The coronavirus pandemic that Saudi Arabia used to launch an all-out war for global market share has turned into an absolute rout. Nearly every corner of the oil world has been affected, and billions of dollars in investor capital has already been destroyed. Eventually the market will turn and there will be big winners after the oil crash, but now is a time for caution.
It’s barely two months in, and the bankruptcies have already started. So before you rush into the oil patch looking for big gains on a bet that the economy opens back up soon and demand for oil rebounds, keep reading. The oil patch is in a massive mess that could take a year or more to correct, and more companies are going to struggle badly and destroy lots more shareholder equity before it gets better.
Five oil stocks in particular that investors should avoid are Occidental Petroleum (NYSE:OXY), Oasis Petroleum (NYSE:OAS), Halliburton Co (NYSE:HAL), Chesapeake Energy (NYSE:CHK), and Valaris plc (NYSE:VAL). As you can see from this list of names, it’s not just shale oil producers at risk. Companies on land and offshore, and in other various parts of the industry, are set for a lot of pain to come.
Torching shareholder value
Matt DiLallo (Occidental Petroleum): The members of management at Occidental Petroleum wanted to buy Anadarko Petroleum so badly that they wouldn’t let anything stand in their way. They outbid rival Chevron by a ridiculous $5 billion, allowing the oil giant to walk away with a cool $1 billion breakup fee for its troubles. They also made sure shareholders wouldn’t have a say on the deal by structuring it to avoid a vote, made possible by piling on a lot of debt and taking on high-cost financing from Warren Buffett.
This deal, however, has blown up in Occidental’s face. Oil prices have cratered this year, which has put tremendous pressure on Occidental’s balance sheet. The company had been trying to sell assets to pay off that debt but has run into several obstacles. Now Occidental has had to slash spending and its dividend to stay afloat. It also had to resort to paying the interest it owes Buffett in stock instead of cash, which will dilute investors.
The company’s debt level and financial troubles could ultimately force Occidental to declare bankruptcy. However, even if it survives this downturn, the oil company is likely to struggle for years to come because of the debt it took on to buy Anadarko.
Leave Oasis Petroleum to the day traders
Tyler Crowe (Oasis Petroleum): Let’s talk about Dave. Dave thinks it’s a great idea to day-trade Oasis Petroleum’s stock because it’s trading in penny stock territory and could be a “once-in-a-lifetime opportunity.”
Don’t be like Dave.
It may be tempting to buy a stock that has dropped by so much and can be had for so little. The thesis sounds pretty simple, too. Oil prices are low, and all of the bad news is baked in. The trouble is, Oasis’ monumental debt load is piling up, costs are well in excess of oil prices, and its management team’s incentive structure is so far out of line with value creation for shareholders that it’s laughable. Somehow in 2019, it’s management team met 100% of its target bonus goals despite more than $800 million in capital expenditures that resulted in negative free cash flow and had the resulting stock performance:
If you want to invest in companies that hand out fat bonuses to its management team for not producing shareholder value and will have to come up with over $167 million in interest expenses alone in 2020, then you can do what Dave does and buy Oasis Petroleum’s stock. But if you want to invest in oil stocks over the long term, don’t be like Dave.
Services won’t be spared from oil downturn
Travis Hoium (Halliburton): No matter how you look at it, a likely reduction in oil drilling in shale and offshore markets will be bad for Halliburton. Oil prices didn’t start dropping until late in the quarter, but the company still reported a 19% decline in completion and production division revenue to $3.0 billion and drilling, and evaluation was flat at $2.1 billion. There was a net loss $1.0 billion, including a $1.1 billion impairment, but the bottom line is likely to get worse.
Halliburton makes money when companies are investing in new drilling, but right now capital expenditure budgets are being slashed. If the oil glut in the U.S. lasts much longer, there’s even a risk that wells will be shut in because there’s nowhere for the oil to go, forcing the bankruptcy of some of Halliburton’s customers.
The next problem for Halliburton after revenue declines is debt. The company has $9.8 billion of debt on the balance sheet and may see cash flow evaporate in 2020. The problem won’t be maturing debt, which doesn’t start until 2023, but rather having existing cash dry up during a long downturn in demand.
I don’t think the current crisis will turn around quickly for oil industry service companies like Halliburton. Instead, I see a permanent decline in demand for their services, and that’s why I would stay far away from this oil stock.
Coming up dry
John Bromels (Chesapeake Energy): Oh, how the mighty have fallen! Oil and gas producer Chesapeake Energy was one of the darlings of the U.S. shale boom. Those days are over: Shares have lost more than 98% of their value over the past five years, and the company has proved to be singularly unprepared for the current crisis.
First of all, Chesapeake is a pure play on U.S. shale production, one of the most expensive types of production. And U.S. oil prices are among the lowest in the world right now, thanks to oversupply and lack of demand. A lack of available storage for all that unused oil is likely to compound the problem.
Companies with solid balance sheets might be able to muddle through, but Chesapeake has $9.5 billion in long-term debt, more than 40 times its current market cap. Worse, $136 million of that debt comes due July 1, and another $192 million in August. With just $6 million in cash on its balance sheet and a “C” debt rating from Moody’s, it’s unclear how — or if — it will pay.
With bankruptcy looking more and more likely, investors should stay far away.
A sinking ship
Jason Hall (Valaris): As much as U.S. shale oil producers are getting destroyed by the oil collapse, the offshore drilling sector might be in even worse shape. That’s because while shale spend over the past five years was booming, it was burying offshore oil in a flood of new supplies that prevented the drilling contractors in that space from ever really recovering. Enter the biggest collapse in demand of all time, and every bit of progress offshore has made the past five years has evaporated in just a few weeks.
As a result, Diamond Offshore (NYSE:DO) declared bankruptcy, becoming the first major offshore driller in this cycle to run out of capital, as we predicted last week. I think it will be joined by Valaris in the very near future.
The company just took $2.8 billion in impairment charges related to a massive 13 vessels on its books, essentially saying that the economic value of these vessels — many of which are not particularly old — is nil. The company also said it would report losses and negative cash flows for the remainder of 2020.
Valaris has $200 million in cash and about $1.3 billion available on its revolving credit facility. But its operating results are on track to deteriorate further, which could limit how much of that liquidity it could access. Management has acknowledged how dire the situation is. CEO Tom Burke said management is “evaluating various alternatives to address our capital structure and annual interest costs, including, without limitation, a comprehensive debt restructuring that may require a substantial conversion of our indebtedness to equity.”
That’s a fancy way of saying “bankruptcy is on the table.”