By Dan Strumpf, Matt Wirz and Nicole Friedman
Energy stocks are on sale following a five-month plunge in crude
oil, but so far few investors are heeding the temptation to
bargain-hunt.
Portfolio managers and analysts covering the sector are bracing
for a wave of dividend cuts, share-repurchase delays and
capital-spending reductions that will likely ripple across an
industry reeling from the 38% tumble in U.S. crude futures since
June. Distressed-debt investors are circling a handful of deeply
indebted U.S. shale-oil producers that are deemed unlikely to
survive further oil-price declines without mergers or
overhauls.
Driving the tumult, traders and analysts say, is a steepening
decline in the price of crude oil. Entering 2014, few analysts
predicted that crude futures would move much from a range of $80 to
$110 that has prevailed since the financial crisis.
But now, following an unexpected decision by the Organization of
the Petroleum Exporting Countries to maintain its existing output
target, prices could soon plumb new depths, analysts say, testing
the finances of many energy companies large and small. Early Monday
in Asia, Nymex crude stood at $64.74 a barrel, a five-year low.
"There's lower prices ahead," said Ed Morse, global head of
commodities research at Citigroup Inc.
On Friday, energy companies in the S&P 500 tumbled 6.3% in
the wake of the OPEC decision. Over the past three months, they
have fallen 18.3%. The broader S&P 500 is up 3.2% in the same
period.
Some investors say that if the crude-price slump intensifies,
many energy firms will suffer from an accelerating retreat from the
sector. More firms likely will pull back on investment spending,
dimming their growth prospects, while others will trim dividend
payouts and share-buyback plans, reducing the appeal of their
shares.
Oil-field-service companies and drillers have been among the
hardest hit, owing to the likelihood that producers will spend less
on new projects. The biggest service company by market
capitalization, Schlumberger Ltd., is down 22% in the past three
months, while Halliburton Co., which is in the process of buying
rival service provider Baker Hughes Inc., has slid 38%.
Last Wednesday, Norwegian offshore driller Seadrill Ltd.
suspended its dividend to focus on paying down its debt. Shares of
the company have plunged 29% since the announcement. Other drilling
companies have tumbled as well, amid fears that they could follow
suit in cutting dividends. Shares of Transocean Ltd. are down 17%
since the news.
"Everyone's paying the price for this drop in oil prices," said
Jason Kotik, senior investment manager at Aberdeen Asset
Management, which manages about $520 billion. "Expectations have
been ratcheted down."
Mr. Kotik owns shares of large service companies but said he is
"struggling to find quality companies" of smaller size.
While the tumble has made some shares less expensive, many
investors say it is too soon to step in. The price/earnings ratio
of S&P 500 energy companies over the next 12 months stood at
13.5 on Friday, down from 14.7 on June 30, according to FactSet.
For the broader S&P 500, the figure is 16.2, up from 15.6 at
midyear.
"If their earnings fall even more due to depressed oil prices
and low demand for energy services, these stocks could still be
expensive, even at these lower prices," said Margie Patel, a
portfolio manager who oversees $1.4 billion in stock and bond
investments at Wells Fargo Asset Management.
Ms. Patel remains parked in shares of oil-and-gas pipeline and
storage companies, whose fortunes are less bound to the price of
oil than producers and service firms are. "I think it's too early
to look for bargains in the energy sector," she said.
Many investors say the drop in oil prices has reduced their
appetite for the many highly indebted, more speculative companies
in the sector. Aaron Dunn, energy analyst on the $8.6 billion
value-investing team at fund manager Eaton Vance Corp., said in the
past two months one fund he works on has bought shares of large
integrated oil companies including Exxon Mobil Corp., whose shares
have held up better in the downturn. He has been avoiding smaller
companies with high levels of debt.
"There's a fair amount of companies that can't survive under
their leverage with lower oil prices," Mr. Dunn said.
To be sure, crude prices could yet recover if the global economy
rebounds, a new geopolitical risk emerges or OPEC lowers its
production ceiling. At the same time, investors say a sustained
drop in crude prices could drive a wave of consolidation among
producers with shakier finances, leaving the sector in stronger
shape in the long run.
The downturn has implications for energy companies' bonds as
well as their shares. A growing number of companies behind the bond
bonanza are struggling to service the debt they took on now that
oil sells for less than $70 a barrel. Credit-ratings firm Moody's
Investors Service on Nov. 25 changed its outlook on oil-and-gas
producers to negative from positive, citing the likelihood of
sustained weakness in oil prices.
Scott Roberts, senior portfolio manager at Invesco Ltd., who
helps manage $3 billion in high-yield bond investments, said he cut
his holdings of energy bonds by half around midyear on expectations
of lower prices, to about 5% of his portfolio.
He still has a modest position, but he has recently been
selectively buying bonds of producers with relatively low leverage
and stronger assets, including those of California Resources Corp.
and Denbury Resources Inc. He said he expects U.S. crude prices to
rise starting in the first quarter of 2015 and finish the year at
$80 a barrel.
"There's been an opportunity here over the last couple of months
to add to quality names that got oversold in this selloff," he
said.
The energy industry has issued $1.22 trillion of new bonds since
2009 and accounted for about 7% of all corporate bonds over that
period, according to Dealogic. That is about twice the $622 billion
the industry borrowed from 1995 through 2008.
Offshore oil driller Energy XXI Ltd. has been a hedge-fund
darling in recent years with Mount Kellett Capital Management LP
and Kyle Bass's Hayman Capital LP holding as much as 11% of its
shares, according to Capital IQ.
The company more than doubled its debt load to $3.8 billion this
year to acquire EPL Oil & Gas, and a bond it sold in May to
finance the deal has fallen 25% to 75 cents on the dollar since
September. Its stock fell 37% on Friday to $4.01.
In a statement, the company said it has hedges in place to help
weather a downturn in oil prices and said it is "cash-flow neutral"
with oil around "the mid $60s" through next year.
In 2011, private-equity firm KKR & Co. acquired Samson
Resources Corp. for $7.2 billion with more than $4 billion of debt,
making the deal the second-largest leveraged buyout of the year.
But Samson's cash flows are "significantly impacted by the price we
receive for our oil," the company said in its third-quarter
earnings report.
Samson's bond prices have fallen by 42% since early September,
according to FactSet. The company couldn't be reached for
comment.
Oil's dramatic move downward takes the commodity far below where
one of the world's most well-known oil speculators, former
Citigroup Inc. trader Andrew Hall, pegged as a potentially
profitable entry point.
Mr. Hall told investors this fall in his Astenbeck Capital
Management LLC hedge fund that oil at $85 a barrel "could be a
bargain," particularly for delivery contracts several years into
the future, as relatively low prices should stimulate demand by
boosting global GDP growth, according to investor communications
viewed by The Wall Street Journal.
Astenbeck's November performance wasn't immediately available,
but the fund lost money in October amid falling oil prices, paring
its gains for the year.
Rob Copeland contributed to this article.
Write to Dan Strumpf at daniel.strumpf@wsj.com, Matt Wirz at
matthieu.wirz@wsj.com and Nicole Friedman at
nicole.friedman@wsj.com
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