Archive for July, 2008

Occidental Petroleum Pays Off Already

Thursday, July 24th, 2008

Yesterday I was writing about OXY and how undervalued it was based upon earnings. Well, they announced their earnings today and the stock took off. It was the catalyst for a turn in many energy stocks to the upside after several down days.

Enjoy the story below from Gary Dvorchak.

Don’t you wish they all turned out like this one?

Mark


OXY Surprises to the Upside
By Gary Dvorchak

7/24/2008 2:21 PM EDT

Amazingly, an oil company is actually getting rewarded for putting up good numbers. Occidental Petroleum’s (OXY) shares are up nearly 2% in a very down market after beating EPS estimates by 4 cents and providing an upbeat outlook for the third quarter and beyond.

Revenue was up 61% year over year and handily beat the consensus, coming in at $7.12 billion vs. the Street’s $6.77 billion. While the flow-through of higher oil prices was expected, of course, the interesting upside surprise was increased production, since analysts were actually looking for a small decline.

Prices and production actually accounted for over 100% of the earnings increase in the oil and gas segment but was offset slightly by higher operating expenses and depletion. (How ironic that the 14% increase in production cost per barrel of oil equivalent, or BOE, was due to energy costs!) Occidental realized $110 on oil and $9.99 on gas, numbers that the company expects to exceed in the third quarter.

Management presented an aggressive plan to continue to boost production. The company noted that CO2 flooding of wells is creating great productivity gains, describing it as “low-hanging fruit.” In fact, Occidental is building a CO2 plant in Texas for use in its Permian plays.

The company also bought a Canadian oil sand player, which put 370 million BOE into reserves. Canada is a long-term play that Occidental wants to develop slowly, but management pointed out the optional nature of the company’s work there — Canada is so hot right now that Occidental could flip the property easily if it loses interest.

Most interesting, management noted that the company is initiating work to enter Iraq next year, contingent on security issues. In all, management is boosting capex by 17% this year, reflecting a surplus of both opportunity and cash flow.

Management does not offer forward guidance for EPS, but it did offer significant detail on production plans for the third quarter. The outlook was very positive, with third-quarter production estimated at 590 million BOE to 600 million BOE per day, ahead of the second-quarter rate. Argentina and Libya should both be up meaningfully. The company noted that each $1 swing in oil price moves $37 million on or off the bottom line.

Despite the strong report and bump in the stock price, over the intermediate term, the stock will still be tied to oil movements. Occidental is one of the most pure oil/gas plays in the exploration and production space, and the bottom-line swing factor is large enough that the stock will be very sensitive. An investor’s position on the stock depends nearly 100% on their position on the next move in oil.

Energy Vs. Financials

Thursday, July 24th, 2008

Below I have cut/paste an article written by noted analyst Scott Rothbert from The Edge. He gives his opinion on the current retreat in energy stocks vis-a-vis financial stocks and oil itself. Energy stocks have corrected much more than the price of oil and he sees that situation correcting itself when the current rush to buy financials ends.

His view mirrors my own, but I thought you’d like to read someone else’s perspective on this issue.

Mark

PS – please note that I’ve added a couple of clarifying comments to his writing and you will find those in blue italics below.

The Edge

Crude/Oil Service Divergence
7/24/2008 9:02 AM EDT

QuickTake
Bullish SLB
Update OIH RIG HAL


The cuffs don’t match the collars for crude prices and oil service stock prices.
Eventually, when the financials end their rebound, money will flow right back to oil service and material stocks.

There is a major disconnect between the price of crude oil and the price of oil service company shares. I call this a “cuffs don’t match the collars” condition. Let’s look at two charts. The first chart is of Nymex sweet crude for the past 12 months:

Click here for larger image.
Source: Oilnergy.com

Compare that chart to the Oil Services HOLDRs (OIH), an ETF of oil service companies.

OIH One-Year (Amex)
Oil Services HOLDRs
Click here for larger image.
Source: Yahoo! Finance

The top three holdings in the OIH are Transocean (RIG) for 16.07%, Schlumberger (SLB) for 10.37% and Halliburton (HAL) for 9.97%.

Through yesterday’s close, when the OIH closed at 194.15, that ETF rose about 3% (over the last year) on a price basis while crude oil rose by over 70% (over the last year). These types of phenomena exist when you have leveraged, fast-money traders move in and out of stocks with no regard for valuation or fundamentals. That is good for investors who are in for the long run, but they unfortunately have to feel the pain of the short-term volatility.

