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Why Does Saudi Aramco Want to Go Public?

By Tyler Crowe and Sean O'Reilly - Apr 27, 2016 at 9:00AM

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As companies start to report earnings, we take a look at some of the big themes from the energy, industrial manufacturing, and airlines sector and whether you should be excited about the Saudi Aramco IPO on the New York Stock Exchange.

News broke this week that Saudi Aramco is considering a listing a small percentage of its massive bulk on the New York Stock Exchange.

In this episode of Industry Focus: Energy, Sean O'Reilly and Tyler Crowe share what they know about the IPO -- why the company is considering it, what it might mean for American investors who might want to buy in, what new information could come to light if it goes through, and more.

Also, they go over earnings reports highlights from a few diversified oil services companies, and take a look at how the low price of oil has affected the airline industry more than most companies would like to admit. 

A full transcript follows the video.

This podcast was recorded on April 22, 2016. 

Sean O'Reilly: A possible IPO from Saudi Aramco. All that and more on this energy and materials edition of Industry Focus.

Good morning, Foolish listeners! I am Sean O'Reilly joining you here from Fool headquarters in Alexandria, Virginia. It is Friday, April 22, 2016. Joining me to talk about the latest in the world of energy and materials is the one and only Tyler Crowe. Long time no see, Tyler.

Crowe: It's been a week. We had a little fill-in for you. We had a lawn ornament take your spot.

O'Reilly: I about died when I saw that.

Crowe: It was pretty good. It was fun. He was very insightful.

O'Reilly: I'm sure. Probably more insightful than yours truly. You guys had a good show, I enjoyed it. I listened to it from northeastern Ohio. I visited the parents.

Crowe: Had a good time?

O'Reilly: Yeah, we actually -- completely unrelated to our topic for discussion today, but I'm going to plug my hometown for a second. Lots of exciting things are happening in downtown Cleveland. They're building apartment buildings and they put it a fancy Heinen's inside of an old bank building. It's just weird to see because I don't think of Cleveland as an urban living city. Long way to go.

Crowe: It must be all the good news around their sports teams that just really has everybody excited.

O'Reilly: It's OK, Tyler. It's OK. I don't want to talk about it. I grew up in the 1990s when Detroit was hot. Anyway, cool.

Diving in real quick here, we're starting to get a trickle of earnings releases from a few of the people in our sector.

Crowe: Yeah. Early reporters, every single time this year you get a couple of the early oil services companies. I would call them the diversified oil services companies. You also get early indications from Kinder Morgan. I think a lot of what's been going on as of late is pretty much what everyone would have expected.

O'Reilly: Right.

Crowe: If you look at things like oil prices, look at things like rig counts in the United States...

O'Reilly: Which, ironically enough, I couldn't help but notice in the Core Labs release, that was in the first paragraph was the rig count. I was like, "Yeah, you guys want everybody to know."

Crowe: Well, I mean Schlumberger (SLB 0.20%) mentions it too. It is very, very hard to make money when you are a drilling contractor or do some sort of oil services business, when the rig count in the United States is the lowest it's ever been since we have records of it. It's around 400 right now, which is just mindbogglingly low.

Looking at some of the results, it's pretty reflective of that. Even CEO Paal Kibsgaard at Schlumberger noticed. He was like, "This is one of the worst cast crunches that I have seen in the oil patch in my career." If you look at the revenue and earnings breakdown of the company, they break it out between North America and international. If you look at international, it's down by 20% and they're still generating operating income of about 20%.

O'Reilly: We were told that international would be a lot better than North America on our trip to Houston last October by DistributionNow. It's because these are national oil companies, longer tail projects.

Crowe: International pre-tax operating margins at Schlumberger are still 20%, which is great.

O'Reilly: It's positive, that's a good thing.

Crowe: Revenue is down year-over-year of about 28% on the international side, which doesn't sound too bad, but then you look at North America. Revenue down 55% and pre-tax operating margins have actually swung into a loss of -0.7%. I think, in the next couple of days when you have Halliburton, Baker Hughes, a couple of the other oil services companies that are much more tied to the North American market, I think you're going to see...

O'Reilly: Even worse.

