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james22
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You've recently been writing some very bullish thoughts on the oil and energy sector. What's your case there?

 

When people get excited about this ongoing cyclical trade, they should look at oil as the ultimate distressed value asset out there. To me, oil stocks are incredibly cheap.

 

There are technical reasons for that, because of the large passive investment flows, and oil is a smaller and smaller part of the index. Also, there are more and more institutional investors who can’t buy oil stocks anymore because of ESG limitations.

 

On the other side, there is no sign that oil demand is weakening. Consumption in emerging markets continues to grow, while conventional oil investments have been reduced significantly, precisely because of all this talk that the fossil fuel era is ending.

 

So in your view, energy the one remaining cheap sector out there?

 

Yes, without a doubt. But I will freely admit that there are all sorts of technical issues because as I said many investors can’t buy oil stocks anymore. We have this bizarre situation where people can’t buy oil stocks, but people continue to consume oil.

 

https://themarket.ch/interview/oil-stocks-are-incredibly-cheap-ld.1384

 

Anyone else see an opportunity?

 

I'm thinking of making Energy (VGELX) a 5% position.

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I have been slowly accumulating energy in the form of VGELX + select names + prefs. + debt and very much overweight in the sector.

 

My valuations cap oil at 75 (on WTI). My rationale is that outside of a really major disruption (Saudi field bombing, Iran flare-up are meaningless in today's world) it's just too easy to get the spigot going. Because of this, I think E&P companies (especially 2nd and 3rd tier) are not going to do well as they will pump with every price pop just to cover drilling + debt. Though their stock might be much more volatile and can probably outperform...or go to 0 (e.g., Sanchez). My other reasons, in no particular order, are:

1) I love the fact that ESGs are getting rid of their stocks (though don't really alter their energy use behavior).

2) Across the board, there is a super disgruntled and pessimistic shareholder base. Performance, MLP structure, MLP conversions, GP take unders, take your pick.

2) Demand is still growing.

3) Couple that with newfound religion of debt paydown by many energy companies (e.g., KMI) and stricter capital allocation. Markets are also not very kind to companies trying to raise debt.

4) Trash assets are being idled or being severely discounted (there is a reason why SMLP is trading where it is). This is a net positive for opportunistic buyers.

 

Edited for grammar.

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I've been focussing on the natural gas segment and specifically pipeline companies.  I think there are some incredibly cheap companies paying very high (and safe) dividend yields that have a feasible growth trajectory.  I've been in Kinder Morgan (KMI) for about a 20% gain, but I think it easily should have another 50% in it over the next year or two.  I also like Williams (WMB) with good natural gas exposure.  Worldwide natural gas consumption is expected to grow until around 2050 according to EIA.  I keep hearing 50% growth in worldwide consumption from 2020 to 2030.  Kinder Morgan is my largest position.  Rich Kinder is still somewhat involved and heavily invested in the company personally.  Listening to him talk I get the impression he knows what he is talking about.

 

I recently sold Cheniere (LNG) for a decent return because the situation was getting too complicated for me, but there is probably opportunity in LNG exporting.  I'm going after the LNG shippers.

 

Risk in natural gas pipelines is primarily counter-party risk as we saw in the last downturn.  The new integrity regulations aren't too burdensome.  Another risk that I'm heavily discounting is that Elizabeth Warren bans fracking.  Doesn't seem possible to me.

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Care to share any of your specific name valuations? I would love to grab some exposure here but can't get a handle on what any of these companies are actually worth.

 

In the pipeline space I rotated into EPD (great management, interests align with Duncan family), ET (amazing assets that trade at Kelcy Warren discount), WMB (amazing assets at good price...and eventually NY will figure out that they need to expand their pipelines), and tiny bit of AM. I think all these names can trade up 30-50%. I like selling KMI puts when it dips to 20s. Wouldn't mind getting some shares assigned to me. I like CNXM but don't love the price.