Speaking of volatility, the CBOE Crude Oil Volatility Index (OVX) stands at a whopping 51.54. That makes the CBOE Nasdaq Volatility Index (VXN), which stands at 27.39, look like a docile mollusk.

Either crude oil will have to decline by 50% or more, or the oil service stocks will rise once again. I am of the strong belief that we will see the OIH and its constituent stocks rise 20% or more before we see crude oil back to the $70 or $80 range. (The level of and has not erased the imbalance between supply and demand).

As long as the energy destruction/financial stock rebound trade maintains its momentum, however, the “cuffs not matching the collars” condition will exist. Eventually, when the financials end their meteoric rebound, money will flow right back to oil service and material stocks.

Position: Long SLB

Occidental Petroleum On Sale

Wednesday, July 23rd, 2008

How often can you purchase a company that has an earnings growth rate of 28%, a sales growth rate of 21%, a net margin of 29%, a return on equity of 25%, and a long term debt ratio of just 7%, for a forward P/E of 7? You can today with Occidental Petroleum – I just bought 2,000 shares for our clients at $72.83, and have an 18-month target price on them of $121.50 (average earnings estimate of $11.05 per share X current year P/E ratio of 11).

Add to this that the company is buying back 20 million shares of its own stock (because it believes it is too cheap) and that it is extending its reserves by buying into the Canadian Oil Sands, and you have a great opportunity here.

It is ridiculous how cheap this company is and its all because of the hedge funds’ shift from energy, ag, and metals companies into financials. This is one of those rare opportunities that you get to buy companies with high earnings potential for dirt cheap valuations – and make serious money once fundamentals take over for the herd mentality of the hedgies not wanting to miss the bottom of the financial company bear market.

Can it get cheaper? Sure it can – and if it does, we’ll just buy more.

mb

Commodity Bubble? Has It Burst?

Thursday, July 17th, 2008

All over CNBC today, the talking heads are proclaiming the commodity bubble has burst.

First, you’d have to believe that commodities were in a bubble – I don’t. Bubbles are situations not supported by fundamentals. Commodities have strong fundamental reasons why they have gone up so much – principally strong demand and strong earnings at the commodity-related companies. Other bubbles (Tech, Housing, Tulips) had poor fundamentals – tech had no earnings, housing was predicated on imprudent lending practices, tulips were just stupidity).

By the end of the third quarter, commodity names will be higher and financial names will be lower. A pretty bold statement, but supported by evidence – demand is still strong for oil, metals and ag, leading to strong earnings and increasing earnings estimates at the companies that produce these things. Financials will still be dealing with problem loans, write downs, and bankruptcies.

What we see now is a rotation out of the commodity names and into other names. Its happened before and it was a great buying opportunity. We will continue to buy shares in strong companies with growing earnings as their prices fall, knowing that this is the set-up for some major gains in coming months.

Mark

Senate Hearings – Bernanke Blasted

Tuesday, July 15th, 2008

You have to watch this video – Republican Senator Bunning from Kentucky is blasting the administration’s response (from Treasury and the Fed) to the current banking crisis. He summed up things on this issue quiet nicely.

http://www.cnbc.com/id/15840232?video=793876610

Just cut/paste the link into your browser.

Mark

Bank Crisis – Politicians Fiddle while Rome Burns

Monday, July 14th, 2008

I have to say that I am truly disappointed in our government.

They allowed mortgage products to be sold to people who could not pay back the mortgage then they have allowed the banking system to deteriorate to the point where it is having a seriously negative impact on our economy.

Fannie Mae and Freddie Mac are technically bankrupt – the equity investors will likely not see their hard-earned investments returned. The government (i.e., you and I, the tax payers) will be forced to cover the losses from these government sponsored entities’ misdeeds. The most recent estimate that I’ve seen is that the losses here will be four times the cost of Iraq. It is stunning the level of incompetence and stupidity that allowed this situation to occur. This financial crime far eclipses Enron and Worldcom, yet we have not heard any rumblings of criminal investigations.

A perfect example of what transpired in the mortgage industry can be found right here in Champaign. We have always been conservative (yet responsive and innovative) lenders. About 18 months ago, we were criticized by a local attorney for not making a mortgage loan to his illegal alien client. We said that since we could not comply with the terms of the Patriot Act in terms obtaining acceptable identification of his client (the regulations require a government issued ID), we couldn’t make the loan. His reply was that he could take it to any of a few of our larger competitors who would happily make the loan as they had done for a few of his other illegal alien clients. We did not make the loan, they did. Our capital is strong and we are having positve earnings this year with no loan write-offs. Them, not so much.