Crowe: ... some struggles. I think investors who have a stake in some of these other companies -- just be ready. It's probably not going to be pretty.

O'Reilly: When I was reading the Core Labs, it was pretty meat and potatoes and was what you would expect.

What did you think about Caterpillar's (CAT 0.73%) results? They are obviously very tied to the mining industry. The results weren't that bad, though. They had quarterly revenues of $643 million, down 7% compared to the same period last year. That isn't complete devastation. They're still profitable.

Crowe: Yeah, they're still profitable. It's just that if you look at the numbers for everything Caterpillar, I don't want to say hanging on by the skin of their teeth. That might be a little too far of it, but if you look at anything when it comes to mining or energy and materials for them, it's just getting absolutely hammered. There are a couple saviors for them. They have their financing arm, which has seen some only modest declines because you have people paying off equipment. One of the things that was mentioned in their release from their CEO was that "We think we're pretty close to the bottom here. Would not be surprising if things were to decline a little bit more. We don't think we're going to see much larger declines from where we are right now. We feel like we have made the adjustments to our cost structure that we can handle being today."

If you look at the final results, they still remained modestly profitable. Cash is coming in the door, not a lot but enough that you don't have to hit the panic button yet. We're looking at a company like Caterpillar. Their pricing stayed relatively well because they have branding power. They have a certain level of trust when somebody is going to buy a six, seven figure piece of equipment you want quality, you want something you can depend on, you want a company that's going to be around to fix it. With something like that, Caterpillar certainly has those advantages. It's looking much better than it has in the past 12 months.

O'Reilly: Given the indications that we might be at the bottom of this cycle, is this when you step up and picking up a few shares in some of these names?

Crowe: Caterpillar has certainly been on my radar for a little while. I've been watching and trying to figure out how they're going to handle their debt situation. They do have pretty large amounts of debt. They are a manufacturing company. If you were to compare Caterpillar and Starbucks, you'd be bewildered at the amount of debt that Caterpillar had but then...

O'Reilly: Different service models.

Crowe: If you start looking at the heavy capital costs that are involved in building all this machinery and having large inventories that are going to last a very long time. You're not turning over a front-end loader in 12 days. It may take much longer for it to sell. You have pretty high inventories. They just have a higher debt capital structure. Just watching it and making sure that it's not having to blow out the bank during this down term, which makes it look a little more promising than twelve months ago when things were still rapidly declining. Watching it, are they going to have to make some drastic measures? They've made some labor cuts and they've certainly brought their operating costs down, but not enough. They haven't had to do the big, deep cuts that you'd assume somebody would have to do in a situation like this.

O'Reilly: Yeah. Obviously talking about oil for the past 18 months has been -- I don't want to call it depressing but I don't have a better word. Mining is not doing so hot. Are there any companies in the energy/industrials space that might make one hopeful of the future?

Crowe: I think one that looks pretty interesting not from an oil and gas but from an overall energy perspective, if you look at the whole space. I really have been impressed with what has been going on at General Electric (GE -1.25%). Obviously oil and gas has been getting hammered just like everybody else. No shock there. But they're doing some very interesting things in the oil and gas segment, and they're also getting some better results from across the board. If you look at their renewable segment, which is something they just started breaking out in their earnings, you have a renewables segment that brought in $1.6 billion in quarterly revenue, which is 66% greater than what we saw in the previous year. Part of that had to do with the Alstom acquisition that they made back last year, basically buying wind turbine and other power generating facilities.

O'Reilly: They were already a big player in wind turbines even before that.

Crowe: Right, so you add Alstom to that and you've got a huge wind, and they have some solar. Again, some interesting things they're doing in oil and gas. They even mentioned it in their release. They have done a new model when it comes to oil and gas equipment manufacturing with rig company Diamond Offshore. Basically, GE has provided all of the blowout preventers. It's a major piece of equipment that is one of the bottlenecks of the oil and gas drilling industry. This thing has to run perfectly. It has to go on scheduled maintenance and there's a lot of down time associated with it. Anytime there's down time, you're not making any money.

