I like Oil

[Running_Man]

Uh, this is exactly the time you SHOULD be buying oil companies because they're cheap. All part of the gains from rebalancing. Buying them when oil is at $120 isn't going to get you anywhere.

Actually Oil was last at $120 in Feb 2012
XOM closed today at $87 in Feb 2012 it was at $83
Chevron closed today at 104 it was at 105 in Feb 2012
COP closed today at $62 in Feb 2012 it was $55

There has been actually little pain in the major oil company stocks to speak of, the idea that these stocks could fall 50 percent from here easily if the price of oil were to stay in it's present range for a longer than expected period of time is not registering with most investors who at this point have been conditioned that a small drop is by far the best time to buy major stocks, despite and maybe because of the 2007-2009 experience.

The dollar, the price of oil and future economic activity all seem to be a negative for their earning power moving forward for the intermediate term and the realization that the hedges will no longer protect earnings is just now begging to be realized.

However if the price of oil were to recover very soon then these companies will be ok again, but there is substantial risk to their price at this point in my opinion

 

[explanade]

If it's not the big oil companies, then what is selling off whenever oil drops?

All these exploration/development companies?

 

[freebird5825]

Go BHP
Go BHP

I'm down a bit (about 7k) but boy was it fun buying low in the last 3 months. I'm a small fish in much larger frying pan.

We shall see what we shall see.

 

[aja8888]

If it's not the big oil companies, then what is selling off whenever oil drops?

All these exploration/development companies?

The big oil companies are the exploration and development companies. What's going to sell off (and already has) will be the oil service companies; Halliburton, Schlumberger, National Oilwell Varco, etc and smaller, less capitalized, oil (and gas) companies.

 

[target2019]

If it's not the big oil companies, then what is selling off whenever oil drops?

All these exploration/development companies?

Here's a short list of companies I'm following. All are energy-related, but each has a different profile. Today is a selloff that continues for how long, can't say. If you look at the last column, it gives you a sense of how far from the top each stock has fallen from its 52-week high. Big companies are selling off, but to a lesser extent.

 

[Running_Man]

BHP Hilton at a glance:

Go BHP
Go BHP

I'm down a bit (about 7k) but boy was it fun buying low in the last 3 months. I'm a small fish in much larger frying pan.

We shall see what we shall see.

Well BHP is the poster child and a small study of what has occurred worldwide.

It is heavily in the commodities that have been in oversupply, and one of the major players in creating the oversupply. In 2008 it had 8 billion in debt and has borrowed another 22 billion to get to 30 million in long term debt at advantageous rate of 4 percent due to worldwide interest policies.
in 2011 on 72 billion in sales it had 5 billion in annual depreciation costs now with 71 billion in sales and falling it has 9 billion in depreciation.

It has another 12 billion in commitments for another 8 projects it has undertook, main attraction appears to be proposed split of their minerals division from the commodity oil and gas properties. Which will increase total debt to about 40-45 billion dollars, (currently with short term debt BHP's total debt is 35 billion dollars. While it is not costly in low interest rate environments to only pay 1.5 billion in interest on such a large sum of debt, this company has positioned itself for long term bull market in commodities in a time when commodity prices are in a major bear market, yet this stock is only off from 100 when the strategy appeared to be a very smart move.

From it's most recent presentation on 6 month performance review of July - Dec 2015:

Group production increased by 9% during the December 2014 half year with records achieved for eight operations and five commodities. Production guidance remains unchanged and we are on track to deliver Group production growth of 16% over the two years to the end of the 2015 financial year.
 Metallurgical coal production increased by 21% to 26 Mt in the December 2014 half year as Queensland Coal and Illawarra Coal both achieved record half year volumes.
 Western Australia Iron Ore production increased by 15% to a record of 124 Mt (100% basis) in the December 2014 half year as the ramp-up of Jimblebar continued and we improved the availability, utilisation and rate of our integrated supply chain.
 Petroleum production increased by 9% to a record 131 MMboe in the December 2014 half year supported by a 71% increase in Onshore US liquids volumes to 24.4 MMboe.
 Copper production(1) decreased by 2% to 813 kt as strong underlying operating performance across the business was offset by lower grades at Antamina.
 Record manganese ore and alumina production was underpinned by strong performances at both Hotazel and the Alumar refinery.

