U.S. Silica (NYSE:SLCA) announced one of its best quarters in over a century, the Royal Dutch Shell (NYSE:RDS.A) (NYSE:RDS.B) merger with BG still has a lot of play in the stock for both companies, and SolarCity (NASDAQ:SCTY.DL) is still outperforming its biggest rivals by far. As Halliburton (NYSE:HAL) and Baker Hughes (NYSE:BHI) keep playing Merger Tag, the huge breakup fee has Halliburton holding out hope that nothing stands in the way of the merger, and you'll be surprised by the country causing it the biggest headache.

A full transcript follows the video.


Sean O'Reilly: We're diving into oil and gas earnings, on this energy edition of Industry Focus.

Greetings, Fools! I am Sean O'Reilly here at Fool headquarters in Alexandria, Virginia. It is Nov. 5, 2015. Boy, we've got a new month here going, guys. I didn't even notice.

Taylor Muckerman: My God. Where have we been?

O'Reilly: With me, for the first time in over two weeks is Tyler Crowe and Taylor Muckerman. Nice to have the gang back, boys.

Muckerman: Yeah, we're here.

Tyler Crowe: A little bit more complete show, I guess, huh?

O'Reilly: Yeah, a little bit. We had a good time. It was fun. We're now in the thick of earnings season and it's only been a couple of weeks, but we've missed a bunch of releases. First off, I'm anxious to get your guys' thoughts on what companies have impressed you so far this earnings season.

Muckerman: I was talking with Tyler before the show about sand producers, and I had gotten my companies mixed up. I thought it was Carbo [Ceramics], and it turns out it was U.S. Silica. So I went back and looked, and yes, indeed, one sand producer did actually do fairly well this quarter despite a terrible quarter for their energy and materials sector.

O'Reilly: The sector itself.

Muckerman: Yeah. They had the best quarter in 115 years for its industrial and specialty products distribution line. So it just shows the advantage that you have with diversification. Sort of like we've discussed looking at oil majors in a supremely down market because they offer natural hedges, whereas this company seems to be doing quite all right, even though you look at the 52-week chart and you think the manager is probably hiding in a hole somewhere. They've been performing outside of their biggest segment, which is obviously oil and gas.

O'Reilly: What about you, Tyler?

Crowe: I think "performing well" under certain conditions.

Muckerman: Right. You look at the high-cost partners and Carbo Ceramics, which is what I was thinking was this company, and it turns out those companies are still doing fairly poorly.

Crowe: One of the things that U.S. Silica has going for it in relation to others is just that it's got a much cleaner balance sheet. If you look at some of the other guys, their interest payments are going to get a little heavy in this coming year if we don't see a big uptick in oil and gas activity anytime soon, that's for sure.

O'Reilly: Yikes. What segment were you talking about that's 115 years old? You're talking about U.S. Silica holdings, and they make the sand for fracking stuff, right?

Muckerman: Yeah. They have a specialty products segment which has a deeper variety of customers. It's not nearly the same top-line number that we're talking about. It's outside the oil and gas sector.

O'Reilly: Got it. Have any of the oil majors surprised you guys at all to the upside?

Muckerman: We talked about Shell last week when they reported. They continue to surprise to the downside by writing off...

O'Reilly: We don't know how they're doing this badly.

Crowe: In talking about this Shell thing, it's one of those ripping off some Band-Aids that have been there for a very long time. The hard thing you have to try to wrap your head around with Shell is they're trying to reshape themselves for this upcoming BG merger that's supposed to finalize in a couple of quarters. What they're saying is they want to shed a lot of things that they were doing previously that they no longer see as profitable. With this BG merger, they're making this huge push into LNG.

If you look at their LNG portfolio with BG on board, they're more than double any other oil major in the space. With that much leverage there, they're really trying to push that. They've got a huge tie to deep offshore, mostly related to Brazil. That's going to be a big push for them. They're one of the ones where, yes, things are going to get rough and anybody looking at this probably needs to wait until we see what happens post-BG merger, because it's making so many moves right now that it's hard to take a pulse on what you want this company to be, in terms of investment.