What they have done is that they have bought back all their blowout preventers from Diamond Offshore, which had originally been purchased, and now are leasing them to them. The goal of this for Diamond Offshore is, GE has some skin in the game. They want to be better about maintenance and keeping it operating. They get incentive bonuses based on getting better performance metrics than they already have. In exchange, GE gets a reoccurring revenue rather than a straight sale. Over the long term, that asset becomes more valuable. If it can pull levers like that in the oil and gas industry, while at the same time seeing this huge boom in other sections such as renewables, GE is looking very impressive at least on the energy side of its business.

O'Reilly: Given their shift that they're in the midst of making toward getting back to their roots of being a good old American manufacturer, I don't think I'd be going out on a limb to say they're a decent bet if you want to get in on the alternative energy, high value manufacturing game.

Crowe: They are doing a lot of things that are very impressive. They are really trying to divest themselves from GE Capital. They said in their release there are about $166 billion worth of that has been divested. They're a little ahead of schedule on that. When they get rid of all these GE Capital that are kind of ancillary to the typical financing arm that you'd see at a Caterpillar or John Deere, or something like that, to help fund the purchase of a major piece of equipment. Once they get rid of that, they're going to be able to get rid of their SIFI designation, basically saying they're too big to fail as a financial institution.

O'Reilly: We don't matter to the financial industry anymore.

Crowe: Right. They want to get rid of that. In doing so, they free up a lot of their capital and cash and things like that, that they can then return to shareholders that are looking at doing a massive buyback, a sizable dividend increase. Once that capital aspect of it and they get back to being a true industrial manufacturer, and you look at those numbers, they're becoming a pretty good industrial manufacturer again. Things do look very promising for GE. Like Caterpillar, GE is another thing that I have been watching pretty attentively as of late.

O'Reilly: Real quick before we move on. I'm interested to get your thoughts on the airlines. These guys have, you think of an automatic beneficiary of low oil prices.

Crowe: Oh and they have been.

O'Reilly: Immediately. Except for, who was it that had really high priced hedges that hasn't really benefited?

Crowe: Sorry.

O'Reilly: No big deal. Anyway. You mentioned before we went on air that you had been looking through their results. Alaska Air and Southwest (LUV -3.80%) have reported. Some good and some bad.

Crowe: I wouldn't say I'd call it bad. More just like flat-lining. Very neutral. Some of the good things that you see, obviously the headline number says they made some of their best return on invested capital numbers. They made some of their best profit numbers in a quarter, which all sound great. Then when you start to break down what those are, some of the gains that you had. You saw a modest uptick in total miles flown, basically they're scheduling more flights. They're building out a little bit more few new routes, but they're very measured when it comes to those things. They're load factor, and this is an important metric when you're thinking about the airline industry. Load factor is basically how full the planes are at any given time. You saw a modest uptick in that. They're in the 80.4-80.5%, which is right around where they were -- like I said not even a full percentage point increase there. But improving.

The one thing that is interesting for both Alaska and Southwest was another important metric which is PRASM, or Passenger Revenue per Available Seat Mile. This is one of the most important metrics when you're looking at airlines because it's basically saying...

O'Reilly: So listeners should be writing this down.

Crowe: Right. That's the one that you really want to look at is how much revenue they're generating per seat on the plane per mile it's actually flown. That includes things like fuel costs and how full a plane actually is. It's a very important metric to actually keep track of. If you look at these companies, Alaska's was down a little bit, Southwest was very modestly up. Again, pretty flat line numbers when we're looking at increases on things like this. It's kind of telling when you look at the big gains in terms of revenue or income that they got -- sorry, income not revenue. And then look at the PRASM numbers which are pretty modestly flat, you can pretty much kind of assume that a lot of these gains are coming from modest expansion in the company and a major benefit from oil and gas prices.

O'Reilly: A lot of people talk, all these articles I read, edit, and occasionally contribute to, that talk about the automakers, GM and Ford or whatever. They're selling just about as many cars as they ever have or arguably ever will. Is it the same case with both autos and airlines, that it's probably as good as it's ever going to get? Unless population explodes or something.

Crowe: It really depends on where you're looking. Certainly in the United States there is some room to grow with regional travel, it is still a growing industry. It's an ungodly competitive industry. When you have flat lining numbers on passenger revenue per available seat mile...