From it's review you can see the 131 million barrels of oil realized an average sale price of 85 dollars per barrel, meaning the price decline of oil has not yet hit BHP. However taking that 131 million of production doubled for yearly production, if it sells for $45 per barrel you have a decrease of 11 billion dollars of sales forthcoming in 2015 just from oil (15 per cent of sales), with all of these dollars falling from the bottom line, meaning at 45 dollar oil BHP as a company is not profitable. I do not think this is reflected in the current stock price as investors instead are focused on the 85 realized and the dividends paid from that as opposed to the future with 45 dollar oil.

If you then layer in copper average of $3.00 per lb realized in 4th qtr now at $2.45 I do not see how this company can withstand current prices and maintain it's current stock price. Already they are announcing they are taking 200 million in provisional pricing for copper in the 4th qtr, a 350 million charge for failure of planned asset sale to go through of their Nickel West business and a write down of those assets, a 850 million tax charge for loss of a deferred tax asset in Australia, a 250 million charge for petroleum producing assets in Louisiana and announced while it plans to go forward with it's tar sand oil project it will review to optimize cash flow.

And this is before even discussing their plan to increase Iron Ore production by 30 percent in 2015 even while iron ore prices have dropped even more than oil.

I think this company is a very good proxy for the overall world process in oil and commodities and will be a leading indicator in 2015 of effects of large amounts of low interest debt tied to high production of natural resources.

 

[Running_Man]

As to a continued theme of mine which is that I hate companies that buy their stock back, Chevron after wasting billions buying stock back at 115 dollars a share announced today with the stock hitting a new yearly low they are suspending share buybacks in an effort to preserve cash and further cutting capital spending. Chevron has fallen back below it's October/December lows down 4 dollars today COP and XOM are similarly making new yearly lows as well, indication that another leg lower is possibly starting unless they can reverse the market quickly here, however the news as we get into the quarter does not appear possible to get favorable to these stocks.

 

[aja8888]

As to a continued theme of mine which is that I hate companies that buy their stock back, Chevron after wasting billions buying stock back at 115 dollars a share announced today with the stock hitting a new yearly low they are suspending share buybacks in an effort to preserve cash and further cutting capital spending. Chevron has fallen back below it's October/December lows down 4 dollars today COP and XOM are similarly making new yearly lows as well, indication that another leg lower is possibly starting unless they can reverse the market quickly here, however the news as we get into the quarter does not appear possible to get favorable to these stocks.

Someone ought to tell Chevron and Exxon that they should be buying their stock back at the lows, not the highs.

 

[Running_Man]

Well actually maybe this is the bottom within minutes of Chevron making a new low in the stock market oil reversed course and is now up 8% today with Chevron recovering to even on the day, a very big reversal and a good sign for those long these oil stocks.

 

[Lakewood90712]

The Chevron Q4 earnings conference call today , for playback Chevron (CVX) Q4 2014 Results - Earnings Call Webcast | Seeking Alpha

Something mentioned near the end , if I understood correctly was a price point of about $50 bl for future projects to be profitable.

 

[Jmlstocks]

I have to ask: Why would you hate a company that buys its shares back-that's a good thing if you're a shareholder

 

[Running_Man]

Because what Chevron does is very often the case of share buy backs, by definition they are buying back stock when they are doing good and the stock price is high. Especially for companies that can be cyclical in nature it means when times are bad and they could use cash to buy assets of other companies at cheap prices they no longer have the cash to do so and frequently end up issuing shares or debt to maintain the company.

In Chevron's case in 2013 and 2014 they bought back over 9 billion in stock at 20-25% higher prices meaning over 2 billion dollars in cash used for stock purchases was totally wasted in an effort to prop up a stock price in a manner that cannot be maintained. Now they are cutting capital spending by 5 billion because of a shortage of cash.

