It's that time of the year! Earnings reports are coming in, and in energy, things are about as muted as oil's consistently low price would probably suggest.

In this week's episode of Industry Focus, energy sector analysts Sean O'Reilly, Tyler Crowe, and Taylor Muckerman go over the main points of the earnings calls from Core Labs (NYSE:CLB), Schlumberger (NYSE:SLB), and Caterpillar (NYSE:CAT). Also, they dip into the Motley Fool mailbag to answer some listener questions and share what big stories they're waiting to see pan out for the new year. 

A full transcript follows the video.

 

This podcast was recorded on Jan. 28, 2016.

Sean O'Reilly: Russia talking to their on-again off-again friend, Saudi Arabia, about cutting production? All that and more on this energy and materials edition of Industry Focus.

Greetings, Fools! Sean O'Reilly joining you here from Fool headquarters in Alexandria, Virginia. It is Thursday, Jan. 28, 2016, and joining me to talk shop are Tyler Crowe and Taylor Muckerman. How's everybody doing?

Tyler Crowe: Hello, hello!

O'Reilly: Everybody enjoy their blizzard experience this past weekend?

Taylor Muckerman: Most snow I've seen in my entire life in 24 hours.

O'Reilly: Yeah.

Crowe: Did you go skiing?

O'Reilly: No.

Muckerman: No, I didn't. I'm going a couple times this year, but unfortunately, not this past weekend.

O'Reilly: Everybody watch Netflix?

Crowe: I actually left town before.

O'Reilly: You did not! Where'd you go?

Crowe: I actually went up to the mountain so I could ski all weekend. It got me out of town, and I showed up on Sunday evening and had to shovel out my driveway.

O'Reilly: My next-door neighbor -- the building put little snow notices, safety protocols or whatever, on the door knocker. And theirs still isn't down. So they left town and they're not back yet, and I'm like, "It's clear now, guys, it's safe to come back!"

Crowe: That was the most surprising thing. I grew up in New England, I'm used to snow. The one thing I didn't really realize until I got down here, there's no place to put it in D.C.

O'Reilly: Dump it in the Potomac, that's all we got. [laughs]

Crowe: All the neighborhoods, there's no place to put the snow. So, if you get any, what the heck are you going to do with it?

O'Reilly: The planning was bad with the whole... Well, really quick, before we get started here with a little bit of earnings news, did you guys see the news this morning that Saudi Arabia publicly just flirted with the idea of maybe talking with OPEC, and of course, it's sent oil up a bunch and all the stuff?

Crowe: Well, that happens.

O'Reilly: Do you think Putin's running out of money? [laughs] Yeah, oil's up like 5%.

Muckerman: Oh, nice.

Crowe: Shows you how much we really pay attention to the daily movements of oil.

O'Reilly: As long-term Foolish investors, we're not supposed to pay attention to daily moves, but it was just funny that Saudi Arabia was flirting with their on-again off-again friend, Russia. Anyways, we've gotten a decent number of earnings reports out for the energy and industrials sector. I want to just dive in and see if any stood out to anybody. Taylor, anybody sticking out to you so far?

Muckerman: Yeah, Core Labs is a company I own, so I pay attention to it whenever they report, not just because I own it, but because they typically have a pretty good understanding of what's going on in the oil and natural gas --

O'Reilly: Basically, for our listeners who don't know, they're the world's favorite oil consultant, drilling and --

Muckerman: Yeah. They use data, technology, science, chemistry, all these different mechanisms --

O'Reilly: Mad datas.

Muckerman: -- to determine the best way to produce oil or natural gas from individual wells across the world. Not only originally produce, but also production enhancement is a big part of their business, and that's the part of the business that suffered the most in this last quarter. You look and total revenue down 7.5%, but enhanced production segments revenue down 13%. So, almost double --

O'Reilly: That doesn't sound that bad. Correct me?

Muckerman: No. That's also going up against a relatively tough comp in 2014. So, we're done with the hard 2013 comps, where oil prices were soaring. We're starting to see comps against a rough 2014.

O'Reilly: And that's why it doesn't seem so bad.

Muckerman: Yeah, because they were essentially flat in the third quarter of 2015, down 7.5%. So, quarter after quarter, they are down. A little tougher for them. And production enhancements segment deals mainly with shale and offshore, so we're talking about some of the more expensive oil to produce at the moment. Obviously, those are two segments that are going to see some decline if oil prices remain at $30 a barrel.

O'Reilly: Now, Core Labs' CEO has been one of the more bullish CEOs, and he just talks about the decline rates all day long. Did you catch anything new from him at all?