Senator Schumer accurately called the collapse of Indymac – who’s next? The administration, Treasury, and Fed shouldn’t be blaming him for his statements – maybe they should take it as a wake-up call and put a Financial Marshall Plan into place to recapitalize Fannie & Freddie and the big banks that are in trouble.

From an investment perspective, I do not believe we can end the current bear market in stocks until the banking crisis is properly addressed. Our government has its head in the sand (with the exception of Senator Schumer, maybe). The current situation is at least as cirtical as the 1990 crisis, yet our government has done nothing to be proactive about fixing things – where is the Resolution Trust Corp for the 21st Century?

We need a regulatory organization that tells the banks in trouble that: 1) we will suspend capital requirements for 24 months to give you time to clean up your balance sheets and raise capital; 2) you will raise capital adequate to cover all of your current and projected losses, and to bring your capital levels up to current regulatory standards at the end of 24 months; and 3) if you do not raise adequate capital, we will force a merger upon you as happened in the 1990 crisis.

I am the last person that believes in government overstepping their bounds, but when companies act irresponsibly and threaten our economy, then a situation exists where the government must act. We, unfortunately, are at that point where the government must act.

Stay away from index funds based upon the S&P 500 – financials are still a huge portion of the S&P 500 and you will likely continue to lose money in an index strategy. Do not try to bottom fish the financials – if 1990 is a guide, we are only in the third inning of this banking crisis. Catching the falling knife can be profitable if successful – unfortunately, most people get stabbed. Rumor has it that the traders on Wall Street are looking at 1,150 on the S&P 500 Index as the most likely bottom to this bear market. Given that we are currently at 1,215, that is another 5.5%-ish down before we bottom – this is clearly speculation and rumor on Wall Street, but sometimes the perecption becomes the reality.

The dollar is likely to continue to fall, despite Wall Street’s protests that the dollar bear market is nearly over. The dollar cannot be strong if our banking system is in shambles – buy gold stocks instead – you won’t be sorry. We are overweight gold stocks in client accounts for safety and inflation reasons. You should be, too.

Biotech was the big winner during the last banking crisis. So far, it shows all the signs of repeating that performance.

Be smart in your investing activities in the current market – don’t follow the crowd, use your head, let history provide you with guidance but most importantly, protect your capital.

Mark

Losing RJ Service 2

Sunday, July 13th, 2008

I was getting caught up on reading the week’s News Gazette and saw an Editorial on this topic. I guess that my head was in the sand on this topic and it is a lot closer to reality than I had thought.

There have already been 30 communities that have lost their airline service, and U of I Willard is on the list of 150 others to potentially lose its service; United has already officially terminated jet service between Bloomington and Chicago.

A healthy and well functioning airport is a driver of economic growth to a non-hub community. The current economic downturn that has been less severe in communities like Bloomington and Champaign could intensify significantly if we lose jet service (or all air service for that matter).

The airlines are in trouble; they have been for years. Cheap travel by air is likely going to be a thing of the past (although I just booked a trip to Martha’s Vineyard – Indy to Providence for $289 – a great deal that surprised me) unless the airlines can get their cost structure under control.

With oil at today’s levels that will likely not be happening.

From an investment perspective, this is one of those things that could easily lengthen the duration of the current bear market (which probably started a decade ago, not two weeks ago given that the S&P 500 has not increased in value in a decade – see the graph above).

If you are an investment manager, it is more important than ever to pay attention to earnings growth and valuations if you are going to make money for your clients. Investing in equity securities is supposed to provide protection against inflation, providing a long-term positive return above inflation. With inflation approaching 5%, you cannot employ a strategy that is based on Index Fund investing in spite of all the hype around low costs. This includes investment managers that simply try to mimic the return of their benchmark, which most often is the S&P 500 Index – a pretty low hurdle given the chart above.

Mark

Losing Regional Jet Service

Saturday, July 12th, 2008

I’ve heard talk from airport and airline staff that our local airport, U of I Willard, as well as the rest of downstate Illinois could lose its regional jet service.

Both American in Champaign and United in Bloomington have stated (albeit not pubicly) that they may be forced to end RJ service downstate as a cost cutting measure. American has already cut back service, reducing the number of flights downstate. It seems maybe this is not the end of the cuts.

I dismissed these stories as unlikely until I read the following posted in today’s Washington Post.

Losing jet service would be a terrible economic consequence for downstate Illinois, as well as all non-hub cities around the country that lose their RJ service.

Here is the article:

Feeling Airlines’ Pain, Airports Seek Help in D.C.