 

For prefs. I have TGPpA (this one is a shipper so I generally don't buy common but it's worth a look) and CEQPp. For debt I bought some Sanchez bonds when they were trading at 5 cents on the dollar (mostly learning/entertainment value of going through BK). Currently they are trading at 3.75 cents on the dollar  ;D.

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Morningstar:

 

The energy sector is the most undervalued heading into the new year: The median stock in our coverage universe trades at a 10% discount to fair value, says director David Meats in his quarterly wrap-up. Oilfield-services stocks look particularly attractive, trading at a 16% discount to fair value. But we see buying opportunities among all industries.

 

https://www.morningstar.com/articles/961514/33-undervalued-stocks-for-2020

 

https://www.morningstar.com/articles/961161/energy-most-undervalued-sector-heading-into-the-quarter

 

They like Cheniere, Unbridle, and Schlumberger.

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Reason number one to be bullish on energy stocks is their relative cheapness. The sector looks extremely undervalued as institutional investors have abandoned their positions in energy stocks and systematic funds are shorting oil.

 

https://www.investopedia.com/5-reasons-energy-stocks-could-surge-4772280

 

Craig Johnson, senior technical research analyst and managing director at Piper Jaffray, said Thursday he had “no question” that now was the time to do a “bottom-fishing exercise.”

 

“Talking to all these institutional accounts, they do not like energy. They don’t want to touch energy. They’ve been burnt in energy for so long. And fundamentally, they’re going to point out all the problems with it,” Johnson said on CNBC’s “Trading Nation.” “But, as a guy that likes to look at charts, these stocks tend to lead the market six to nine months ahead of time.”

 

https://www.cnbc.com/2019/11/22/energy-stocks-to-invest-in-as-worst-performing-sp-500-sector-turns-up.html

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My question is - if there's diminishing institutional investor interest in these names, how can you have a position that's going to rerate upwards in terms of valuation?

 

I don't dispute that these names are quantitatively cheap. But I would think that for good returns, you would want to be in a name that sees the potential for multiple expansion. What is the case for multiple expansion in energy?

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Institutional interests wax & wane over time & across sectors.

 

http://pages.stern.nyu.edu/~adamodar/New_Home_Page/dataarchived.html#corpgov

 

It seems like just yesterday that we were going to run out of oil soon,

and then we were awash in the stuff.

 

Predicting supply & demand is like predicting hurricane tracks.

Better to just say there will be hurricanes.

 

Energy will go down & it will go up, and down & up, and down & up...

 

I like my chances with VDE.

I was an idiot for buying CLB.

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RDS is an oiled major that seems to become more like an utility over time. At least that’s the ghost I am getting from the management presentations. The bull case is probably that it is way cheaper than any utility one can buy, with a dividend yield of ~6%+ and improving financial performance, I can see the stock retreating over time.

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My question is - if there's diminishing institutional investor interest in these names, how can you have a position that's going to rerate upwards in terms of valuation?

 

I don't dispute that these names are quantitatively cheap. But I would think that for good returns, you would want to be in a name that sees the potential for multiple expansion. What is the case for multiple expansion in energy?

 

...economic theory suggests the share prices of “sin” businesses will become depressed if a large enough proportion of investors choose to avoid them.

 

Such stocks would have a higher cost of capital because they would trade at a lower price-to-earnings (P/E) ratio, thus providing investors with higher expected returns.

 

...as more investors express their personal beliefs through their investments, shunning sin stocks, it seems likely their prices would be further depressed, further raising their forward-looking return expectations.

 

Thus, it is possible the sin stock premium (relative to the market) could not only persist, it could increase...

