Think three steps ahead in energy investment
Tuesday, January 13th, 2014
Two guest speakers on CNBC recently discussed what a great time it is to buy companies that will benefit from lower energy prices.
I was thinking to myself, “Guys, you should have said this six months ago!” While some of these stocks may continue to rise, most of the gains have already been made, in my opinion.
Investors need to understand that investing is like a chess game. You can't just think about the current move; you have to think two or three moves ahead. I think one reason investors don't perform well in the stock market is they are reading yesterday's newspaper and listening to commentators. They're not thinking what will happen over the next 12 to 18 months. This is where most of the good money can be made for longer-term investors.
So while I would not be buying companies that benefit from lower energy prices, I have continued to discuss buying the drillers and energy-related companies. Many of these companies are down 50 percent to 60 percent. Because I have encouraged you to buy only the companies with strong fundamentals, such as a strong balance sheet and good cash flow, some of you may be scared away by the large decline.
So I decided to look at the world’s largest publicly traded oil and
Exxon Mobil reached a high of nearly $105 early last summer and has since fallen to about $92 a share. As you can tell, the decline is only about 12 percent, so don't expect a big gain when oil prices turn around and go back up.
What investors can benefit from is a current debit end of 3.1 percent and a company that has a dividend growth rate averaging 10 percent per year over the past five years.
When I looked at the valuation ratios, the price-to-earnings ratio was very attractive at 11.4, well below the industry average of 20.0. Price to sales also favored Exxon Mobil at 0.9 -- half the industry average at 1.9.
Many energy companies are on sale; based on their price to tangible book value, some companies are trading at 50 cents on the dollar for the tangible book value of the company. Exxon Mobil is not in that category, with a price to tangible book value of 2.13. I also noted the company has no intangible assets on the balance sheet, a rare occurrence.
The industry average is a better deal, based on the price book value of 1.5.
Exxon Mobil’s fourth-quarter numbers haven’t been released yet, so the following numbers are based on financial statements ending Sept. 30, 2014. I was very surprised to see year-over-year sales fell for Exxon Mobil at 1.5 percent when the industry actually increased by 13.1 percent.
When we see the release of 2014’s fourth-quarter earnings, it will concern me if there will be a greater drop in sales, putting downward pressure on the stock price.
On the bright side, earnings-per-share year over year increased 4 percent when the industry started feeling the pressure of lower oil prices.
Looking at the balance sheet, I was disappointed to see a current ratio of 0.89 for Exxon Mobil, which is below the industry average of 1.0. Because Exxon Mobil is a very large company, we can give it some leeway on the current ratio, which shows the capability of the company to pay off its short-term liabilities with its short-term debt.
However, be aware that no company is too big to fail. With thelow current ratio, I do see a benefit to a total debt to equity of only 12.1 percent, well below the industry average of 57.2 percent. Half of that debt is long-term debt; the other half is a short-term debt due in less than 12 months.
I took a peek at the balance sheet and saw that the short-term debt is $10 billion. However, on the cash flow statement it shows that for the past nine months the company had a cash flow of $38 billion. So obviously, the company can pay this debt without it being a burden. However, investors should be aware of this and keep an eye on it to make sure it doesn't become a problem.
Exxon Mobil has equity of $181 billion, which is up 10 percent from 12 months ago. The return on the equity is very attractive and 19.6 percent is almost three times the industry average of 7.1 percent.
At 8.5 percent, the net profit margin for Exxon Mobil is slightly under the industry average of 9.4.
Based on efficiency, Exxon Mobil runs a very good company. The receivable turnover over the past 12 months was 13.0 for the company, twice the industry average of 6.5. Inventory turnover in the past 12 months was also very comforting at 18.1 times, far better than the industry at 11.1 times.
There are 25 analysts who follow Exxon Mobil and the main average for the earnings-per-share going out to December 2015 is $5.68 per share. This is down from December 2014 at $7.54 per share. But be patient here because we will be seeing December 2016 earnings estimates in the next couple of weeks.
These earnings-per-share numbers should go back up. Using a forward price-to-earnings ratio of 16.5 would give investors a target selling price of $123 for a potential gain of 34 percent.
Keep in mind you are looking out nearly two years to get that 34 percent game. However, add to that a 3 percent dividend per year and that would give you a total gain of 40 percent, or about 20 percent per year.
Can you be patient and wait two years for a potential gain of 20
percent per year? If you can, I think you'll be pretty happy with the returns. But you have to stop listening to the media, traders, friends, neighbors and relatives because they are talking about the negatives in the past and what is happening -- not looking at where you’ll be in December 2016.
Remember, investing is like a chess game and you are thinking three moves ahead while other people are still thinking about their current move.
Do you have a question or a company you'd like me to take a look at? Email me at Brent@WilseyAssetManagement.com!
Wilsey is president of Wilsey Asset Management and can be heard at 8 a.m. every Saturday on KFMB AM760. Information is provided by Reuters.
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