By Sholnn Freeman
Washington Post Staff Writer
Saturday, July 12, 2008; D01

Airline passengers have long traveled the United States on a hub-and-spoke system, an ever-expanding air service network connecting travelers from small communities to big-city airports.

Now some of the spokes — the smaller airports — are feeling the pressure of higher oil costs as airlines pull routes and raise prices. That worry brought dozens of airport directors to Washington this week for hastily called meetings of the American Association of Airport Executives. They wanted to put together a battle plan.

They had to “create drama” to make themselves heard, said Klaasje Nairne, airport manager in San Luis Obispo, Calif. “We need to emphasize that this is really not unique to our town.”

Late last month, she got a call from regional carrier American Eagle, a sister company of American Airlines. The airline was close to announcing that it would end service at the airport and close a major maintenance base. The action represented a 38 percent cut in plane service and a personnel cut of at least 10 percent at the airport. “I couldn’t believe it,” Nairne said. “I had to find a place to sit down.”

After years of steady growth, service cuts planned for this fall by major airlines could blow a hole in the nation’s commercial air transportation system, according to the airport managers. Major airlines have announced cuts that could represent 10 to 20 percent loss in air service by the end of the year. Airlines have announced cuts of 30,000 employees this year and could rack up losses of $7 billion to $13 billion, according to industry lobbyists.

There was no shortage of politicians and officials ready to meet with the executives — and offer to enlist the airports in fighting the energy wars already underway on Capitol Hill.

Thursday, the group heard a speech by Secretary of Transportation Mary Peters, who asked for support for Republican initiatives to increase domestic oil production.

Later, Sen. Byron L. Dorgan (D-N.D.), a member of the aviation subcommittee, argued that the executives should back legislation to tighten regulatory scrutiny aimed at curbing oil-price speculation.

Already, the Air Transport Association, the airline industry’s lobbying arm, has been building pressure on Congress to take on the speculation fight. On Thursday, airlines sent out millions of e-mails to frequent fliers asking them to contact members of Congress to act on the issues.

The ATA says that 100 cities this year could lose all commercial air service and that as many as 200 could lose service next year. Some of the cities that have lost service include Hot Springs, Ark.; Athens, Ga.; Trenton, N.J.; Santa Fe, N.M., and Youngstown, Ohio.

To cope with the downturn, airport directors say they are halting expansion projects, putting a freeze on hiring and trying to preserve what they’ve got.

In Asheville, N.C., airport director David Edwards said he’s preparing for a 10 to 15 percent drop in passenger traffic this year, to about 250,000 passengers a year — the equivalent of passenger levels from five years ago. The airport, he said, has escaped deep service cuts, but high ticket prices are taking a toll.

“Fare increases are discouraging traffic,” Edwards said. Decreased traffic from higher fares will eventually lead airlines to cut more flights, he said.

Edwards said he’s holding back on a project to develop 28 acres on the airport site. In the past two years, $38 million has been invested in the airport.

At North Carolina’s Wilmington International Airport, director Jon Rosborough has seen service to Philadelphia cut back to two days a week from seven. He fears that more will come if oil prices stay high. “I expect all of us to be hit,” he said. His airport has rolled out a Reduction in Service Plan of Action to study the impact on the airport of cuts in airline service. The airport might shift full-time employees to part-time status, freeze hiring and explore offering early retirement packages.

“We adopted our budget earlier this year, and we were planning for a slight increase,” Edwards said. “Now we are stepping back.”

At Roanoke Regional Airport, higher ticket prices have led to fewer travelers. In May, traffic dropped 15 percent, according to Sherry Wallace, manager for marketing and air service development at the airport. She said Delta has notified the airport that it is ending its three-flights-a-day service to Cincinnati.

“Cincinnati might not be the last cutback we see,” she said. “It’s my job to get air service, not lose it.”

Bigger airports are not immune. American Airlines has made steep cuts in service at New York’s LaGuardia Airport, one of the busiest in the country.

In Cleveland, Continental announced flight cuts for September that end service to 24 cities, largely dismantling a major expansion project that would have called for a 40 percent increase in service from Hopkins International Airport. Ricky Smith, director of the Cleveland airport system, said he’s been able to swallow the cuts, partly with the knowledge that the ax fell harder at airports in Newark and Houston.

“We’re not panicking,” he said, “but there is a sense of urgency.”

Smith sees more cuts if oil prices stay high. “At that point, they will be cutting bone — eliminating service that our passengers are relying on,” he said.

By yesterday, the airport executives had engaged politicians, vented about their problems, formed committees, issued a fat news release — and flown home.