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Did You Think About Investing in Energy? Warren Buffet v. Richard Pzena

November 18, 2013 | About:
Every once in a while industry giants behave similarly, while describing hard to ignore tendencies. Something of the like is happening in the energy industry, with weaker than expected performance on both sides of the Atlantic. ExxonMobil (XOM), Chevron (CVX) and Valero (VLO) in North America, and Royal Dutch Shell (RDS.A), BP (BP) and Total (TOT) in Europe, continue to miss the right path to steady growth. Similarly, gurus have reacted and began to right size their positions.

The Declining Industry Giant

ExxonMobil is the world’s largest integrated oil and gas company, with a market cap of $416.2 billion. Size, however, was not enough to counter environmental weaknesses. An acquisitions strategy focused on North America and a highly regarded management was offset by lower production volumes. Besides that, the firm has been able to improve overall revenues, while widening margins and lowering costs in the chemical business. Last, with undergoing projects coming online in the near term, performance is expected to receive a push for the long term.

Looking ahead, geographical diversification of upstream and downstream operations is one the most remarkable characteristics for ExxonMobil. Upstream operations are present in every major oil and gas production region, while downstream operations are spread through North America, Europe and Asia. Portfolio diversification, on the other hand, is supported by the chemicals segment. The company is the largest producer of basic chemicals olefins, paraxylene, benzene and polyolefin. Additionally, several specialty chemicals are included in the portfolio, further widening the product offerings of the firm.

Future prospects are questioned by analysts because the last quarterly report indicated a net income decline of close to $2 billion year over year. Most responsibility has been placed upon downstream operations, and it is coherent with lower production levels. Meanwhile, the upstream operations showed small improvements and the chemicals segment continued its improving tendency. It is not surprising then, that future prospect for the long term remain positive amid current difficulties due to a strong portfolio, dominant market positioning and global reach.

Financially, ExxonMobil is strong thanks to wide operating margins, growing revenues and low debt. Currently trading at 12.1 times its trailing earnings, the stock carries an 18% premium to the industry average. Most impressively, Warren Buffett took a position in the company during the last quarter and turned into the largest stake holder. Donald Yacktman, the guru holding the second largest position in the firm, continued to grow his stake. I share their optimism because of the market positioning supported by a diversified geographic presence and product offering.

The Declining European Giant

Royal Dutch Shell is the largest European integrated oil and gas producer by market cap. And its fourth quarter performance has suffered due to a recent spending splurge on Repsol’s liquid natural gas assets and stake in Brazilian oilfields expected to force the divestiture of assets in order to balance finances. Additionally, exploration during the last quarter has been unable to find much success. Last, management has been questioned by shareholders because of its slow reaction to gas and downstream issues.

The road ahead for Royal Dutch Shell is bumpy but not slippery thanks to development projects that offer attractive long-term opportunities. Additionally, a strong and diverse portfolio offer attractive long-term growth opportunities and important protection against economic headwinds. Opportunities are furthered supported by cost reduction initiatives, the exit of unprofitable markets and streamline of the organization. With these policies management expects to counter current production shortcomings.

For the long term, Royal Dutch Shell has announced that a greater focus will be placed upon upstream exploration and production activities. The strategy is founded on new projects coming online in Qatar, Australia and North America. It is important to note that the firm has about 30 ongoing projects that should guarantee upstream growth for years to come. Also the company´s gas operations deserve to be highlighted since the company is the second largest natural gas producer in the world.

The balance sheet for Royal Dutch Shell is moderate due to declining revenues, a high debt and reasonable operating margins. Trading at 10 times its trailing earnings, the stock trades barely below the industry average. Richard Pzena is the largest stake holder in the company, and increased his position throughout 2013. I share his optimism due to a strong market position and important undergoing projects.

A Stock Price Issue

The two largest companies on each side of the Atlantic currently face similar obstacles, deeply related to their downstream operations and declining volumes. I have a positive feeling towards both firms but do not think this is the right time to enter a position in either company. In short, stock face value has strongly risen in the last quarter. I expect the coming of a better opportunity in the first quarter of 2014, after the Northern Hemisphere's winter.



Disclosure: Vanina Egea holds no position in any of the mentioned stocks.


About the author:

Vanina Egea
A fundamental analyst at Lone Tree Analytics

Visit Vanina Egea's Website


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