 

https://www.etf.com/sections/index-investor-corner/swedroe-sin-stocks-are-profitable?nopaging=1

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I was just looking at a company that has usecured bonds, maturing in 2021, trading at $0.55. Although I know hardly anything about energy, the deep discount and the fact that an investor I highly respect holds the bonds made me look into it. The company is generating free cash flow and has been gradually paying down its highly leverage balance sheet the last few years. Upon closer look, as much as 60% of the long-term debt comes due in 2021. Obviously the company will have to refinance a huge amount of debt for the bonds, which only represent 2% of the debt, to be paid at par. I don't think I'll touch this because I just don't really understand all the dynamics. But I may follow it to conclusion out of curiosity. At the end of the day, it seems like the question is how likely is it the company is able to refinance.

 

The energy patch in general confuses me. I'm generalizing, but most of the companies generate no profit or cash-flow for shareholders. All the capital is just plowed back into the ground. From a stockholder's perspective, it's like, what's the point in expending all this energy (no pun intended), on companies that make no money. Is Fed policy (low rates) the driving reason why banks and the bond market continue to lend?

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All the capital is just plowed back into the ground. From a stockholder's perspective, it's like, what's the point in expending all this energy (no pun intended), on companies that make no money.

 

A company that produces no money can still be very valuable.

 

The trivial example is a company that acquires appreciating asset that does not throw off cash. Its value still rises as the asset's value rises.

 

Coming closer to E&Ps, if a company acquires land with potential oil reservoir, drills couple wells and discovers the oil, they have not made any money, but they are worth more than before they discovered the oil.

 

Now, the real life is more complicated. No company just acquires the land, drills for oil, discovers the oil and sells itself. Usually it starts producing the oil - so producing some cash - but then plowing it into discovering more oil. If done well, the FCF still might be zero - "All the capital is just plowed back into the ground" like you say - but the company's value might be rising as it has more reserves. OTOH, due to capex, low oil prices, etc., it's possible that the value of the company actually drops even as it discovers more oil. Practically every E&P CEO expects (or at least pretends to expect) that plowing money into the ground is gonna grow the company. Depending on exploration results, oil prices, etc., these expectations might be right or totally wrong.

 

Anyway, yes, E&Ps are usually not FCF gushers and are not valued per FCF.

 

This is all very simplified.

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Guys,

 

I think there are enough Midstreams that are trading at distressed prices.  If you are looking at Energy, look for ways to get paid in the interim.  Many of these MLPs used to be valued at 4-6% yield.  Now they are high quality one that are valued at 7-10% and the more trailer types paying mid teens.  You get the distribution and an optionality that it re-rates to a 6% yield.  If oil goes to $100, you probably do better owning the E&P.  IMHO, E&P are uninvestable, yes, likely "famous last words."  But I have never owned an E&P ever.  That rule has applied for the last decade of my investing.   

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My question is - if there's diminishing institutional investor interest in these names, how can you have a position that's going to rerate upwards in terms of valuation?

 

I don't dispute that these names are quantitatively cheap. But I would think that for good returns, you would want to be in a name that sees the potential for multiple expansion. What is the case for multiple expansion in energy?

 

...economic theory suggests the share prices of “sin” businesses will become depressed if a large enough proportion of investors choose to avoid them.

 

Such stocks would have a higher cost of capital because they would trade at a lower price-to-earnings (P/E) ratio, thus providing investors with higher expected returns.

 

...as more investors express their personal beliefs through their investments, shunning sin stocks, it seems likely their prices would be further depressed, further raising their forward-looking return expectations.

 

Thus, it is possible the sin stock premium (relative to the market) could not only persist, it could increase...

 

https://www.etf.com/sections/index-investor-corner/swedroe-sin-stocks-are-profitable?nopaging=1

 

+1

 

If you're holding for the long-term, you don't need a re-rating if you have a low multiple and you, or the company, can reinvest those earnings at a sufficiently high return.

 

If you're getting a 20% return per annum by buying a company at 5x it's earnings - you don't need it to relate relative to it's book or earnings. Just that those earnings continue to be retained and redeployed at attractive returns OR paid out as a dividend for you to reinvest for more shares.

