5 billion of that and every asset they have bought as part of the Consolidated Thompson deal they've gotten divested from.

O'Reilly: A huge project they had in Canada is gone.

Crowe: Everything that they bought Consolidated Thompson is gone.

O'Reilly: You're talking about everybody buying it. Is there anybody who was even remotely conservative enough to talk to Glencore about any of these assets?

Crowe: If you look at balance sheet strength of companies in the mining space right now, I think the only one that you can look at that has the conservative balance sheet and the size to take on something Glencore has is BHP Billiton. They have the lowest debt-to-capital ratio.

O'Reilly: Taylor, I kind of knew he was going to go there. Did you?

Muckerman: I don't know. He kind of talked about this company a couple times.

Crowe: They have a debt-to-capital of about 32%, which is much more conservative than some of the other plays like Vale, or Rio Tinto, or anybody like that. They have that ability, and one thing they did mention is that Glencore is actually looking to a lot of streaming deals. If they have a copper mine and they're pulling out some gold with it, they want to sell it to the streamer just as a way of raising equity.

Glencore is looking to do about $1.5 billion in the streaming deals, and one company that could obviously be a big winner in that is Silver Wheaton.

Muckerman: Yep. Currently, they've spent all the money they've planned on spending for the next couple of years, but obviously if an opportunity like this arises, it might be tough to pass up because they do have a pretty secure balance sheet because they aren't a miner. They haven't been crushed by having to go out there and continue to spend to keep mines open, or to continue expanding mines. They just provide a lump sum and then a per-ounce fee and that's pretty much all they're on the hook for.

O'Reilly: Taylor, I know you're the Fool's Canada guy, but can you shed any light on Glencore? Their stock is down 73% and you've got this headline here that say their business is robust. They said this two days ago. Are they delusional? What's going on here?

Muckerman: The market seems to think they are. If you look at miners across the board, I would assume that, yes...

O'Reilly: "Robust" is not the word choice I would make.

Muckerman: It's not quite appropriate in terms of where the mining industry is right now. I don't know of one mining material that's price isn't near a 52-week, multi-year low. They keep talking about the mid term and long term looking bright, but there's that catchall phrase: "The market can remain irrational longer than you can remain solvent."

Mid term to long term, depending on how long-term this company is thinking down the road, they might not have five to 10 years to wait for this to pick back up. They have $50 billion in debt and they only have $3 billion in cash.

O'Reilly: I can't imagine they're free cash flow positive right now.

Muckerman: On the operating side they're making about $11 billion in cash from operations, but it's a mining company so they have tons of capex that they need and they just cut the dividend. Maybe that will help a little bit, but a lot of this debt is due in the next five years. If that's their medium term, they'd better hope things turn around pretty quickly.

Crowe: The one thing I find interesting about Glencore being in as much trouble as they are...

O'Reilly: Those crazy Swiss, right?

Crowe: It's the fact of how big they are. If you look at it from a revenue standpoint, Glencore's revenue is greater than the next four giant miners combined. If you were to take BHP's, Rio's, Vale's, Freeport-McMoRan, and even Anglo American, all of them combined don't make as much revenue as Glencore. That's how big of a company we're talking about here. To see them in trouble is quite fascinating.

Muckerman: If they do collapse, maybe you'll see the market turn around really fast.

O'Reilly: The tree that dies in the forest.

Muckerman: Yeah, because if their mines have to shut down, or they get sold at basement-level prices, companies can buy them up and not feel burdened by the need to have an instant return. They can let those assets idle for a bit if they can buy these for pennies on the dollar. Maybe that's the reversal this market needs rather than a bank that we saw collapse in 2008. If this isn't too big to fail, this could be the necessary failure to turn around the mining industry.

Companies are slow to trim their own capex because they don't want to lose market share, but if you see the giant in the industry...

O'Reilly: We need a little creative destruction here.

Muckerman: Yeah. Survival of the fittest. If the biggest fails, there's a lot of room to grow for other companies and you could see a lot of supply erased just from one company falling off the map.

O'Reilly: Glencore isn't the only giant metals company making moves right now. A headline hit the wires the other day that I never thought I would really see, but Alcoa is splitting in two. Why?

Muckerman: They're basically pulling...

O'Reilly: Is it the mining?

Muckerman: Yeah. They're pulling a ConocoPhillips -- or name any energy producer that's cut its upstream away from its downstream. They're going to have Alcoa as the upstream, the mining, the box site miner, and the alumina smelter. Then they're going to have their downstream company to be named in the future. Personally, I thought they would have a name for it when they announced this. Now the pressure's on to come up with that.

