Investors can look to three places for thoughts on a particular stock; Wall Street analysts, the company itself, and one's own personal opinion. Shares of NOVA Chemicals (NCX) have dropped 12 straight points. The analysts hate it (Prudential just slapped a "sell" on the stock yesterday). The company is very upbeat and current earnings estimates look impressive. So why is the stock getting crushed?
I think the main reason is that chemical companies are very cyclical and are extremely reliant on commodity prices cooperating in order to make a nice profit. With input prices rising and uncertainty as to if that trend will continue or come back down to earth, investors are afraid of these stocks.
That said, at what point do we say that all of that has been more than priced into the shares? NCX stock trades at 9.3x 2005 estimates and 5.7x 2006 profit expectations. Yes, that's less than six times earnings! Even if you use the lowest estimate for 2006 on the Street, you get a P/E of 7.4x.
Investment theory says that low P/E's on cyclical companies are a signal of a peak in their profit cycle. However, the company is fairly early in their recovery and company executives don't see 2006 as the peak. Instead, they figure 2008 is a better guess. NOVA is a controversial name in a controversial industry, but I think the stock is worth much more than $40 per share.
Unlike Airlines, Plains Exploration Updates Hedging Strategy
A press release issued today by Plains Exploration and Production (PXP) shows what smart management teams can do for investors. In prior pieces I have highlighted that mismanagement of oil price hedges has caused the major domestic airlines to lose billions of dollars. A deal announced today by Plains worried me a bit after reading the headline. It said "Plains Exploration to Sell 275 Oil Wells in $350 Million Deal With XTO Energy."
I wondered why Plains, a stock I own personally and for clients, would be selling oil wells at this point in time. After all, those very wells are the reason I own and like the stock. However, after reading the release I realized how great of a move this was.
Plains Exploration will use the deal's proceeds of $350 million to eliminate all existing 2006 oil price swaps and collars. You see, all oil companies have some type of hedging program in place, for the sake of some predictability of cash flow. So even if crude oil was $55 per barrel, energy companies rarely get market prices for all of the oil they produce. Plains has 2006 oil price swaps in place involving 15,000 barrels of oil per day at an average price of $25.28 and an average ceiling price of $34.76. With oil in the mid $50 range, you can see that they would have to leave some profit on the table with these hedges in place.
However, eliminating these swaps and collars will cost about $295 million. The proceeds from the XTO deal will more than cover that expense, and the move will tremendously increase future cash flow. "These transactions remove the significant headwind that the company has experienced in 2004 and 2005 from our previous hedge positions, which negatively impacted cash flow," said Chairman, President and CEO James Flores. In addition, the company has acquired $45 put options on about 40,000 barrels of oil per day in 2006. These options ensure $45 per barrel, whereas the ceiling from their prior swaps was less than $35 per barrel.
Not surprisingly Plains shares are rallying 3% today. Still, shares only trade at 12x 2006 earnings estimates, and those estimates will surely prove too low given the company's new hedging strategy.
Goldman Bullish on Oil, But Why?
Just like I took the "over" for the Wildcats (70 points) when Arizona faced Illinois in the NCAA Tournament Elite 8 last weekend, I'm going to take the "over" again on the number of energy stocks Goldman Sachs (GS) owns. Today's $1+ jump in crude prices is being attributed to Goldman's bullish note today that they see a "super spike" in oil prices on the horizon. Previously, GS had said they thought oil could hit $80 per barrel in such a scenario, but that number was lifted to $105 today, sparking much conversation on the Street.
Call me crazy, but I think the Goldman call had more to do with boosting the stocks they own, rather than some meaningful change in oil fundamentals they saw change overnight. After peaking at $57 or so, oil futures fell $5 fairly quickly in March, leading to a correction in the sector's shares. By raising their already overly bullish view, this slide would quickly turnaround, stopping the losses from their energy holdings and allowing them to unload some stock at favorable prices if they were so inclined.
American Airlines' 2005 Fuel Costs: $5 Billion
The ineptitude of the major domestic airlines continues to amaze me. There are some things these companies cannot control; their unions, for example. However, the management teams of United, American, Delta, and US Air are most to blame for extremely poor operations, and as a result, a lack of profitability. In fact, the airline industry since inception has a cumulative net loss. That's right, they haven't made a dime.
