Among companies trading on the New York Stock Exchange and the Nasdaq, energy companies suffered the most during the “oil recession” of 2015.
These companies generally experienced sharp declines in operating margins, which could result in lower profitability and predictability ranks. This article discusses the historical trend of three global energy companies: BP PLC (BP, Financial)(LSE:BP, Financial), ExxonMobil Corp. (XOM, Financial) and Total SA (TOT, Financial)(MIL:TOT, Financial) and industrial company General Electric Co. (GE, Financial). While the historical financial trends suggest poor value potential, increasing oil prices offer a second chance.
The 'sensitive super sector'
Our data vendor, Morningstar, classifies the companies into three super sectors: cyclical, defensive and sensitive. The previous two articles discussed historical trends for consumer cyclical and consumer defensive companies, highlighting differences between cyclical and defensive companies. Morningstar loosely classifies the sensitive super sector as a “middle ground” between the cyclical and defensive super sectors.
The sensitive super sector contains energy, industrial and technology companies. Energy and industrial companies are generally sensitive to crude oil prices as sharp changes in oil prices can severely impact energy companies. Figure 1 graphs the 10-year price trend of ExxonMobil and the West Texas Intermediate index.
Figure 1
As illustrated in Figure 1, ExxonMobil’s stock price generally fluctuated along with crude oil prices: When crude oil prices increased, ExxonMobil’s stock price increased and vice versa when crude oil prices decreased. This suggests that ExxonMobil is sensitive to oil prices.
Historical financial trends for ExxonMobil
Texas-based ExxonMobil produces crude oil and natural gas, manufactures petroleum products and transports them to customers. The company has a one-star predictability rank, likely due to volatile per-share revenue and EBITDA per share. Figure 2 shows ExxonMobil’s Predictability Chart.
Figure 2
ExxonMobil’s business predictability fluctuated between one star and four stars during the 10-year period, as illustrated in Figure 3. This occurs because the predictability rank depends on the trend of per-share revenue and EBITDA per share during the most recent 10 years as discussed in a research article on business predictability. ExxonMobil’s predictability rank reached four stars in 2009, likely due to consistent per-share revenue growth from 1999-2009.
Figure 3
Figure 3 also graphs the historical trend of ExxonMobil’s financial strength rank and profitability rank. Likely due to steadily climbing oil prices from 2010 to 2014, ExxonMobil’s financial strength ranked a strong 9 out of 10. However, the integrated oil company’s financial strength tumbled to 6 out of 10 as oil prices dropped nearly 50% in early 2015. (See Figure 1 above.)
The Texas energy company has issued about $14 billion in long-term debt from 2014 to 2016 with about $6 billion in first-quarter 2014 and another $8 billion in first-quarter 2015. The company discussed its latest debt issuances in a March 3, 2015, current report filing with the Securities and Exchange Commission, entering into underwriting agreements with Citigroup Inc. (C, Financial), JPMorgan Chase & Co. (JPM, Financial) and Morgan Stanley (MS, Financial). Likely due to these debt issuances, ExxonMobil’s cash-debt ratio dropped to a 10-year low of 0.11. The company’s financial strength still ranks a moderately strong 6 out of 10 as ExxonMobil has comfortable interest coverage.
ExxonMobil’s Altman Z-score remains above safe zones albeit declining throughout the past 10 years, as illustrated in Figure 4. The company’s Piotroski F-scores are more volatile than its Z-scores, ranging from 4 to 9. Despite this, ExxonMobil neither faced financial distress nor had poor business operations during the past 10-year period.
Figure 4
Although the company has moderately strong financial strength, ExxonMobil’s profitability currently ranks a weak 4 out of 10. Declining operating and gross margins likely contributed to the sharp drop in the energy company’s profitability rank during late 2015 to 2016. Figure 5 illustrates ExxonMobil’s historical profit margin trends.
Figure 5
Even though the company’s operating margin and net margin dropped to 10-year lows, both margins still outperform over 54% of global integrated energy companies. Likewise, ExxonMobil’s returns on equity and assets outperform 63% of competitors. As discussed in the latest earnings report, ExxonMobil reported $2.65 billion in earnings in the third quarter and diluted earnings per share of 63 cents. While these results underperformed third-quarter 2015 results, CEO Rex Tillerson praised the company’s management for delivering solid results even in a challenging operating environment. ExxonMobil’s continued focus on “capturing efficiencies and advancing strategic investments” likely contributed to a $950 million increase in earnings during the quarter.
BP PLC versus Total SA
ExxonMobil, British Petroleum and Total SA represent three of several “Big Oil” super majors, oil and gas companies that have high public ownership around the world. Headquartered in London, BP engages in supply and trading of petrochemical products around the U.K. On the other hand, Total SA primarily operates in its headquarters in France.