O'Reilly: I'm glad we went this direction. We talked about Shell a bit last week, but we didn't get your thoughts because you were busy down in Houston. Do you think that's a good move, given that the cleanliness of natural gas as a fuel, and the push toward being a greener planet, and the cost -- it is a very cheap fuel right now -- is this smart, given their bungling of the oil sands and Antarctica?

Crowe: If you look at the anticipated demand for LNG, it looks like the right idea. The only question is if they can bring on enough profitable ventures in which to do it. It's one of the things that the CEO mentioned a couple quarters ago in their conference call. He said: "We think this is great, but we can't simply invest on the fact that it's a greener alternative. It actually has to make some money for us."

One of the things that they're really looking at with investing in this end is not just the terminals, but they're also looking at the marketing because it's going to be a huge issue to deal with. If you look at prices, which have declined significantly because we've brought so many new projects online in the coming years, they're going to have to find that effective way of finding the markets that need it the most and will be able to actually pay a premium.

The thought was that it was going to be China, but it may not be that way. It's going to be interesting. It's worth watching because you don't know exactly how it's going to turn out yet.

O'Reilly: Before we move on to the few other companies that have disappointed on the downside this past quarter, I wanted to point our listeners to a newly redesigned focus.fool.com. All Industry Focus listeners have access to a special discount on Stock Advisor that works out to $129 for a full two-year subscription. Just go to focus.fool.com to take advantage of this offer. Once again, that's focus.fool.com.

We've already talked about a few companies that surprised you guys on the upside, flirted a bit with Shell -- any other companies that disappointed you and made you rethink your previous bullishness?

Muckerman: This one didn't disappoint me to the fact that I'm rethinking my bullishness, but I was kind of caught off guard in the negative aspect of SolarCity.

O'Reilly: How did I know you were going to go there?

Muckerman: Down big. I think Friday...

O'Reilly: Twenty percent, right?

Muckerman: Yeah. Not because it had anything terrible to say; they're just changing the strategy a bit. They're actually going to be profitable rather than growing like wildfire. They just had so much growth priced in, and I think the fact that people probably saw that they're trimming their growth forecast and then forgot about the fact that they're planning on being cash flow positive for the first time.

I think that's a benefit long term. Unfortunately, this company has been a giggity-growth stock since its inception.

O'Reilly: Wall Street wants free cash flow generators. Why are they...?

Muckerman: Fools love free cash flow. That's what we want. Long term, I'm still very bullish on this company.

O'Reilly: You are? OK.

Muckerman: I saw where they said they've installed more solar installations than the next 70 competitors combined. They're doing something right. They're going to continue to grow. They're not abandoning growth. They've stated they're preparing for the reduction in the investment tax credit at the end of this coming year.

O'Reilly: I'm kind of surprised that's going away.

Muckerman: It's going from 30% to 10%. It's still not nearly as meaningful...

O'Reilly: That's a 66% hit.

Muckerman: Yeah, because it's only a 10% tax credit. They said that sales are getting more costly because of competition, so they're going to focus on reducing the cost of making a sale and focus on lower-cost sales and also focusing on the commercial market, which they're only about 8% of right now. They're expanding into new markets; they're just not focusing on residential growth as heavily.

Crowe: Like you said, one of the things that was a big red flag for investors, or Wall Street, or whoever...

O'Reilly: Day traders.

Crowe: ...whoever you want to say that reacted so negatively to their release, was the fact that, if you look at their cost-per-watt development -- sales, general, administrative costs -- over that quarter had grown substantially to the point where it was starting to hamper profitability. If you look at the cost per system, the amount that it takes for installation, the procurement of the solar panel system, that has gone down rather impressively and has actually beaten their goals so far. However, the fact that their sales had gotten so high...

Muckerman: They were doing a lot of hiring.