Share buybacks are done almost exclusively for short term stock gains for the benefit mostly of near term issued stock incentive awards for executives and have little in the way of long term planning for corporations.

Some companies such as Berkshire Hathaway only repurchase their stock when price is in a value range and they have significant cash to take advantage of special circumstances, in those cases it is strategic, but in most it is not.

 

[Jmlstocks]

I see your point on companies that are cyclical in nature, could be a sign that they're buying at a high point.

I know from history that stocks doing heavy buybacks have outperformed over the long term, that's why I wondered why you said that. I don't think a buyback is an automatic reason to like a stock, I've always viewed it as a nice added bonus.

 

[Totoro]

There is basically two common ways to get unproductive excess cash out of a company and transfer wealth to shareholders. One is dividends, the others is stock buybacks.

Dividends have a tax disadvantage.

Stock buybacks on the other hand have an effect of removing short term shareholders that value your stock the least and concentrating shareholding, which might be argued is a positive.

The big issue with buybacks is the valuation as running_man said. Buying back stock when it's below its real value is a good thing for the remaining shareholders, you are buying at a discount.

Buying back stock when it's above its real value however is only good for the selling shareholders - the long term holders and remaining shareholders get a bad deal.

In other words, buying back stock is a great thing to do provided that 1) there is no productive way to reinvest the excess cash in the business and 2) your stock is below its true (intrinsic) value.

In practice though companies tend to buy back stock only when 1) is fulfilled and forget about the 2) part. Sometimes they even forget about the 1) part.

As running_man said sometimes this is willful as a CEO wants to meet its short term incentive plan and/or has stock options about to vest. Can hardly blame the CEO for that though, blame the board for setting the wrong incentives ...

 

[FUEGO]

Wait, what? Share buy backs reduce the number of outstanding shares thereby increasing the earnings per share by making the denominator smaller. What's not to like about an EPS increase? Maybe they flubbed the timing and could have bought it back cheaper later, but overall it tends to be a positive sign.

 

[haha]

Wait, what? Share buy backs reduce the number of outstanding shares thereby increasing the earnings per share by making the denominator smaller. What's not to like about an EPS increase? Maybe they flubbed the timing and could have bought it back cheaper later, but overall it tends to be a positive sign.

If you pay more than the stock's basic value, you are destroying value. If you pay less, like a few companies that are very well managed and good capital allocators, you are accruing value.

Ha

 

[aja8888]

Wait, what? Share buy backs reduce the number of outstanding shares thereby increasing the earnings per share by making the denominator smaller. What's not to like about an EPS increase? Maybe they flubbed the timing and could have bought it back cheaper later, but overall it tends to be a positive sign.

The immediate EPS increase is generally recognized as the result of the buyback and not an increase in earnings based on performance. Laying out the huge sum of cash that could be used for future CAPEX or acquisition of a strategic asset places the company in a potential disadvantaged position.

 

[Jmlstocks]

I personally like the fact that the excess capital is taken out of the hands of management. Too much capital often results in inefficiency

 

[aja8888]

I personally like the fact that the excess capital is taken out of the hands of management. Too much capital often results in inefficiency

Like management bonuses...?

 

[Running_Man]

Let me give two companies that are in the S&P500 that have been I think excellent examples of people who think the share reduction is wonderful yet in the same time I think it is just a lazy management way of increasing share price while slowly destroying the company:

1st McDonald's in 2005 McDonalds dropped managements prior commitment to expanding into casual healthy dining that they had been involved in with Boston Market and Chipotle. They owned 90 percent of Chipotle and has been instrumental in expanding the chain from 16 original stores to over 500 led by McDonald's leadership. Rather than hold on to that investment and grow with it McDonald's sold it's stake leading to the Chipotle IPO for one billion dollars in 2006. Today that stake would be worth over 20 billion dollars, worse than that they built a chain that is single handedly destroying McDonald's for lunches.

