Energy Stocks: The Good, The Bad, and The Ugly Truth

Sure, energy is on an upswing, but the damage from the protracted oil and gas price recession still lingers. Many popular energy plays are in reality debt-hobbled “zombie stocks” poised to collapse.

If the consensus is correct and a stock market correction lies ahead in 2017, inherently weak stocks could shipwreck your portfolio. If you want to gain exposure to the resurgent energy sector, you must choose the strong and avoid the weak.

Which brings me to a good stock and a bad one: Schlumberger (NYSE: SLB) and  Transocean (NYSE: RIG), respectively.

Schlumberger is an oilfield services company with earnings growth momentum, manageable debt and promising international prospects. SLB is an appealing buy now. Transocean is a deeply indebted offshore oil and gas driller with negative earnings growth. Shun or short RIG.

Oil price volatility: the new normal…

Oil prices may be the most volatile factor in today’s world economy. After plunging for most of 2014 and 2015, crude started to rebound in the middle of 2016 and its upward trajectory continues (with plenty of ups and downs along the way).

The rapidly changing landscape in this industry has effectively sorted out the winners and losers. There are opportunities to profit, but also several dangerous stocks that beckon the overly optimistic.

First, let’s look at the positive news. Robert Rapier, chief investment strategist of The Energy Strategist, is justifiably bullish on energy as a whole.

That’s a picture of Robert, at a recent luncheon with his friend Lesley Stahl of 60 Minutes fame. You wouldn’t know it from his humble demeanor, but he often gets invited on national television to discuss energy.

Robert describes energy’s ascendancy:

“First quarter earnings are starting to roll in, and as expected energy sector earnings are much better year-over-year. So far ExxonMobil and Chevron have both reported results that beat expectations.

These results signal a healthier energy sector, but after a first quarter correction in the sector, you can buy many companies at the same price they were a year ago…

Companies that can generate positive cash flow in this environment are companies that will survive regardless of how long it takes oil prices to move higher.”

Robert also notes that, love him or hate him, President Trump has been good news for the energy sector:

“Regardless of your opinion of President Trump, it was pretty clear that he would be good for the energy sector. In fact, my top prediction for 2017 was that his actions would result in the completion of the Dakota Access Pipeline.”

To be sure, the long-term picture for energy looks bright. The International Energy Agency recently released its widely followed Oil 2017 report, which projects continued multi-year growth for the energy patch. The report estimates the addition of at least a million barrels per day (bpd) of demand every year. The report estimates that global oil demand will pass 100 million bpd in 2019 and reach about 104 million bpd by 2022.

Nonetheless, volatility will likely plague the sector into the foreseeable future. Anything can happen with the mercurial Donald Trump in the White House, and the slightest whiff of bad news can send energy prices reeling again. That’s why you should be highly selective in your energy investments.

Transocean: a weak foundation…

One toxic energy stock now is Transocean, a beleaguered offshore oil drilling company that’s suddenly attracting some bullish sentiment because of its recent earnings beat.

Transocean last week reported first quarter earnings per share of 1 cent, beating consensus forecasts for a loss of 8 cents, on revenue of $785 million, exceeding analysts’ estimates of $735 million. The earnings report cheered some analysts (although tellingly, the stock went down).

Don’t get suckered; a turnaround isn’t in the offing. Let’s look closer at the numbers.

Transocean’s EBITDA margins in the first quarter declined to 52%, down from 59% during the fourth quarter of 2016. Total debt now stands at $8.39 billion, for a total debt-to-equity ratio of about 53, which is high compared to its peers. Operating cash flow is an anemic $1.46 billion.

With a market cap of $4.37 billion and a far-flung global presence, Switzerland-based Transocean uses internal cash flows and capital markets to finance new build rig campaigns.

Transocean is the industry’s largest offshore driller, operating 56 mobile offshore drilling units that consist of 30 ultra-deepwater floaters, 7 harsh environment floaters, 3 deepwater floaters, 6 midwater floaters, and 10 high-specification jackups.

A major problem for the company is that it primarily offers deepwater and harsh environment drilling services, two areas that were booming when oil prices were high, but which are now only slowly recovering with the rise in oil prices.

During the halcyon years leading up to the oil bust of 2014, Transocean expanded with an aggressiveness that in hindsight now appears reckless. When prices started to head south in mid-2014, Transocean was caught in the vise of declining revenue and rising debt costs.

Transocean’s projected earnings growth paints a grim scenario. The average analyst expectation is that RIG will generate year-over-year earnings growth of -110.1% in the current quarter, -158.8% in the next quarter, -133.7% in the current year, and -78% next year. That’s hardly reassuring and probably insufficient to cover the company’s staggering debt load.

RIG shares have fallen more than 24% year to date and more than 42% over the past two years.

Transocean had its “sell” rating reiterated by analysts at BMO Capital Markets in a recent report. Deutsche Bank (NYSE: DB) recently cut its one-year price target on RIG from $8.00 to $7.00; shares currently trade at about $11.00.

Ignore the optimists and stay away from Transocean. There are better places for your money. If oil prices fall again or if the broader market corrects, stocks such as RIG will be among those that fall the hardest and farthest.

Schlumberger: from Houston to China

If you want to buy shares of an energy stock that’s positioned to profitably leverage rising oil prices, consider Houston-based Schlumberger, a denizen of The Energy Strategist Growth Portfolio.

The high-tech exploitation of North American shale is boosting the oil and gas production of the United States, which has motivated China to do the same with its reserves. The world’s second-largest economy is aggressively developing its vast storehouse of homegrown shale energy, which is good news for oilfield services provider Schlumberger.

With a market valuation of $100.74 billion, Schlumberger has deep roots in China, where established relationships and a proven track record are crucial to winning business.

The Middle Kingdom has recently discovered huge oil plays, and Schlumberger is poised to get the contracts to develop them. This work in China supplements the company’s other work around the globe and also cushions it against today’s oil price volatility. SLB’s total debt-to-equity ratio hovers at 46.

The average analyst expectation is that SLB will generate year-over-year earnings growth of 30.4% in the current quarter, 64% in the next quarter, 31.6% in the current year, 102% next year, and 54.7% over the next five years on an annualized basis.

SLB shares have taken a beating in recent months, along with the rest of its sector. Shares are down 13.6% year to date, but they’re getting ready to break out.

SLB shares currently trade at about $72; the average analyst one-year price target for the stock is $90.84, for an implied gain of more than 26%.

Got any questions or comments? Drop me a line: — John Persinos

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Joe Clenney

Joe Clenney

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