O'Reilly: Now it's just "spin-off co.," isn't it?

Muckerman: Yeah. We talked about this on MarketFoolery, and we had some readers submit some ideas and one guy said they should call it "Aluminium." The word for aluminum that everyone else pronounces, other than us here in the United States. Personally, if I was a shareholder I would want the downstream stock. The company that's selling the rolled products to the aerospace industry, the automotive industry, the packaging industry, and aerospace and automotive sectors are going to drive the growth.

O'Reilly: That was my question. Obviously, the value creation that's going to happen is the downstream stuff that you were talking about that will be awarded a higher multiple by investors.

Muckerman: You would imagine, yeah.

O'Reilly: Should they have done this three or four years ago?

Muckerman: I haven't heard about it, but apparently investors were pushing for it for several years.

O'Reilly: Now they don't have a leg to stand on, so they're doing it?

Muckerman: Well, the company wasn't doing terribly, so I don't think this was forced. I think it's a wise move and you see Klaus Kleinfeld, the CEO, going to the downstream business.

O'Reilly: He wants it and so do you.

Muckerman: Yeah. Whether or not he thinks that's the best business to go to, or because he thinks because he's the CEO he needs to be with this business more. Personally I think he's making the right move. You saw Pete Miller go with DNOW and they spun off and people thought that might be the better side of that business. I think shareholders should -- if they're looking for a long-term growth stock, I think that could be it.

If you're a trader, I think you stick with Alcoa because I think that's more of the hold into the price of the commodities. What did you have, Tyler?

Crowe: One of the things I was going to mention... you were saying, "Why didn't they do it sooner?" They've actually made a couple deals in the past couple years that have actually made this much more possible.

O'Reilly: So it would have been harder in the past?

Crowe: Right. They made a $1.3 billion acquisition of RTI International Metals, which is mostly a defense supply contractor and aerospace contractor.

O'Reilly: That's definitely a downstream.

Crowe: They built them with a couple of bolt-on acquisitions into aluminum as well as titanium that gives those higher-valued products that would almost give that spinoff side of the business a bit more scale and make them that much more competitive. Without those deals, I think making this sort of split with the company would have been more difficult.

O'Reilly: It would have been a "Good luck, see you later" thing?

Muckerman: And they've sold or shuddered 30% of their smelting capacity over the past five to six years. You look at China preparing to make moves to create the largest miner of aluminum.

O'Reilly: Aluminum in China is -- yeah.

Muckerman: They're going to overtake Rusal, I believe is the name of the Russian company. Alcoa was No. 2. If those steps are taken in China Alcoa will be No. 3, but that could be good for the aluminum industry because it could remove some competition as you see a bigger player emerge in China.

That will give them some scale to shut some underperforming plants that they've kept open just to drown the market.

O'Reilly: Cool. Before we move on, I wanted to point our listeners to our newly designed focus.fool.com. There you'll discover a special offer to join The Motley Fool's Stock Advisor newsletter for all Industry Focus listeners. All loyal IF listeners have access to a special discount on Stock Advisor that works out to $129 for a full two-year subscription. Just visit focus.fool.com to take advantage of this offer. Again, that's focus.fool.com.

Moving on, deals don't look as great as they did a few months ago. Williams Companies (WMB 1.21%) is up to some shenanigans. Tyler, what have we got?

Crowe: Williams Companies back in June announced that somebody was trying to buy them for $48 billion at the time. Energy Transfer was the company that announced it.

O'Reilly: So Williams wasn't making it up?

Crowe: No, they weren't making it up. Energy Transfer came out and announced it.

O'Reilly: "I have a date to the prom. I swear!"

Crowe: Yeah. They said, "We've been working on this for months." They gave them a bid of around $48 billion, but they think it's more than fair. If you looked at the share price of Williams Companies at the time in comparison to what it was -- the offering was about $64 per share -- it was a generous offer.

Williams came out and said they think they're worth more. They think they're more valuable than that and based on their giant backlog of projects they think they could get a better deal. It started to get into negotiations with several other companies. Some of those that were linked to them were Kinder Morgan and Spectra Energy.

The best bid they could get this time around was $32.9 billion.

O'Reilly: I'm looking at a chart here. They held out for more and it did not pan out.

Crowe: If you looked back in May, at the time...

O'Reilly: You don't think they were crazy then?