 

No turnover. No transaction charges. Few taxes. And 20+% compounded pending how well you/company did on reinvesting the earnings.

 

The problem is precisely when it DOES re-rate and then you need to pay to sell it, pay the taxes on it, and find another opportunity worthy of the capital.

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My question is - if there's diminishing institutional investor interest in these names, how can you have a position that's going to rerate upwards in terms of valuation?

 

I don't dispute that these names are quantitatively cheap. But I would think that for good returns, you would want to be in a name that sees the potential for multiple expansion. What is the case for multiple expansion in energy?

 

...economic theory suggests the share prices of “sin” businesses will become depressed if a large enough proportion of investors choose to avoid them.

 

Such stocks would have a higher cost of capital because they would trade at a lower price-to-earnings (P/E) ratio, thus providing investors with higher expected returns.

 

...as more investors express their personal beliefs through their investments, shunning sin stocks, it seems likely their prices would be further depressed, further raising their forward-looking return expectations.

 

Thus, it is possible the sin stock premium (relative to the market) could not only persist, it could increase...

 

https://www.etf.com/sections/index-investor-corner/swedroe-sin-stocks-are-profitable?nopaging=1

 

+1

 

If you're holding for the long-term, you don't need a re-rating if you have a low multiple and you, or the company, can reinvest those earnings at a sufficiently high return.

 

If you're getting a 20% return per annum by buying a company at 5x it's earnings - you don't need it to relate relative to it's book or earnings. Just that those earnings continue to be retained and redeployed at attractive returns OR paid out as a dividend for you to reinvest for more shares.

 

No turnover. No transaction charges. Few taxes. And 20+% compounded pending how well you/company did on reinvesting the earnings.

 

The problem is precisely when it DOES re-rate and then you need to pay to sell it, pay the taxes on it, and find another opportunity worthy of the capital.

 

I agree totally with TwoCitiesCapital here. If you have a high reported ROE combined with a low P/E at the point in time of purchase, you don't really need some kind of rerating, nor even expected/projected growth in the investment, to get good returns. If you actually can see growth, more icing on the cake.

 

The issue at hand is, that the combination of a high ROE and low P/E for an investment almost always imply, that there is "some hair" on the investment, that one has to relate to. There are not two persons who have the same limit for start puking for "hair", on individual "hairy" investments, nor the identical ability to stomach total amount of "hair" on total portfolio level. That part of it is about individual position sizing.

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Guys,

 

I think there are enough Midstreams that are trading at distressed prices.  If you are looking at Energy, look for ways to get paid in the interim.  Many of these MLPs used to be valued at 4-6% yield.  Now they are high quality one that are valued at 7-10% and the more trailer types paying mid teens.  You get the distribution and an optionality that it re-rates to a 6% yield.  If oil goes to $100, you probably do better owning the E&P.  IMHO, E&P are uninvestable, yes, likely "famous last words."  But I have never owned an E&P ever.  That rule has applied for the last decade of my investing. 

 

I agree about shale E&Ps being almost a hard pass for anyone without near-expert level knowledge about factors like lateral length, EURs, acerage quality, downspacing, etc. A few quick reasons why:

 

1) Price takers for both inputs (oilfield services like drilling and completions, pipeline capacity) and outputs (literally commodities)

 

2) Rarely have the balance sheet strength or investor base to invest counter cyclically. This means they more-or-less all move in the same direction at the same time, thus doing the reverse of value investing.

 

To give you an idea what I mean by this, XOM is intentionally outspending operating cash flow in an attempt to increase its upstream production by ~25% over the next four or five years. Whatever you think about XOM as an investment, it is at least attempting to invest counter cyclically by spending more when competitors are spending less.

 

E&Ps can rarely, if ever, do this. Peyto is the only one I am aware of that, historically, invested counter cyclically to lock in lower service costs, but lower for longer Canadian NG prices + debt blew up its business model.