Both companies, especially Total SA, had sharply declining operating margins since 2012. Figure 6 shows the historical trend of BP’s profit margins while Figure 7 shows the historical trend of Total’s profit margins.
Figure 6
Figure 7
Total SA generally had higher operating margins than does BP with Total’s operating margin increasing from 15% to about 27% between 2006 and 2010. BP’s operating margin is -2.70%, lower than 69% of competitors. Total SA, on the other hand, has an operating margin of -0.12%. Additionally, the Paris-based energy company has a moderately strong gross margin of 35%, suggesting narrow to wide “moat,” Warren Buffett (Trades, Portfolio)’s term for “durable competitive advantage.”
Unlike ExxonMobil, both BP and Total SA have weak Altman Z-scores, tumbling into distress zones by 2012. As illustrated in Figure 8, BP’s Piotroski F-score declined from a high of 9 to a low of 3 in 2009. Although BP’s F-score gradually increased from 2009 to 2014, the scores then dropped to the current value of 2. This suggests that the British energy company has a weak business operation.
Figure 8
Unlike BP, Total SA had less volatile F-scores, only decreasing from 7 to 5 from 2006 to 2016. The French energy company’s F-score seldom dropped below 4 during the period, suggesting a stable business. Figure 9 shows the historical trend of Total’s financial strength scores.
Figure 9
Likely due to gradual declines in operating margin and Z-scores, BP’s financial strength rank declined from 8 to 3 during the 10-year period as illustrated in Figure 10. Total SA had less volatile financial strength likely due to relatively strong gross margins and less volatile F-scores. Figure 11 graphs the historical trend of Total’s financial strength rank, profitability rank and predictability rank. While both companies currently have a one-star predictability rank, Total SA reached five-star status during 2009. BP’s predictability rank seldom exceeded four stars during the 10-year period.
Figure 10
Figure 11
General Electric
While it is not an energy company per se, GE manufactures oil and gas production equipment for energy companies like ExxonMobil. As the company offers diversified energy and industrial products, GE is not directly sensitive to crude oil prices. The company’s per-share stock price steadily increased from its 10-year low of $7 in March 2009 to its current value of $32.21, as illustrated in Figure 12.
Figure 12
The Connecticut-based industrial company has a moderately strong profitability rank. Even though the company’s profit margins sharply contracted in 2016, GE’s current operating margin of 14.94% outperforms 86% of global diversified industrials companies. Figure 13 graphs the historical trend of GE’s operating margin and gross margin, which generally remained constant until 2015.
Figure 13
Despite contracting profit margins, GE provided strong third-quarter earnings results and a good organic revenue outlook. Continuing operating earnings based on generally accepted accounting principles increased 21% from third-quarter 2015 to third-quarter 2016, with industrial operating and verticals EPS rising 10%. GE CEO Jeff Immelt praised the company’s strong “diverse, digital industrial” platform, enabling GE to deliver in a “slow growth, volatile environment.” The acquisition of Alstom likely contributed to GE’s growth. As discussed in a recent press release, GE and Baker Hughes Inc. (BHI, Financial) definitively agreed to merge Oct. 31, aiming to create a “world-leading oilfield technology provider” that offers an eclectic variety of equipment, technology and energy services. The merger expects to generate total synergies of $1.6 billion by 2020, offering an NPV of about $14 billion.
However, GE’s Altman Z-scores generally languished in distress zones during 2006-2016, as illustrated in Figure 14. Despite Z-scores seldom exceeding 1.5, GE has moderately strong Piotroski F-scores, increasing from 3 to 7 from 2015 to 2016. As illustrated in Figure 15, the company’s financial strength rank ranged from 5 to 8 while the profitability rank ranged from 4 to 7. Currently, GE’s financial strength ranks 5 out of 10 while the company’s profitability ranks 6 out of 10.
Figure 14
Figure 15
Low Shiller P/E suggests rebounding potential
As discussed in a previous article, the energy sector has the lowest Shiller price-earnings (P/E) ratio among the market sectors. The energy sector remains the most undervalued sector as of Dec. 20, based on sector valuations. This suggests that the energy sector has good potential to rebound from the 2015 oil recession.
Figure 16 graphs the historical trend of crude oil prices for both the West Texas Intermediate index and the Brent-Europe index. While both indices dropped to a 10-year low of $25 in early 2016, crude oil prices increased to about $52 per barrel for the WTI index and $54 for the Brent-Europe index. As crude oil prices increase, energy companies have potential for increasing operating margins.
Figure 16
See also
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Disclosure: The author has no position in the stocks mentioned in this article.
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