O'Reilly: I can't believe the profits that these companies have been making these last few years. You had David Tepper making a couple of billion dollars off buying them after the Great Recession. I grew up reading about Warren Buffett as a teenager. Rule No. 1: Stay the heck away from airlines.

Crowe: Well you also have to take into account when you look at somebody like Warren Buffett, he's looking at it across the cycle. It looks like we're on one of the up cycles in the airlines where fuel is cheap, everybody wants to fly, economic conditions are good. Those are when the opportunities are. The big question will be, can they carry some of that momentum into when oil prices start to increase? That's going to be the biggest question for them going forward. How long is this party going to last with oil prices? At the same time, when you look at those flat lining numbers for passenger revenue per available seat mile, it starts to wonder how much more competitive are these people going to get when it comes to fares and fees? Let's face it. Airline travel has become a race to the bottom when it comes to prices nowadays. It's why a company like Spirit Airlines, as miserable of an experience as it is to fly on a Spirit Airlines plane, I don't know if you've flown it but it wasn't exactly the best experience I've ever had.

O'Reilly: Even with Southwest...

Crowe: It is cheap. Oh my goodness is it cheap.

O'Reilly: My flight to Port Columbus airport in Ohio last week, I booked a month and a half in advance. My flight was $69 one-way on Southwest. I got peanuts and a Coke. It was great.

Crowe: But again, it's the race to the bottom.

O'Reilly: It is a race to the bottom. They did not make money on me.

Crowe: Dynamic pricing model where you bought it a month out and it's going to be cheaper than if you had waited a week.

O'Reilly: But now it's $200.

Crowe: You have those sorts of dynamics going on. It will be interesting to see what happens with fares. We're starting to see a little industry consolidation with Alaska buying Virgin America and things like that. If industry consolidation does happen a little bit more, will they be able to raise prices a little bit because the amount of competition won't be as robust.

O'Reilly: Right. Alright, well before we dive in to talk about Saudi Aramco's probable IPO, I wanted to point any listeners out there who are hungry for more Foolish content to, where all Industry Focus listeners have access to a special discount on The Motley Fool Stock Advisor newsletter. The discount works out to $129 for a full two-year subscription. Once again that is So, Tyler Crowe ...

Crowe: Yes.

O'Reilly: Saudi Arabia really really really wants to raise a couple trillion dollars, it looks like. Or at least a couple hundred billion from selling a 5% stake in what is the country's arguably only industry. Why didn't they do this a couple of years ago?

Crowe: There's a couple things going on here. I'm not going to delve deep into Saudi Arabian politics because...

O'Reilly: Nobody knows.

Crowe: I don't know that very well. As you've seen, there's been some rather vocal commentary coming out from the kingdom. Not the king, but...

O'Reilly: Various princes are saying this.

Crowe: Right. Trying to get away from oil. Need to move away. Either they're trying to build this massive sovereign wealth fund where they can start to wean themselves off of oil. One of the ways they want to raise money to get this fund off the ground is to IPO a certain segment of Saudi Aramco. It's pretty modest. They only want to sell about 5% of the business. Granted, that 5% is a lot, because it's such a big company. From an investing standpoint, it's going to be listed on the New York Stock Exchange, so you and I can buy it just like anybody else. Before anybody gets too excited about this. I'm sure there's going to be a ton of media like "Should you buy Saudi Aramco when it IPOs?" Right now, we don't even know what the heck we're going to get. They said, "Oh we're going to 5%." Does that mean 5% of the whole thing? 5% is just the certain segments of assets? We don't have the slightest clue what that necessarily means.

O'Reilly: That was the most interesting part of the Wall Street Journal article I read the other day. It was entitled "Saudi Aramco IPO could be 5% of value." As you said, value of what? The most interesting thing I read was they're not even sure if they're going to include the country's oil reserves. As I understand it, the country is structured to where everything is the property of the Saudi royal family. It seems to me like they could do whatever they want with all the stuff anyway. I'm almost inclined to say: give me the refining assets and you keep the oil. I don't know.

Crowe: It's one of those things again too, where you're looking at a business that is trying to serve two masters. What we have seen at least in the oil industry over the past several years, is a company that is trying to serve two masters like that in terms of being a hybrid of a state run oil company, and being one that is publicly traded where it is beholden to returns. Those can be conflicting things.