Crowe: Yeah. The cost to acquire was getting to the point where it didn't make as much sense to grow gangbusters. To be fair, one of the things when you look at their growth targets previously -- I believe it was somewhere in the high 60s per year...

O'Reilly: And this is just investor presentations; they broadcast it, and -- yeah.

Crowe: Yeah. Their compounded annual growth rate they were anticipating was in the 60s. What they had been doing previously was 100%.

Muckerman: Yeah. They'd been doubling over the last five years.

O'Reilly: But we're still talking about tripling your size every two to three...

Crowe: Right. They've cut from high 60s down to 40%. Let's be clear here: 40% year-over-year compounded annual growth rate is still pretty good.

Muckerman: Yeah, and they were going to be generating cash on top of that 40%. At least that's their hope.

O'Reilly: Yeah. We're about halfway through earnings season. Are there any trends in the energy industry itself that you noticed this quarter?

Crowe: One of the trends that I was very surprised with -- maybe not completely surprised, but a little more of a greater reaction than I would have, though -- you're seeing a lot of rig companies like Transocean, Diamond Offshore, and companies like those that have been taking on contracts for rigs. That sounds great, but if you look at the rates at which they're taking them, they are at bargain-basement prices.

O'Reilly: Who is doing this?

Crowe: You're getting some exploration and production companies -- not necessarily your big oil companies -- some of the smaller, independent oil producers that are mostly outside the United States. Guys like Tullow Oil, which is a British company, Dana Petroleum, and things like that. They're taking a flier on these super-cheap rigs.

To give an example, Ensco last quarter had a couple of jack-up rigs, which working in the North Sea will normally generate $135,000 a day. That's been the average for a jack-up rig in the area. This past quarter they took on contracts for $50,000 a day. The idea is that they're just going to keep them working to a certain degree rather than keeping them stacked and paying out money. At least in this way, you can more or less break even.

O'Reilly: Are they at least servicing debts and depreciation with this $50,000 a day?

Crowe: I think it's not necessarily servicing anything other than preventing from having to pay the costs of keeping it stacked in the yard. There are costs associated with these things not at work. So just getting a contract to keep them working and not have to pay those is slightly beneficial.

What it kind of showed me when I saw these was that these companies are really bracing for a longer downturn than they had originally expected  -- this could still get a lot worse for us.

Muckerman: Mine is short and sweet: Natural gas is near a five-year low right now.

O'Reilly: It's crazy.

Muckerman: It's just like oil...

O'Reilly: Is it below $2.50?

Muckerman: No, the last I saw it was $1.80-$1.90.

Crowe: That is the spot market price, because a lot of companies like Chevron this past quarter, their realized natural gas price was $1.93. You're seeing a lot of exploration and production companies, in some cases, losing money on every BTU that they produce.

O'Reilly: That's crazy.

Muckerman: Natural gas is the future of power, it's the future of the chemical industry, and yet the price...

Crowe: When it's that cheap, it can be the future.

O'Reilly: It's just crazy to think that it was $13 six years ago.

Muckerman: 2012, wasn't it?

O'Reilly: Yeah, even worse.

Crowe: We saw it bottoming in 2012 because there was a glut of rigs. It was actually very similar to what we're seeing today in oil, although it's taken a bit longer to clear. In 2012 we had where everyone was talking about natural gas and how great it was going to be, and people were giving natural gas companies all the money in the world to go out and drill.

Muckerman: Then they drilled too much.

Crowe: Drilled too much. Lo and behold. We're getting the same thing again today where there's too much gas and not enough demand, especially in the United States, because we haven't seen a lot of those LNG facilities actually fire up. When those do, that's a lot of demand that's going to start to spark things up.

Muckerman: We saw a spot price of almost $3 at the beginning of the quarter, and now it's below $2.

O'Reilly: What's been surprising to me over the last couple of months has been the diversity of opinions within the oil and gas sector. I was thinking this the whole time when we were in Houston, Tyler. You've got guys like the CEO of Core Labs and a couple of gentlemen that we spoke to who are quite bullish. They're like, "This is silly. This is not going to last."