Crowe: Maybe not crazy. Maybe slightly greedy. Right around May, we started to see this small rebound in oil prices. Back in March or February we saw the bottom. We were down in the $40s back in February and March. Come May, we were looking at $60 again and everyone was thinking we've gotten past it.

Muckerman: Rational minds have won!

Crowe: Rationality did not hold sway. So we've seen this big decline and I think it showed Williams this might get a little tougher. This is me speculating more than anything, but I think the biggest speculation for them was they started to realize that financing was going to get more difficult now that oil prices are cheap and banks and financiers aren't going to be throwing junk-rated bonds -- 2% or 3% bonds -- anywhere they want.

With a slightly higher debt capital that's going to come, bringing on that scale of Energy Transfer is going to allow them to actually build out that massive project portfolio. I believe it's around $35 billion. It's more than the equity that's in the company right now. That's my speculation as to why they're trying to get teamed up with bigger scales.

Muckerman: I don't know a lot about both these companies, but they're more natural gas- and liquids-based. Oil prices does influence the price of natural gas a little bit, but not too detrimental. I think long term, natural gas pipelines are a better play than oil pipelines and the access that Williams provides to New England.

Between them and Spectra, that's the only two companies I can think of that provide natural gas to the Northeast. That market needs more. So that's $35 billion of projects that could find their way into the business pretty easily. I know Spectra also has plans for $30 billion worth of projects since 2012.

O'Reilly: There's a Bond movie coming out about Spectra, right?

Muckerman: Yeah. That's exactly right. The pipeline of Bond.

O'Reilly: Before we move on, what do you think about Halliburton and Baker Hughes having to divest more just to get approval for their allotted deal?

Muckerman: Were they told that they needed to divest, or was this a pre-emptive strike?

O'Reilly: It's a pre-emptive strike. My read on it was it was pre-emptive, but they don't do things for the fun of it.

Muckerman: I agree. A lot of the assets are international so they're still keeping a stranglehold on the North American market. They're selling sand business in Australia and a few other Asian business lines. I think Baker Hughes is trying to sell a couple North American businesses, but for the most part, this new segment of businesses looks to be predominantly international.

I would imagine they want to grow internationally because more revenue...

O'Reilly: Right. The U.S. is mature.

Muckerman: That's their business, but maybe they just think that the safer future is with North America based on politics and financing and the natural gas and oil that's provable and ready to come out of the ground.

O'Reilly: One of the reasons the shale revolution happened here -- technological advances aside -- is our political stability and the land-right laws.

Muckerman: Exactly. That's holding back most of Europe, infrastructure's holding back most of Asia and South America. We're primed at the pump and ready to go for the next couple decades. Whereas pipelines are needed in Argentina and China to get their oil and natural gas out of the ground.

I think Kinder Morgan might have more pipeline than all of China combined. That's just for some scale.

Crowe: I'll take the slightly bearish outlook.

O'Reilly: I was going to ask you how surprised you were.

Crowe: I'm not hugely surprised. I've looked at this and I can understand the benefits of the North American market, but if we look at the oil services industry, having that diversity across all of every geographical market, it does have its benefits. If you look at someone like Schlumberger, it has benefited immensely from a more diversified geographical exposure.

All these assets they're shedding for Halliburton and Baker Hughes -- which were much more levered to the North American market in the first place -- it makes them even more so. As we've seen in the U.S., we're much more of a boom-and-bust. Yes, there's an immense opportunity to grow here...

O'Reilly: We're cowboys.

Crowe: Yeah. We have that cowboy, boom-and-bust mentality and it can wreak havoc a lot more down the road. That's the one thing that makes me nervous about some of these deals.

Muckerman: If I have one more minute. I know this is a long segment, but if you look at what's happening, maybe these forced asset sales -- these companies don't really want to shrink, but maybe they need to a little. This could force them to really examine their books a little bit harder than they might want to, sell off some assets that are a bit more questionable that you would hang on to if things were rolling out.

O'Reilly: "Share cash flow" is the name of the game.

Muckerman: Yeah. I don't think it's going to hurt them to raise another $5 billion in cash at a time where cash might really be one of the more important factors in the oil and gas business.

O'Reilly: Our final story.

Crowe: It's a podcast. We can go for a few extra minutes. There's no hard line. There's not a producer knocking on the door saying, "Stop talking, guys! You're going too long!"