Now McDonald's did retire from 2006 to 2015 33% of their shares and for a couple of years from 2006 to 2013 as their share reduction and focus on dividends seemed to make the company more profitable per share the price rose. However by the end of 2013 it became apparent that McDonald's has fallen out of step with the economy and had no strategy other than to convert cash to dividends and share repurchases with the stock is falling, with sales only up 20 percent in actual terms in the nine years from 2006 to 2015.

Because management was focused on converting cash flow to share repurchase it held the stock up very well, but they didn't focus on how to improve their business. Even as the PE of McDonald's has expanded under this share repurchase program and ZERP from 14 to 20 the underlying business is getting weaker and weaker. Long term debt has gone from 7 billion to 14 billion, dividends have gone from 34 percent of income in 2005 to 66 percent in 2014. As a result of these actions book value remains at only 14 dollars per share.

Now let's look at another company IBM that in that same time frame 2006 to 2014 has reduced their share count by forty percent. Their revenues over this time have been flat but because of share repurchases it looks like 40% growth in per share sales. They are spending 1/ 2 the amount of capital spending that they averaged in the years 1998 to 2001. As the initial push of this share repurchase pushed up shares they doubled the stock price from 2006 to 2010, yet despite getting even more aggressive with the share repurchase program, increasing long term debt with easy financing from 22 billion to 36 billion dollars the stock has done nothing the last three years. So now the same sales that supported 22 billion in long term debt is now supporting 36 billion in long term debt, while the company is struggling what IBM would have to do on it's present course is increase the long term debt to 50 billion over the next few years to support the stock, this of course is merely wasting corporate resources but there are many investors who believe this is a great thing with such low interest rates. If rates were to pop up I do not know what companies like this would do other than have falling stock prices, this is the biggest bubble that the federal reserve has created corporate debt for share repurchases, I dislike it personally.

Overall my main point is a massive share repurchase program usually signals a management team that is timid and afraid and wants to play it safe and not one you would normally want to invest in because they lack a corporate vision, the current interest rates have exacerbated this problem as many companies can borrow for cheaper than their dividend rate meaning they can increase the dividend in their shares merely be retiring stock, but this is not a business plan this is short term thinking at it's finest. When interest rates rise the folly of companies that engaged in the most egregious examples of this will be exposed.

I cannot help but believe that Chevron wishes they had the 9 billion they used to buy stock back last year at an average price of 120 to instead buy assets that are available in a fire sale right now instead they are cutting capital and their normal budget even more.

 

[clifp]

You make good points Running Man. However certainly for a business like McDonald and to a less extent IBM, there aren't any obvious high growth areas to invest in.

Domestically I am sure that McDonalds store saturation was reached long ago,and international it has to be slowing. I'd expect McDonalds to have same store revenue at approximately inflation say 2%, and new store growth match population plus emerging markets another 2-3%. I'd expect them to maintain gross margins. I really have no problem with them borrowing money for as cheaply as Mcdonalds has <1% 5 years 2% 10, and long at 3.5% when their dividend is also at 3.5%. The companies 55% increase in dividends over the last 5 years is nothing to complain about it.

If I owned MCD (I don't) I'd expect 3-4% dividend yield and 4-5% dividend growth going forward. I agree a certain amount of innovation is vital for any company, and over the last 5 years McDonalds has pretty much failed that. But on the other hand I wouldn't buy McDonald's expecting the company to move into upscale restaurants, much less day care facilities. It's great Chipotle was a hit for them (which they obviously sold too soon and too cheaply). However for every company that enhance shareholder by moving into new areas I bet there are two that squander corporate resources doing so. I'd rather see them return profits to shareholders ideally via dividend boost, but repurchases also make some sense.

 

[Running_Man]

I think perhaps I have not adequately done a good job describing the problem and the bubble I see building in corporate debt, and this applies equally to the oil stocks and to MCD.