Muckerman: Not necessarily on decline rates, but he did say that he expects a V-shaped recovery to begin in the back half of this year. So, look for it maybe late third quarter, early fourth quarter -- in his mind -- to see some recovery. And not just a slow, U-shaped recovery. They either go V or U in the oil markets, that's all people ever refer to. So, he's looking for a relatively sharp recovery.

Crowe: There's nothing in between. It's either a V or a U recovery. You can't have anything else.

O'Reilly: It's all black and white.

Muckerman: No W, no Y, no X.

O'Reilly: No Js, none of that. [laughs]

Muckerman: No. So, he's expecting a sharp recovery relative to what other people are expecting, including Schlumberger, who Tyler, I think, is going to talk about a little bit.

Crowe: Yeah.

O'Reilly: You spoiled it! What the heck, man? I'm just kidding.

Muckerman: I'm just saying. I'm passing the buck here.

O'Reilly: Alright, Tyler, what do you have to say about Schlumberger?

Crowe: If you want to call Core Labs the optimist, I guess Schlumberger was a little bit more of the pessimist. On the earnings basis, kind of the same thing, some low hurdles to jump over. Or, actually, not jump over. Their fourth-quarter revenue was down about 9% compared to, actually, last quarter. Pre-tax margins are down to about 16%, which doesn't sound great, considering that over a year ago, they were in the high 20s.

O'Reilly: Are they having to cut --

Muckerman: Core Labs has the same margin.

O'Reilly: -- prices? Why is that?

Crowe: A lot of it has to do with activity decline in a certain sense, where if you look at the land rig market in the United States, there's only about 680-690 rigs, compared to 1,500, 1,600 that we had --

O'Reilly: A year ago, yeah.

Crowe: --18 months ago. So, you have that, of just, idled and lack of sales. But you're also seeing one of the things that CEO Paal Kibsgaard actually did mention, is that they're seeing lower prices on contracts. Certainly ExxonMobil and Chevron have mentioned this, where they're getting about 15% to 25% savings on their surface contracts, in terms of their day rates and things like that. So, that's where you're starting to see a lot of the declines in margins and sales. On that 16%, it doesn't sound great coming down from the high 20s, but putting it in a little perspective, if you compare them to HalliburtonBaker Hughes, Weatherford International, they still have at least 7%-8% points higher on their pretax margins. So, they're having a good time in comparison to the rest. It's not great, but, you know.

And on their outlook, a little bit of echoes of Core. Not as optimistic. They were saying that in 2016, in the second half, we'll start to see that recovery in oil prices. But they're saying it won't lead to increased drilling and surface activity --

O'Reilly: There's going to be some conservatism, yeah.

Crowe: -- until 2017. And one of the biggest reasons was the fact that a lot of these producers have obliterated balance sheets, and they've got to throw some cash back at the business itself before they're ready to take on anything new.

O'Reilly: Plus, it's like, we're at $30 right now. Even if it went back to $60, there would be, "OK, is this for real?" Because we flirted with that last spring, and...

Crowe: Yeah, last spring, we went to $60, and... not everybody, but there was a small handful of companies that wanted to open the pipes up again. I know Pioneer Natural Resources was one of them. And it just backfired on them.

O'Reilly: Cool. Does anybody know who I picked?

Muckerman: We didn't segue into yours, but Sean, do tell.

O'Reilly: I was curious what Caterpillar had to say. They're stuck in the midst of a three-year bear market for commodities, and up until 18 months ago, oil and energy was the last holdout for their machinery and everything. And that hasn't panned out either. So, they actually reported this morning, and the earnings were pretty good. They beat a little bit. Obviously, revenues and everything were down. Revenues came in at $11 billion, down from $14.2 billion in Q4 2014.

They reported a loss of $0.15 per share, but they would have reported gap profits of $0.74 had they not taken a $900 million hit from restructuring costs. So, I mean, investors really should keep that into account, because any large organization like that, they're going to have restructuring stuff all the time. You shouldn't really take any credence of that $0.74 per share number. Anyways, management talked exclusively about how tough it is out there, and they went on and on about how they're cutting costs. That was literally half of their call, their press release, everything.

Muckerman: Yeah. Schlumberger laid off a bunch of people, but Caterpillar's been laying off people for a couple years now.