Then you have these rig companies and you have a couple of the majors that are like, "This is going to be lower for a long time." You have BP saying it will be the end of the decade or something before oil recovers. Nobody actually knows what's going on, evidenced by the diversity of opinions.

Crowe: You could consider it the "hope for the best, plan for the worst" situation.

O'Reilly: I was like, "Are the rig guys and a lot of the majors saying it's going to go until 2018 or 2019 that oil is going to be below $50 -- is that them lowering expectations?"

Crowe: I'm sure there is a certain element to that. I would actually feel better with a management team that is bracing for the fact that it could last that long rather than one being like, "Hey! 2016, we're going to do great because everything is going to turn right around. Don't worry about it."

O'Reilly: Because you can't know that.

Crowe: Exactly. Nobody knows. To be conservative today and position yourself to be ready when it actually does turn, I think, is a better place to be than to put it on snake eyes and see what happens.

O'Reilly: "Put it all on black." Anything else piquing your interests this earnings season?

Muckerman: Not necessarily earnings season, but over the next couple of quarters, Halliburton and Baker Hughes are still up in the air. It's a never-ending argument. Going on now for just over a year...

O'Reilly: What's the longest it has taken regulators to approve something?

Muckerman: I don't know. They've been approved in Canada, Colombia, South Africa, Turkey, all these countries, but Australia is apparently voicing some negative opinions on the deal even though some of the assets these two companies are selling were based in Australia. Then a Jefferies analyst lowered their estimate to a 67% chance that this deal passes. Their focus was on Europe not approving it, though.

Crowe: I was surprised to hear that -- not surprised that regulators have been pushing back on this a little bit because of how much market share the culmination of Baker Hughes and Halliburton have. I'm more surprised at the regions where we're seeing resistance. If you look at Baker Hughes and Halliburton's portfolio, they're extremely levered to North America -- the United States and Canada. My thought was, if we were going to see regulatory resistance it was going to be in the United States and Canada simply because so much of what they do is based in that area -- not surprised that it's happening, but surprised where it's happening.

Muckerman: The two companies are still very much bullish on the fact that it's going to go through.

O'Reilly: What's the breakup fee on that?

Crowe: $3 billion. So if it doesn't go through, Halliburton has to pay Baker Hughes $3 billion.

Muckerman: That's not going to make up for that market share that they've gained based on the deal acquisition. So the share price is still going to suffer if this doesn't go through.

O'Reilly: What's the over-under?

Crowe: Going into 2016, something I think that could be really interesting and worth watching is, watching the capital spending habits of exploration and production companies. Most notably -- at least for me because I have a tendency to follow them a bit more than the big oil companies and integrated majors -- so many of them built out five-year development plans back in 2012-2013 that end in 2017.

We're getting close to that time. It will be interesting to see what those companies view for their future from 2017 out to 2020, 2021. It would be the next five-year plan for them. If we have any indication of Chevron, they've been very bearish on their spending. In the next couple of years, if you look at one of the announcements they had in this past quarter was "We're going to trim." What was estimated to be $35 billion this year in terms of total spending will be looking in the $20 [billion]-to-$24 billion range in 2017.

O'Reilly: Hefty cut.

Crowe: That's a big cut. $15 billion off your capital spending in two years. That's a really big deal. For investors looking forward, I think you could see a nice boom in terms of profitability for these companies in that 2017 range. All of these projects they just finished up are coming online, and they're making a lot of money.

O'Reilly: They're also eating into reserves. Long term...

Crowe: Long term the question is, if you're not spending the money to develop, what's going to happen in that 2021 time frame?

O'Reilly: Right. Very good. Boys, it was a pleasure chatting.

Crowe: Yeah, it was a good one.

O'Reilly: 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. 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. For Tyler Crowe and Taylor Muckerman, I'm Sean O'Reilly. Thanks for listening, and Fool on!