Mc Donald's in 2008 made 4.2 Billion dollars, in 2014 4.8 Billion dollars. For the past 7 years net income has grown at 2.2 percent annually on average, this is based on actual dollars. On a per share basis thanks to share buy backs net income has grown 6 percent annually. The difference investors and McDonalds thanks to the continual pressure of share buybacks results in a higher PE than the company would deserve otherwise, currently at 19.4 which at 2 percent growth really belongs at a PE of no more than 14 in my view which would value the stock at 70 not 95. As McDonald's continues to participate in this poor use of corporate funds it is wasting the resources it has.

Over the last 7 years McDonalds has earned 34.8 billion dollars and paid 18.1 billion in dividends and 14.7 billion in share buybacks. Leaving McDonalds to fund it's net investment in the actual business with 2 billion dollars over those 7 years, to supplement that it has borrowed 7.1 billion in long term debt in this time and has had net cash investment (Capital Spending less depreciation) of 8 billion with another 1.5 billion or so used for other cash purposes such as inventory, receivables and changes in accruals. Total capital spending in this time frame was 18 billion dollars.

How effective is that investment of 8 billion dollars of cash - for that investment over the past 7 years of 8 billion income increased 500 million annually by the end of 2014. On total capital spending of 18 billion this is a return of 3 percent, McDonald's would do better buying Apple's long term debt with their short term 5 year debt. On the other hand the 320 million invested in Chipotle by Mcdonalds is now worth 22 billion or more than all the dividends paid by McDonalds in the last 7 years and built with capital McDonalds invested to create a national company that now openly mocks and is taking business from the very company that made it possible.

That a company cannot own soda shops, ice cream shops, railroads and banks I think is not true, with the proper management a company can invest in anything but a review of what they do with their investments should be the judgement of investors, not how much of the income they return to investors. And I firmly believe it is management's responsibility to return income to their investors but for a normal corporation I expect 33-40 percent. Over the last 7 years McDonalds has returned 94.5 percent of income to investors through dividends and share buybacks, I just think it is not a prudent use of valuable resources to be such as high percentage. The red flags on this stock are just so high to me and this is a similar problem the oil companies have.

Over the course of time described here as McDonald's has been on their share buy back spree the price has gone roughly from 50-55 dollars to 90-100 dollars, so looking at the share price one would think this has been a good thing for investors, but what this has been is a company overpaying for it's shares which are not worth more than 70 dollars in my estimation. I wonder how much better McDonald's would be if it had used the 14.7 billion in share buybacks to buy stock in Berkshire Hathaway instead and at least give their money to someone who understands investments better than Ronald!

 

[Brat]

I agree about the corporate debt bubble. I think the big corporate debt risk is oil production. A lot of leveraged producers will fail and default on their debts. Add to that the fact that the economies (housing, service businesses) that are supported by those businesses will fail as well.. there will be a bumpy ride ahead.

Demand for coal is dropping too.

We will be back to the days where to find a geologist you call "waiter".

MCD also has issues with its business model as more and more consumers purchase fast food from the grocery deli counter.

 

[explanade]

Fast casual is the big thing. There's a Washington Post story about the growth of fast casual at the expense of fast food.

 

[aja8888]

Thanks, Running_Man for the excellent financial analysis of the McDonald's situation. Here's something from a customer's prospective:

My wife has been sick lately and the other day she asked me to run to the nearby McDonald's to pick up a burger for her rather than have me cook something at home. I usually only buy coffee at McD's as I like their brand and usually do so through the drive thru, of which now most locations have two drive thru isles. (looks like the customer service focus is on the car people and not the counter customers).

Well, I was surprised at the amount of items on the wall menu and tried to order just a burger and got hit with a flurry of questions about which style, off what menu, with or without the "meal", "supersize it", etc. So I just bought two $1 cheeseburgers off the dollar menu and left. No wonder they are losing market share to other shops like 5 Guys, etc. Plus, that dollar menu gotta be killing there revenues...

I think McD's needs to get back to basics and re-evaluate their customer's needs and wants. Maybe the recent management change will look at the menu issues and try to make it simpler and easier for customer's to buy their products.

Different burgers: 16
Different Chicken Sand: 13
Different Wraps: 14

http://www.mcdonalds.com/us/en/food/full_menu/full_menu_explorer.html

Crazy!