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"They're Done": CNBC's Jim Cramer Says Fossil Fuel Industry "In the Death Knell Phase"

 

"You can tell that the world's turned on them, and it's actually kind of happening very quickly," said Cramer.

 

Climate campaigners drew attention to CNBC's Jim Cramer's comments Friday that he's "done with fossil fuels" because they're "in the death knell phase."

 

Cramer added that "the world's turned on" the industry as they did with tobacco.

 

"They're done," Cramer said of fossil fuels on the network's "Squawk Box." "We're starting to see divestment all over the world. We're starting to see... big pension funds saying, 'We not going to own them anymore."

 

"The world's changed," Cramer continued. While companies like BP still mark profits, "nobody cares," because "new money managers want to appease younger people who believe that you can't ever make a fossil fuel company sustainable."

 

"You can tell that the world's turned on them, and it's actually kind of happening very quickly," said Cramer. "You're seeing divestiture by a lot of different funds. It's going to be a parade... that says look, 'These are tobacco, and we're not going to own them.'"

 

https://www.commondreams.org/news/2020/01/31/theyre-done-cnbcs-jim-cramer-says-fossil-fuel-industry-death-knell-phase

 

https://www.cnbc.com/video/2020/01/31/jim-cramer-fossil-fuels-oil-energy-squawk-box.html

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"They're Done": CNBC's Jim Cramer Says Fossil Fuel Industry "In the Death Knell Phase"

 

"You can tell that the world's turned on them, and it's actually kind of happening very quickly," said Cramer.

 

Climate campaigners drew attention to CNBC's Jim Cramer's comments Friday that he's "done with fossil fuels" because they're "in the death knell phase."

 

Cramer added that "the world's turned on" the industry as they did with tobacco.

 

"They're done," Cramer said of fossil fuels on the network's "Squawk Box." "We're starting to see divestment all over the world. We're starting to see... big pension funds saying, 'We not going to own them anymore."

 

"The world's changed," Cramer continued. While companies like BP still mark profits, "nobody cares," because "new money managers want to appease younger people who believe that you can't ever make a fossil fuel company sustainable."

 

"You can tell that the world's turned on them, and it's actually kind of happening very quickly," said Cramer. "You're seeing divestiture by a lot of different funds. It's going to be a parade... that says look, 'These are tobacco, and we're not going to own them.'"

 

https://www.commondreams.org/news/2020/01/31/theyre-done-cnbcs-jim-cramer-says-fossil-fuel-industry-death-knell-phase

 

https://www.cnbc.com/video/2020/01/31/jim-cramer-fossil-fuels-oil-energy-squawk-box.html

 

Right or wrong, I'm feeling energy too.

 

I'm not capable of meaningful analysis so I simply added to VDE this week.

 

Cramer's a putz. He'll shift to shilling energy co's when the wind starts blowing that direction again.

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I dont buy Cramer's argument. It is valid, but meaningless IMO. Wall Street is filled with money obsessed whores. Add to the list the plethora of underperforming hedge funds and money managers who preach a "value investing" style. If there's money to be made in energy, they'll go there. Just look at the activity on sites like this with the tobacco stocks and lately even stuff like XOM.

 

While its admirable on the surface(but also more a manipulative look at me Im woke or whatever move by the pension funds and such) it won't hold. If its green, buyers will go there. If, over the long run, pension fund managers underperform they'll face pressure and ultimately start letting the things that matter dictate their investments. Its just easy right now when you can buy Tesla and claim to be a socially responsible fund.

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Yeah, I think that Cramer's wrong on all counts (as usual?). He's mainly talking about E&P majours being cheap and making this bizarre, no testable thesis about snowflakiness of wall street types (really?) that's affecting the sector.