O'Reilly: It's getting hairy, yeah. And of course, I was really interested in what they thought about their 2016 outlook. They do not anticipate any bounce-back. Obviously, they're not just in oil machinery. They do copper, all the mining machinery and everything. And they're not expecting an improving demand picture at all for their equipment. They called for sales and revenues around $42 billion, and gap earnings per share, I was happy to see this, of $3.50 per share. 

Crowe: Not the worst.

O'Reilly: Not bad.

Crowe: What was it this year? I think total year was somewhere, $4.00 and change.

O'Reilly: Yeah.

Crowe: So, it's not the worst in the world. Obviously, Caterpillar's a cyclical business, just like everything else here, and we'll probably see a lag on pickup on equipment similar to what we were talking about with drilling activity, where, they're probably not going to be buying any new equipment until prices go up --

O'Reilly: You have to pay your bondholders back. [laughs]

Crowe: Pay the debt and stuff like that. But, at today's prices, if we're looking at, as a long-term investor, is their value baked into shares nowadays? Or do you think, maybe hold off a little?

O'Reilly: And that's how I went into this, like, "Oh, we're at the bottom of the cycle, things are getting really bad, maybe it's a buy now." They're trading at $59 and change this morning, it's up like 1.5% on earnings. It's down from, I think, $110 a year ago or something, it used to be well over $100. But you've heard me say, the guidance for 2016 is $3.50 a share. So, they're trading at 16 times forward earnings. I think that's more than fair, given we don't know when things are going to rebound, we don't know when earnings are going to rebound. The market multiple is 19 or 20 right now. So, I think it's fairly valued.

Crowe: Fair enough.

O'Reilly: Alright. Moving on...

Crowe: Sean's first foray into deep analysis on the show. We should get some feedback on emails, how did Sean do?

Muckerman: Save that for the major league baseball draft.

O'Reilly: Yeah, right? What are we calling that, by the way? Oh, yeah. Anyways.

Next story, Royal Dutch Shell (NYSE:RDS-A) (NYSE:RDS-B) and BG Group, their deal got finalized. But the real question is, now what? Eighty percent of shareholders approve of the merger, thinking management would be able to make something of it. Obviously things have not been going well in the oil and natural gas markets, BG being a natural gas player. Is it too early to call this a failure, or did shareholders really truly get burned for their trust in Royal Dutch Shell's management? Taylor, what do you think?

Muckerman: Too soon. Yeah. They're not expected to double their LNG production for a couple more years with this deal. Let's give them at least a little time to be one company. They're not together yet, it's still in the approval process, so let's give them time before they either do or don't shoot themselves in the foot. Right now, they haven't done anything except make an offer and try to solidify it. That's all right.

O'Reilly:
Everything's 20/20 in hindsight: Do you think given what we know now -- natural gas is at $2 -- do you think maybe they shouldn't have done it? Given what we know now.

Muckerman: I guess you could compare Exxon, when they purchased XTO.

Crowe: XTO Energy back in 2010.

Muckerman: And then natural gas prices fell off a cliff. Granted, they didn't buy it in the middle of the downturn. Or, at least, Shell thought they were buying at the bottom of the downturn, it turns out it wasn't the bottom. But, I could only see upward movement from here over the long term.

O'Reilly: Fingers crossed.

Muckerman: Exactly.

Crowe: I think the LNG scenario, for them, will be pretty robust. There's calls for over the next two-three years that it won't be that great, but let's look beyond that, because, like you were saying, a lot of their ramp-up is going to be a few years down the road. On that end, I think they're going to be pretty good. But offsetting that, one thing that worries me a little bit is going to be, when you combine these two companies, they have a very high exposure to deepwater production, especially in places like Brazil.

O'Reilly: Which is long-tail, high costs. Lots of fun.

Crowe: Exactly. And that's one of the things that certainly... well, I'm not going to say we're going to stay in this low-price oil environment for a long time. I think in the next couple years or so, we're going to see some sort of recovery, because right now, it's pretty unsustainable in terms of development and anybody actually making any money. But, beyond that, these high-cost places like Brazil, Shell already nixed its Arctic exploration programs... being tied so heavily to the deepwater production is going to make me a little bit nervous when we have shorter-cycle, cheaper options like shale oil, shale gas, that are starting to emerge. Maybe then, deepwater isn't going to be as attractive as it looks today. That's my only concern.

O'Reilly: Cool. Before we move on to our mailbag question, I wanted to point our listeners to focus.fool.com, where they can take advantage of a discount on The Motley Fool's Stock Advisor newsletter that works out to $129 for a full two-year subscription. Once again, that's focus.fool.com.

