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Disclaimer. After nearly 40 years managing money for some of the largest life offices and investment managers in the world, I think I have something to offer. These days I'm retired, and I can't by law give you advice. While I do make mistakes, I try hard to do my analysis thoroughly, and to make sure my data are correct (old habits die hard!) Also, don't ask me why I called it "Volewica". It's too late, now.

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Friday, April 27, 2018

Oil goes ex-growth

Shares with high earning per share growth tend to be highly valued.  Their dividend yield is low or non-existent.  It doesn't matter to the market because investors are confident that future profits will grow dramatically, so they are prepared to bid up the share price.  A good example of this today is Tesla, while in the past, companies like Microsoft, Apple and Amazon were also high growth low yield companies.  

On the other hand, low-growth companies have high dividend yields.  These high yields are needed to compensate for the lack of growth.  And when a company's profit growth starts to slow, its share price tends to retreat, or at any rate grow more slowly than the the rest of the share market.  Over time, the market demands a higher yield, because prospective earnings growth is falling. In the market, this is called "going ex-growth".  If profits or earnings per share are growing, this rise in yield can be achieved without the share price falling.  But usually, share prices decline, and market capitalisations fall, until the market thinks that the high yield adequately compensates  for low growth.

This is not to say that high yielding shares are necessarily bad investments.  Once the readjustment process is over, a high yield means a high income, without the volatility that can affect high growth stocks.  But during the process of adjustment to the new reality can be painful.  This is what is happening now to oil companies.  There is no reason why oil companies won't go on being profitable--for now.  But the traditional model has been expensive research and development to find new oil fields as replacements for old, emptying, ones.  And that's no longer a viable model, because 15 or 20 years out oil demand will have collapsed.  New oil fields will be worthless.  The money spent finding them and developing them will be wasted.  In short, oil companies which accept the new reality may still be worth investing in; those which do not are likely to be  big losers in this shift.

And it seems the market accepts these conclusions:

For generations of investors, Exxon Mobil Corp. has been a cornerstone of fund managers’ portfolios alongside the biggest names in corporate America. Not so much any more.

From leading the S&P 500 Index a decade ago, the company has dropped to the ninth-largest in a top 10 now dominated by technology giants. Its rivals Royal Dutch Shell Plc and Chevron Corp. aren’t faring much better, with investors demanding unusually high dividend yields to hold the stocks.
Source: Bloomberg
Note: The "energy" sector includes coal and some renewables companies as well as oil and gas.


At fault, a toxic troika that combines gushing supply with fears that long-term demand will flat-line as electric vehicles and renewable energies grow, and climate change policies proliferate. And while cash flow for oil’s majors in 2018 is likely to be the highest in 12 years, investors are largely unmoved.

“Earnings have started to come through but no one believes it’s sustainable,” said Kevin Holt, who helps manage $934 billion at Invesco Ltd. in Houston. “That’s why the stocks haven’t worked even though the commodity has gone up. Everyone’s saying they don’t believe it.”

Years of elevated spending on mega projects worldwide caused costs to soar. That kept drillers from taking full advantage when oil prices were averaging about $95 a barrel in 2011-2014, and it left them exposed when a stubborn two-plus year rout took hold. In February, the weighting of energy stocks in the S&P 500 dropped to 5.5 percent, the lowest in 14 years.

Beyond the S&P, Big Oil’s weighting in global equity indices is now at a 50-year low, Goldman Sachs Group Inc. said in a March report. Of the MSCI World Index’s 100 biggest stocks, only six are oil producers.

The tepid interest in oil “is reflective of a significant paradigm shift in the global energy landscape,” Paul Cheng, an oil equities analyst at Barclays Plc in New York, said in a note to clients. “Investors, particularly generalists, seem to be growing increasingly skeptical of the long-term value of oil and gas assets given the supply and demand risks posed by shale oil and EVs.”



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