O'Reilly: The average American's commute is exactly 20 minutes and we try to keep it at that. Royal Dutch Shell (RDS.A) (RDS.B) is throwing in the towel on Arctic drilling to the joy of the environmentalists.

Crowe: Again?

O'Reilly: Is this the straw that broke the camel's back? What's going on here?

Crowe: Oh, boy. When it comes to Shell and the Arctic, they have...

O'Reilly: They just can't dance.

Crowe: I don't know. It always seems like Don Quixote out there trying to slay the windmills. They just kept on going out and saying it was going to happen and it was going to be profitable, and they would find a ton of oil. Everybody else was saying it didn't look too great. Alaskan tax code is rough for them in terms of regulatory environment.

It might not be as promising as some had thought. Then you have to deal with the harsh environment that makes things that much more costly. After spending about $7 billion in the Chukchi Sea...

O'Reilly: Hold on. Drilling in the Arctic is more difficult than drilling in the Texas desert?

Crowe: Who would have thought?

Muckerman: You're not going to sweat as much.

O'Reilly: Something else will happen. Extremities will freeze off.

Crowe: Yeah. Shell spent about $7 billion on this so far and they are going to take a $4.2 billion writedown in the next quarter, or over the next couple of quarters, to accommodate for that. I think everybody saw the writing on the wall on this one. It takes a very high oil price to justify what they're doing up there. It isn't there right now.

O'Reilly: They may go back in four years.

Muckerman: They still have the leases.

Crowe: They can go back. If oil were to shoot up to $140 all of a sudden and stay there for a while, then maybe finding something in the Arctic could be lucrative. If prices are like this today, and looking at the portfolio of the things they have going on right now -- they have the merger with BG Group, they're really leveraging hard to LNG and offshore, especially in Brazil. These are going to be their two biggest drivers of value.

Muckerman: Not exactly cheap adventures either.

O'Reilly: Because that's all offshore.

Crowe: But at the same time LNG is mostly under long-term contracts, so that's going to keep things from being swayed by commodity prices too much. What they've said is that they want all of their projects to return free cash flow at $70 oil. Not the highest level, but a pretty reasonable amount. At that level, they can't justify Arctic anymore.

Muckerman: They're the only company doing it, so why rush? I don't understand what the big hurry was. No one else is dragging a rig from Seattle to the Chukchi Sea.

O'Reilly: They've got to beat Putin, Taylor!

Muckerman: I guess. I guess Russia's trying to drill in the Arctic, but in their own Arctic. Not our Arctic. If they tried that, all hell might break loose. They were the only company going for it. Take your time. You're in no rush. It's not like we're in a supply shortage or anything. Maybe you hang on to it for the next couple of years and do your due diligence better.

They didn't find any oil and they expected to find billions of barrels.

O'Reilly: Before we sign off, did you guys buy all your Pop-Tarts at Wal-Mart before the hurricane hits?

Muckerman: Hurricane Joaquin.

O'Reilly: Joaquin's coming.

Crowe: I've got a really -- if people love sensationalist media, they have to love The Weather Channel. The Weather Channel...

O'Reilly: Have you been to their website lately?

Muckerman: It has nothing to do with weather.

Crowe: They can unabashedly demonize what's on the news. With more regular news you can't be that sensationalist when it comes to talking about crime, but when it comes to the weather, a hurricane is like Darth Vader and the bad guy from Indiana Jones: Temple of Doom combined. It's that evil. It's absolutely hilarious and it gets you going every time. You're like "Oh, man. This is beautiful."

Muckerman: Hopefully, it doesn't wreak too much havoc. I expect a lot of rain. You must like your Pop-Tarts cold.

O'Reilly: I saw this special one time about Wal-Mart and the supercomputers they use to do inventory management. They went to a Wal-Mart and this supercomputer did all this analysis for Wal-Marts in Florida during a hurricane and people are statistically 26% more likely to buy strawberry Pop-Tarts during a hurricane than any other time.

Muckerman: Go figure.

O'Reilly: Strawberry Pop-Tarts.

Muckerman: I'm a blueberry or cinnamon kind of guy myself.

O'Reilly: I'm a cinnamon man. I don't know what else to say. If you are a loyal listener and have questions or comments, we would love to hear from you. We really want to hear about your favorite Pop-Tarts, maybe a question about oil stocks would be fine, too.

Just email us at [email protected]. Again, that's [email protected]. 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. For Tyler Crowe and Taylor Muckerman, I'm Sean O'Reilly. Thanks for listening, and Fool on!