Philip Van Doorn
If you ignore the daily headlines about the beleaguered energy sector, invest in companies with low debt and wait for the inevitable rebound in oil prices, you could eventually make a lot of money.
Oil news has been grim, as analysts rush to lower their crude-price predictions week in and week out. Wolfe Research, in a shocking report, is expecting as many as a third of U.S. oil and natural gas producers to go bankrupt.
Oil has already hit its lowest level in more than 12 years, and the drop over the past 18 months has been breathtaking. Investment banks expect crude oil prices to head well below $30. As recently as July 2014, prices topped $100 a barrel.
In an interview Friday, Bill Mann, chief investment officer of Motley Fool Asset Management, gave an example of an oilfield services and equipment company that’s well-positioned to take advantage of the turmoil in the energy and materials industries, and bounce back beautifully when oil prices recover.
“In the materials sector and oil services, there are companies that have been thrown out with the bath water, including National Oilwell Varco NOV, -1.84% ” Mann said. He called the company ”spectacular,” with a “very conservative capital structure in a disaster of a market right now.” “The last 18 months have been the worst in history for the price of Brent crude oil LCOH6, -5.73% and those things tend to reverse in time,” he said.
National Oilwell Varco’s ratio of long-term debt to equity was 15.3% as of Sept. 30, according to FactSet. That’s the lowest among the six companies in the oilfield services/equipment subesctor of the S&P 500 SPX, -2.16% according to FactSet. Having low debt is crucial for companies that wish to scoop up competitors or assets during a wave of bankruptcies.
To be sure, a relatively high level of debt doesn’t mean a company has been a poor long-term performer, as you can see from the five-year average returns on equity and total return figures above. The idea is that a company with low debt can take advantage of the unusual market turmoil.
When discussing market conditions and strategy during the company’s third-quarter conference call in October, National Oilwell Varco CEO Clay Williams emphasized the company’s cost-cutting efforts, as well as the opportunity for expansion ahead of the oil-price recovery that eventually “will come.”
It has been difficult for the company to find bargain acquisition targets, and Williams said the company remained “patient and disciplined in these discussions.”
“As we move into 2016, we believe sellers are likely to reduce their expectations and better capital returns on M&A will follow. Consequently, our capital deployment strategy is shifting from share buybacks to an external focus on potential acquisitions,” he said.
The company made four small acquisitions during the third quarter. If we expand the comparison to the 67 companies in the S&P 500 energy and materials sectors, National Oilwell Varco had the second-lowest debt-to-equity ratio, with Helmerich & Payne Inc. HP, -3.17% the lowest at 10.9%.
Among the 67 S&P 500 companies in the energy and materials sectors, 18 had debt-to-equity ratios of over 100% as of Sept. 30. With oil and gas revenues plunging, while interest rates are expected to rise in the U.S. during 2016, the timing of that high leverage couldn’t be worse. And those 18 are all large-cap companies. Among smaller players, there will be plenty of bankruptcies, which means plenty of distressed assets for survivors with lower leverage to acquire.
In his daily energy report on Tuesday, Phil Flynn of Price Futures Group said: “Many shale producers have lost more than 90% of their market value and many can’t survive this meltdown. I would expect four or five bankruptcies to be announced in the coming days.”
It’s interesting, and comforting, to see integrated giants Exxon Mobil Corp. XOM, -1.95% and Chevron Corp. CVX, -2.11% on the list. The low level of leverage underlines how conservative the companies’ management teams are. And when oil rises again, as it always has following a major downturn, the big low-leverage players are likely to do what they have always done, which is ride the wave back up.
Keep in mind that oil is a long-term investment. On Tuesday, Credit Suisse analyst Jason Gammel called the short-term outlook for oil “bleak.” But he expects the price of Brent crude oil to rise to $57.75 a barrel in 2017 and $71.75 in 2018. So the price of oil could double within two years.
Which other industries could benefit from the price of their products or services rising that fast?