 

Well I've looked quite a bit lately at the sector and I don't buy it. Yes, the E&P majours have made great strides in financial discipline. They actually have real free cash flow now. All the money isn't going "back into the ground anymore". Koodos for them. But by any normal company standard they're not anywhere close to a bargain. Let's not forget that what we're talking here is really a commodity - so supply and demand dominates. The demand, while a tad weaker has been there. Yea you can talk about Tesla and the electric revolution, blah blah, but Tesla's vehicle count is in the hundreds of thousands - TOTAL! while Detroit 3 pump out say 10 million trucks a year. Meanwhile all over the world people are switching from their Toyota Corollas and Volkswagen Golfs to crossovers which use more gas. So that's about for the demand side.

 

Now let's look at supply. Over the past decade essentially Iran and Venezuela have dropped off the oil map. These are/were 2 of the largest producers of oil with some of the largest reserves on the planet. Oil prices did what? They went down! This summer you had the attack on Aramco facilities. At any point in the past 30 years this would have been a majour event. This time it was basically a global yawn. All of this points to a very, very well supplied market of oil. So I think tat E&Ps are in a very tight spot right now.

 

MID STREAM

 

In my view this is where it's at.

 

They call mid stream energy. I have no idea why since it looks very different than up stream. People buy trucks and crossovers, but do you see any new refineries popping up? There's a massive switch from coal to nat gas. Yea you can frack the hell of of the soil and bring the price of nat gas to naught.  But there's only one way to bring nat gas to a nat gas power plant.

 

Then you have the infinite wisdom of index funds. Where you direct capital flow by sector and a nat gas regulated mainline is the same thing as an E&P and they get dumped at the same rate. I mean, you just gotta love these guys!

 

Out of the whole bunch what I find most interesting is EPD followed by PSX. EPD being more pure play. The only reason why I haven't backed the truck on EPD is that I'm still doing research to understand their recent profitability spike and whether it can be reversed or it's here to stay. But it sure looks that most of mid stream is undervalued to some degree. And that's actually saing something in a time when it's hard to find anything that's undervalued.

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MID STREAM

 

In my view this is where it's at.

 

They call mid stream energy. I have no idea why since it looks very different than up stream. People buy trucks and crossovers, but do you see any new refineries popping up? There's a massive switch from coal to nat gas. Yea you can frack the hell of of the soil and bring the price of nat gas to naught.  But there's only one way to bring nat gas to a nat gas power plant.

 

Then you have the infinite wisdom of index funds. Where you direct capital flow by sector and a nat gas regulated mainline is the same thing as an E&P and they get dumped at the same rate. I mean, you just gotta love these guys!

 

Out of the whole bunch what I find most interesting is EPD followed by PSX. EPD being more pure play. The only reason why I haven't backed the truck on EPD is that I'm still doing research to understand their recent profitability spike and whether it can be reversed or it's here to stay. But it sure looks that most of mid stream is undervalued to some degree. And that's actually saing something in a time when it's hard to find anything that's undervalued.

 

I own some WMB, which I consider undervalued, despite the noise around bankruptcies impacting their G&P operations. I like EPD, but I don’t like dealing with MLP, unless I absolutely have to and I am willing to make a larger and long term commitment. For me PSX is the most interesting as their midstream and chemical business becomes a larger part of their cash stream, yet it still is largely valued as a refiner. it has the Buffet seal of approval (despite the fact that he exited) and their share buybacks truly identify it as a cannibal. In the CC, they mentioned that thy have ~900M annual EBITDA thwt could be dropped down into their MLP. Do this at 10x EBITDA while the stock trades at 7x and we are talking about serious value accreditation.

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You might want to keep in mind that location and investment horizon matters.

If you're US based, and just trading, it's hard to see past the pending shale BKs, falling nat gas prices, and the various reporting 'spins'. To you, the whole industry is sh1te, and getting worse - because you're trading headlines, not fundamentals. And you do so as you've no intent in holding long enough for changing fundamentals to matter.

 

Nothing wrong in that. But you're the gambler in the casino, and addicted to 'the trade'.

Not a good combination.

 

SD

 

 

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