Our mailbag question of the day comes from Joseph Corvelli, who writes to Sean, Tyler, and Taylor -- say that five times fast. He says: "I have an oil question. Given that the U.S. has advantages you've all discussed in the past regarding our possession of advanced oil refineries and high-quality oil in the ground, I wonder if you might add some color to the nation's relative strengths in one or other end markets for oil-based products. What does the U.S. pie look like sliced up into various other oil product families? Do non-fuel uses of oil color our domestic and new export market potential? We tend to reflexively think fuel products are the most important drivers of the domestic oil product, but plastics and other products may be even more important for faster-growing domestic oil uses. How important are these other uses for crude? Yours Foolishly, JC."

Muckerman: Can you repeat the question?

O'Reilly: Yeah, I can... no. Honestly, you know what, I'm going to just boil it down for you. It's kind of like that scene in The Graduate when Dustin Hoffman gets told that he should get into plastics.

Muckerman: Fair enough.

O'Reilly: Is that the future? Is that a big deal? [laughs]

Muckerman: It's still going on. It's been a good run for Dustin Hoffman if he did get into that market. I don't know what his future held in the movie --

O'Reilly: Didn't George Bailey's friend get into plastics in WWII or whenever in It's a Wonderful Life? Like, "Oh, George, put all your money in plastics!"

Crowe: You're really throwing it back to something that none of us are familiar with.

O'Reilly: I like old movies, I'm sorry. No, these are two American classics! I apologize for nothing!

Muckerman: I watched The Graduate over New Year's on my flight back from Portugal.

O'Reilly: And you probably saw It's a Wonderful Life at Christmas.

Muckerman: No, I did not see that.

O'Reilly: You didn't?

Muckerman: No, only The Graduate.

O'Reilly: Why do you hate America?

Muckeman: So, plastics! In the international scheme of things, oil does impact plastics, because you can... naphtha turns into ethylene, somehow, I guess, in the whole formulation...

O'Reilly: Somehow. [laughs] With alchemy.

Muckerman: But in America, we're producing ethylene at near-record rates for us thanks to natural gas booming. So, 2014, you saw the U.S. have a tremendous advantage when oil was over $100 a barrel. So, on a global platform, we're not quite as competitive anymore, because oil prices are in the $30-a-barrel range, so naphtha is not cheaper to produce in parity with ethylene here. But long-term, we have this natural gas supply that we could use for decades. So you see companies like Dow Chemical (NYSE:DOW) pouring billions of dollars into facilities down in the Gulf region to take advantage of this, and I think that's going to probably continue. The money right now is being spent, so these plants aren't necessarily coming online, but we're producing at over... what was it, I had it right here... record levels of ethylene in America. The aggregates number doesn't necessarily matter. It's at a record. So, I think long-term, that's going to be a competitive advantage. Right now, oil prices came back, so it's not necessarily. But this is a long-term thing.

O'Reilly: Right. Tyler, you were saying something interesting upstairs when we were talking about the show.

Crowe: It's on the same idea, with the fact that with such cheap natural gas... even at $30, surprisingly, we --

O'Reilly: Wasn't it $13 like five years ago?

Crowe: $13 what?

O'Reilly: $13 per BTU for natural gas. It had the peak in 2008 or something.

Crowe: That was quite a while ago, before the shale boom took off. But really what Taylor is getting at is that oil and gas spread price. I believe that, at right around eight to nine times the price of gas, if you multiply the price of gas about eight or nine times, that's about the equivalent when you're looking at naphtha and ethylene production. So, even today, there's a slight margin. It's certainly not as great as it used to be, like you said, at $100. But going back to Joseph's question, do we have any opportunities of using oil in that regard? If you look at the way oil is used in the United States and almost everywhere else, the portion of pie of oil that is used outside of transportation is rather small, more than 70% of all oil goes into --

O'Reilly: Petroleum.

Crowe: -- transportation. So, if you're looking to make a play, I guess you could say, in the non-transportation aspect of oil, it's a very hard niche to invest in.

O'Reilly: Just buy Dow Chemical at that point, right?

Muckerman: They're actually trying to move away--

Crowe: They're moving into natural gas anyways. If you look at all of these companies... and if you want to really think about how to get into that realm of plastics, or the non-transportation aspects of petroleum and hydrocarbons, look at the investments right now. The investments are all in natural gas in the United States, as a feedstock. And if that's the way you want to make a play on it --

O'Reilly: We're the Saudi Arabia of natural gas, haven't you heard?

