A Crude Awakening
Investors must think the oil patch is becoming a quagmire.
After a run-up in the first half of last year, major oil company stocks have been slowly but steadily dropping since October--right in step with a falloff in crude-oil prices. The declines may be cheered by motorists, but they’re causing headaches for investors.
Crude prices have tumbled more than 25% in some cases. For instance, the price for West Texas Intermediate, a benchmark light crude, has dropped to a recent $16.50 to $17 a barrel from $23 in October.
In turn, Standard & Poor’s index of domestic oil stocks has skidded 9% since Sept. 30, and its index of the major international oil producers is off 7%. The broader market during that period has inched up 2%.
Several of the industry’s big names, including Mobil Corp. (ticker symbol: MOB) and Unocal Corp. (UCL), have skidded more than 5% over the period.
The sell-off has been even more severe among oil field services stocks, which had been one of the market’s strongest sectors until the middle of last year. So far this year, S&P;’s index of oil and gas drilling shares is off 13% since September, making it one of the worst performers among S&P;’s 90 sector indexes.
And the degree to which investors have shunned oil stocks has surprised some analysts. “We confess to underestimating the response of the equity market to the decline of oil prices,” analyst David Bradshaw of Donaldson, Lufkin & Jenrette Securities wrote to clients recently.
Crude-oil prices certainly get lots of headlines, and their sharp movements no doubt influence how investors feel about the oil companies’ prospects. But the companies’ profits don’t move in lock-step with changes in crude prices.
Higher crude prices are, needless to say, welcomed by companies that focus on exploration and production of crude. But in some cases--especially among refiners--lower crude prices are good news, because the declines lower the cost of the companies’ primary raw material.
And, of course, demand for oil is the other big factor in the equation. Even if crude prices are stable and there’s plenty of oil around, a surge in demand from oil users could enable the companies to nudge up prices and fatten their profits.
Consider: In 1995, crude prices were relatively stable, generally holding between $18 and $20 a barrel--about where prices were in 1994. Yet owing to good demand and other factors, the major oil companies’ after-tax profit margin in 1995 rose to 4.7% on average from 3.9% the previous year, according to Value Line Investment Survey, a stock research firm.
Be that as it may, analysts are cautious about the oil stocks’ outlook for this year. Crude prices aren’t expected to rise significantly, and profit margins on refined products--gasoline, heating oil, jet fuel and the like--are expected to shrink.
L. Bruce Lanni, analyst at CIBC Oppenheimer, is looking for West Texas Intermediate crude to average $18.50 a barrel this year. That’s up somewhat from current levels, but down from the $21-a-barrel average of 1997.
He’s also forecasting that worldwide demand for oil products will rise 2.4% in 1998, a slight contraction from last year’s 3% increase, that is mainly a reflection of lower demand in economically troubled Asia.
The result: Douglas Terreson of Morgan Stanley, Dean Witter, Discover & Co. in New York recently cut his estimates of industrywide oil-refining profit margins this year, to the 5%-to-6% range. Not long ago, he was expecting the companies to earn 8 to 9 cents per dollar of sales.
And so Terreson has been shaving his earnings estimates for the oil companies, “and our investment strategy toward the group is decidedly neutral,” he said.
But there are still a few stocks being recommended by Terreson and his colleagues. And some of them are focused on the West Coast market.
Among their favorites: Atlantic Richfield Co. (ARC), the Los Angeles-based powerhouse in the Western gasoline market. Lanni has a “strong buy” on the stock, and Paul Ting of Salomon Smith Barney views only Arco and Texaco Inc. (TX) as “solid long-term investments” among the big oils.
“The West Coast is unique” among the nation’s gasoline markets, Lanni explained. Among other things, “there are no product pipelines” to move oil into the region, “so the only way to get it in there is to ship it in.”
Also, “there are a fixed number of refineries to produce” gasoline and other refined products, and that means “there is restricted capacity” to produce those products in the West, he said.
At the same time, “demand [for gasoline] has been very high,” because California has so many vehicles and because of “the resurgence of the California economy,” Lanni said.
“Put that all together, and it paints a very bullish picture” for oil companies in the region, he said.
Tosco Corp. (TOS) is in the same camp, and gets “strong buy” ratings from Terreson and William Hyler of CIBC Oppenheimer. Tosco’s profile in the West became much higher last year when it bought Unocal’s West Coast refining and marketing assets, including the Union 76 brand of gasoline.
Terreson also likes another big West Coast player, San Francisco-based Chevron Corp. (CHV), but for other reasons as well. In December, Chevron announced a $2-billion share-repurchase program and announced the discovery of a second big oil field off the coast of Angola.
Overall, Chevron’s profit growth “is likely to be among the best in its peer group in 1998-99,” he said.
Paul Cheng of Lehman Bros. likes two of the medium-size oil companies, Amerada Hess Corp. (AHC) and Kerr-McGee Corp. (KMG), mainly because “they’ve been unfairly beaten down the most” by investors even though “the fundamentals on the stocks remain intact.”
He’s also recommending Arco and Texaco for investors looking for yield. Arco is currently carrying a dividend yield of 3.7%, and Texaco’s is 3.3%, compared with the S&P; 500’s yield of only 1.6%.
And among the bloodied oil-services stocks, are there any candidates to buy? Arvind Sanger of Donaldson, Lufkin & Jenrette has one: R&B; Falcon Drilling Co. (FLC), even though it’s dropped 12% so far this year to a recent $30.25 a share.
The company is the product of the recent merger of Reading & Bates Corp. and Falcon Drilling Co., and it operates the world’s largest and most diverse fleet of offshore drilling rigs, Sanger said.
Moreover, R&B; Falcon is expanding its role as a driller in very deep waters, which oil-exploration firms are demanding, he said.
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Times staff writer James F. Peltz can be reached at james.peltz@latimes.com
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Sticky Situation
Major oil stocks haven’t given investors anything to cheer about since crude oil prices began dropping in October. Here are some of the major players:
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Stock Ticker symbol Friday close % change from 9/30 Amerada Hess AHC $53.50 --13% Atlantic Richfield ARC 78.50 --18 Chevron CHV 76.75 --8 Exxon XON 60.81 --5 Mobil MOB 69.75 --6 Occidental Petroleum OXY 27.31 +5 Phillips Petroleum P 44.88 --13 Sun SUN 41.75 --5 Texaco TX 54.31 --12 Tosco TOS 32.81 --6 Unocal UCL 36.44 --16 Standard & Poor’s 500 +2
Stock P/E* Amerada Hess 76 Atlantic Richfield 15 Chevron 17 Exxon 20 Mobil 16 Occidental Petroleum 15 Phillips Petroleum 13 Sun 14 Texaco 16 Tosco 21 Unocal 18 Standard & Poor’s 500 24
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*Price-to-earnings multiple based on analysts’ 1997 consensus forecasts.
Source: Bloomberg News