A great example of that is Petrobras (PBR -12.48%) in Brazil. Never mind all of the things that have gone on with the kickback scandals and corruption as of late. If you watched Petrobras at the early times, it was "We have this immense opportunity because we have these pre-salt fields. They're huge. We need to raise some capital." They wanted this hybrid model where they could raise the capital and generate returns for investors over time. The only problem is that there were so many restrictions from the state-run side. It's like, well you still need to subsidize gasoline prices within the country, so you're automatically going to take a loss on those. You have to have certain local content restrictions so you can't be the most competitive on price all the time in comparison to an oil major. When you have those conflicting...

O'Reilly: Do you contract out to just Brazilian companies when it's all...

Crowe: When you have those conflicting interests, it can be very very difficult to balance that. If you look across Petrobras, PetroChina, even Sinopec to a certain degree, it's very hard for a company to serve both of those masters well and to have everybody satisfied. Sure, Saudi Aramco might make 5% available. Is it going to be a great investment? It's going to be really hard to tell right now. Don't go jumping in the minute you see it.

O'Reilly: Right. What do you think -- you see this valuation of $2.5 trillion for Saudi Aramco. Maybe that includes the reserves or not. 5% of that would raise the country $125 billion. The whole number itself seems suspect to me, because oil prices are at the low 40s right now and that's after rallying over 50% from $26-27. Does that imply that the Saudi Aramco is worth $5 trillion 18 months ago? I don't quite buy that. Where are they getting this $2.5 trillion number? I seem to remember that from a year or two.

Crowe: You also have to take into account too that the numbers that are given on these aren't necessarily beholden to SEC regulations on how you evaluate reserves, how you evaluate property and things like that. Perhaps once they do go public on the New York Stock Exchange they will have to disclose things like that.

O'Reilly: Right. Reserves and stuff.

Crowe: Maybe once that happens, we'll get a little clearer picture and transparency into a business that has been very opaque for a long time.

O'Reilly: Yeah. Before we head out Tyler, I wanted to get your thoughts real quick. Can you tell our audience really quickly why, if your stock falls 50%, a CEO shouldn't get a 20% raise?

Crowe: At least that's what a couple of companies have said recently with some shareholder votes. Both Anglo American, a major diversified mining company, and BP, both in their shareholder votes, both companies had either a large plurality or a majority of their shareholders saying no to the pay packages that were proposed by the board for these companies' CEOs. In the case of Bob Dudley, the CEO of BP, he was looking at a 20% raise to about a $19.6 million annually.

O'Reilly: Which is absurd.

Crowe: It all comes down to how you evaluate what your ... how you structure your compensation packages. If you look at some of the ways that BP had structured it, it was rather favorable to the business on these certain metrics that looked favorable almost regardless of the current price environment. The total return that a shareholder would get. Contrast that with ExxonMobil or Chevron's CEOs. Both of them saw pretty decent sized declines in their salary from 2014-2015, because their compensation packages were based somewhat on total return. When you have your stock drop 20%, 30% in a year, some of that is going to be reflected in your pay package.

This is one of those things, and I think as a shareholder it's one of the nice things, where you can actually say no to something like this and actually have a voice in it. That's one of the great things about being an individual shareholder of a company, is as little as it may be, you still have a voice in what goes on in the company. You can say, "Hey you guys are paying your CEO too much." Or, you can even sometimes bring up amendments for oil companies. A lot of them have to bring forth votes on things like climate change disclosure. It's encouraging to see shareholders actually holding companies' feet to the fire for a change. Sometimes these guys can get away with a few things every once in a while. To see this happening is a little encouraging.

O'Reilly: Good. Well thank you once again for your thoughts, Tyler. Always a pleasure.

If you're a loyal listener and have questions or comments, we'd love to hear from you. Just email us at Once again, that is As always, people on this program may have interest in the stocks they talk about and The Motley Fool may have formal recommendations for or against these stocks, so don't buy or sell anything based solely on what you hear on this program. For Tyler Crowe, I'm Sean O'Reilly. Thanks for listening and Fool on!

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