Muckerman: Oh yeah, Dow's trying to make from like 70% of their ethylene coming from the U.S. to about 80%-85% of it coming from the U.S. over the next few years.

Crowe: Yeah, CP Chem, which is a joint venture between Phillips 66 and Chevron, mutlibillion-dollar ethylene facilities down in the Gulf Coast, ExxonMobil is looking to more than double their production down there. There's companies left and right going down to the Gulf and setting up shop with these massive chemical manufacturing facilities.

O'Reilly: Cool. So, we're going to do a little round-robin question for everybody: What storylines are you following in the most recent earnings season that is now well under way? Who goes first? Anyone? Draw straws?

Crowe: I'll go first. I follow big oil a lot --

O'Reilly: ExxonMobil?

Crowe: -- so I'm definitely going to be watching how the Big Oil players do this quarter, and how they start looking at 2016. Typically, we don't start to see their analyst day presentations where they release their budgets until like March, so maybe not for a couple --

O'Reilly: This is when they go to New York and do a little dance?

Crowe: Yeah. That's when we'll start to see what's going to happen in the coming year. But sometimes, you get a little bit of hint of what's going on in their conference calls, or in the coming one. But at prices today, we've seen companies -- Shell, ExxonMobil, Chevron -- they've really been struggling meeting their capital obligations. Chevron especially, because they're spending so much on those large projects like Gorgon and Wheatstone. Are they going to be able to maintain it all the way through '16 without significant deterioration of their balance sheets?

O'Reilly: Cool. Taylor?

Muckerman: Continuing to watch margins. We have to continue to wait and see some normalization at the very least. I don't expect any expansion, but maybe the reduction in margins starts to slow down. And also, who cuts their dividend this quarter?

Crowe: [laughs] Somebody.

O'Reilly: Whose turn is it? [laughs]

Muckerman: Somebody's cutting their dividends this quarter, I just don't know who.

Crowe: Let's make that a game.

O'Reilly: Let's do that next week --

Crowe: No, let's make that a game for our listeners. Email us.

O'Reilly: IndustryFocus@Fool.com.

Crowe: Or tweet at us. Find us somewhere, and tell us what company you think is going to cut their dividend this quarter. We got some Motley Fool swag sitting around.

O'Reilly: You will get, at the very least, a shout out on the show by name. It'll be awesome.

Muckerman: At the very least.

O'Reilly: Well, I don't know, we can't guarantee swag without clearing it.

Muckerman: We could give a hat out.

O'Reilly: Fine, we'll give a hat out [laughs]. I'm particularly interested to see... companies have been cutting a lot of capexes. We're all fully aware of this, hundreds of billions of dollars. However, this came along with some impressive efficiency gains last year, which pretty much kept production... U.S. lost 500,000 barrels a day, but we're still over 9 million at last count. We're starting to see 2016 budgets come out, as Tyler mentioned, so I'm expecting deeper cuts, but I'm extremely curious to see where companies think their production is going to be for this year. This question came to mind for me because Continental, led by the one and only Harold Hamm, came out and said they're cutting capex again this year by two-thirds or something.

Muckerman: 60-something%, yeah.

O'Reilly: It's crazy. But they actually think their production is only going to drop something like 10%, and they think their natural gas production is going to go up. And I was like, "Woah, woah!" So, I don't know if they're an outlier, or...

Muckerman: Because they're going to capture more of their flared natural gas. [laughs]

O'Reilly: Yeah, or whatever.

Crowe: I'm slightly apprehensive.

O'Reilly: You think they're an outlier?

Crowe: It's not that I distrust anything that he says, but this is also a guy that, back in 2014 when oil started to decline, completely wiped out all of the hedges on his company to protect cash flow, saying, "This is unsustainable." Well, now we're 18 months later, and it's still going on.

O'Reilly: It's lower.

Crowe: It was a wrong bet. So, I'd like to see him make some right bets before I really start to trust what's going on with him.

O'Reilly: Cool. Well, that's it for us, folks. If you're a loyal listener and have questions or comments, we would love to hear from you. Just email us at industryfocus@fool.com. As always, people on this program may have interests in the stocks 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 am Sean O'Reilly, thanks for listening and Fool on!

Sean O'Reilly has no position in any stocks mentioned. Taylor Muckerman owns shares of Core Laboratories and Halliburton. Tyler Crowe owns shares of Core Laboratories and ExxonMobil. The Motley Fool owns shares of and recommends Core Laboratories, Halliburton, and Netflix. The Motley Fool owns shares of ExxonMobil. The Motley Fool recommends Chevron. 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.