Guessing Direction of Oil Stocks Is Risky . . . Except for the Long Term
Oil company stocks continued to churn Thursday as Wall Street wrestled with the question of who has the smarter money--the investors who are buying oil now or those who are selling.
While Mobil stock fell 50 cents to $65.875 and Chevron was flat at $76.875, Atlantic Richfield inched up 12.5 cents to $135.875, and Amoco rose 50 cents to $56.75.
Many investors who own the stocks are too petrified to hold on, fearing that oil prices could collapse if the United States successfully contains Iraq in the Mideast. On the other side, investors who don’t own the stocks are worried that they’ll miss another major move upward if the Iraq situation ensures higher oil prices ahead.
Trying to predict the outcome in the Mideast, however, is nothing more than an exercise in gambling with poor odds, analysts admit. Investors who are mulling whether to jump into or out of oil stocks would be smarter to look at the fundamentals and make the call based on a two- or three-year view, many experts say.
If you take that approach, you’ve got a lot more to work with. For example:
* Based on analysts’ estimates of earnings per share for 1991--estimates not yet adjusted for the Mideast turmoil of the past week--many major oil stocks are trading for 12 or 13 times earnings. Meanwhile, the market price/earnings (P/E) ratio on 1991 estimated earnings is 13, using average Wall Street expectations for the Standard & Poor’s 500 index. So oil stocks are no more expensive--or cheaper--than the market as a whole.
* Oil stock dividend yields remain pretty generous. The yield on Texaco stock now is 4.8%; on Chevron, it’s 4%. In contrast, the S&P; 500 average yield is 3.6%. If you have to wait for a stock to move, a hefty dividend at least helps make it easier to be patient.
* Even before the Iraq crisis developed, sentiment toward oil stocks had been favorable. Most experts had expected growing energy demand--and rising prices--throughout the 1990s, after the oil bust of the 1980s. Just look at the spread of capitalism in Eastern Europe. A lot of oil and natural gas will be needed to fuel the growth of those new market economies. And a lot of new wells will have to be drilled in the United States even to make a dent in our dangerous growing dependence on foreign oil.
Still, there’s little question that, in the short run, the market is going to move oil stocks according to the next dramatic move in the price of a barrel of oil, now $25.67. “If you really think $25 oil is going to last for a year, then the stocks are undervalued” for the short term, says Ed Derkum, veteran oil analyst at RCM Capital Management in San Francisco. But if you assume oil is going back to $18 soon, the stocks are fully priced, he says.
Frank Knuettel, analyst at Prudential-Bache Securities in New York, is even more bearish in his warning for traders. He says a fast slide in oil prices could slash 10% from oil stock values. That could take Arco, for example, to $122 from $135.875 in a hurry.
But that’s the trading game. For the investor , the real question is whether these stocks have run too high to hold any potential for the next two to three years.
Of course, valuation of stocks is all relative. Historically, oil stock P/E ratios often have been well below the market average. So some investors argue that they see nothing attractive about P/Es of 12 or 13 on the stocks now, matching the market. “I can remember oil stocks trading at four or five times earnings” at various times in the 1970s and 1980s, says Charles Brandes, who runs money management firm Brandes Investment in San Diego. “So I can’t buy them at 12 times earnings now,” he says.
Nonetheless, when oil stocks have returned to popularity on Wall Street in the past, the P/Es have jumped well above the market average. Amoco’s average P/E, for instance, was 20% above the market average in 1980, at the peak of the last oil price cycle.
Many analysts, looking ahead to the early ‘90s, say investors would be more foolish to bet against a rising energy cycle than with it.
By almost any reckoning of the Mideast situation, says Knuettel, “Oil prices are going to be higher than the more modest increases Wall Street was expecting.” Higher oil prices (and concurrently higher natural gas prices) would mean oil companies would get more for what they produce, spurring new exploration.
Of course, at the same time, some aspects of higher energy prices hurt oil company results: More exploration means higher expenses; profits from refining may be squeezed; the government could slap a tax on profits, and higher prices could cause a recession, causing consumption to plunge.
Still, a new report from Moody’s Investors Service, the people who monitor the health of corporate balance sheets, says it’s clear that the energy industry overall should benefit from higher energy prices in the 1990s, just as the industry benefited greatly in the late 1970s.
Which brings up a good point. “Energy cycles seem to come and go by decade,” RCM’s Derkum notes. Oil companies had a lousy time in the 1960s, a great time in the 1970s, and a lousy time again in the 1980s. So the ‘90s should see a return to a strong cycle, if history is any guide.
If you’re a small investor, remember that you don’t have to stay away from energy just because you can’t buy individual stocks. Mutual fund companies such as Fidelity, Vanguard Group, T. Rowe Price and others offer stock funds that specialize in energy stocks.
VALUING THE OIL STOCKS Here’s how major oil stocks stack up versus their expected 1991 earnings. The estimates, Wall Street averages, haven’t yet been adjusted for the current Mideast crisis.
Thursday Est. ’91 ’91 Div. Stock close EPS P-E yield Amoco $56 3/4 $4.21 13 3.6% Arco 135 7/8 10.38 13 3.7% Chevron 76 7/8 5.24 15 4.0% Exxon 51 7/8 4.18 12 4.6% Mobil 65 7/8 5.08 13 4.4% Occidental 25 5/8 1.34 19 9.9% Oryx 53 1.59 33 2.3% Phillips 28 5/8 2.37 12 3.4% Texaco 62 7/8 5.35 12 4.8% Unocal 31 5/8 1.86 17 2.2% S&P; 500 339.95 26.22 13 3.6%
Source: Zacks Investment Research