So, you would think that if there were things you could control as the CEO of a major airline, you would. I am referring to fuel costs. You can hedge fuel costs. You can lock in prices for certain amounts of fuel, deliverable by a certain date in the future. In the world we live in today, you would think the major airlines would have hedged much of their future fuel needs, especially when these companies are losing money hand over fist and United and US Air are in Chapter 11.
Amazingly, American Airlines has hedged only 15% of its fuel costs for the first quarter of 2005. With oil futures hitting a record $57 per barrel this week, that could be disasterous for the company's bottom line. To make matters worse, hedging beyond March was recently characterized as "minimal" by American's CEO. He added that total fuel expense for 2005 could hit $5 billion in 2005, if prices remain high. American is only expected to have $19 billion in revenue this year, so 26% of that is paying for gasoline.
If oil keeps rising, it's hard to see how this industry can avoid having more well-known carriers headed back to bankruptcy court.
Full Disclosure: I am short American Airlines (AMR) stock and own Delta (DAL) puts.
GE Capital Pulls GM's Credit Facility
Yields on General Motors (GM) long-term corporate bonds jumped to over 10% in early trading this morning on news that GE Capital has pulled its credit facility. The bonds have rallied slightly off the lows, as traders take into account GM's various other sources of liquidity.
Other notables:
Electronic Arts (ERTS) is down $9 after warning on 2005 EPS and projecting 2006 profits would be roughly flat year-over-year. Although the shares are getting slammed today, the valuation still doesn't look all that compelling.
Martha Stewart Living (MSO) is nearing my $20 target price for taking profit on the Sep 05 $45 puts. I don't think the stock looks attractive here, but at some point you just have to take your money off the table to avoid being too piggish. If there was any stock available to borrow (there isn't), I'd like to short it with some of the put option proceeds.
Interesting Fact of the Day
General Motors (GM) Market Cap: $16.0 billion
Harley Davidson (HDI) Market Cap: $17.6 billion
Maytag Needs A Repair Man
Take a look at this chart of Maytag (MYG) stock. Talk about brutal. The analysts hate it. More sell recommendations than all other ratings combined. It's the kind of situation that gets a contrarian's attention. I've yet to buy the stock, but it will be something I plan to look at very closely in coming days, as the stock looks too cheap despite its problems. Anybody have any thoughts on MYG? Let me know!
GM Profit Warning Hits the Dow
General Motors (GM) shares are down $4 and account for more than half of the Dow's 50-point loss this morning. Nobody should be surprised by this earnings warning. The U.S. auto makers are getting crushed by foreign competitors, and that phenomenon is nothing new. GM and Ford (F) rely on their financing divisions for the majority of their profits. In fact, I read somewhere a few months back that GM makes a profit of only $300 on each car sold (not including the loan GMAC extends to the buyer).
Companies like Toyota (TM) will continue to take market share in the United States. If you want to buy an automobile stock, buy that one. I know GM and Ford pay hefty dividends, but there are many other places to get that type of yield, and you won't have to worry about capital depreciation. If you are leary of giving up on the domestic auto companies at these lowly levels, consider GM's corporate bonds. That paper is paying more than 9% interest and comes with less risk than the common shares.
Has Oil Peaked?
Everybody is talking about oil and a potential double-top after the commodity failed to break through $55 a barrel in yesterday's trading. Nobody can really predict these short-term movements, and enough people look at charts that we might not see $60 near-term. Even if we get a pullback in oil prices on technical trading, I doubt that is the end of high oil prices. Any meaningful pullback should be bought as far as the energy stocks are concerned, just as a run above $55 presents a good opportunity to take some profit off the table.
High oil prices are here to stay, contrary to many people who blame the current escalated priced to hedge fund trader speculation. We might not see a run to $60 this week or next, but I would not be surprised if we saw oil hit $60 before it drops to $40 per barrel. When picking stocks in the group, focus on those companies that not only do well with prices high, but will have strong production growth as well, so when prices do give back some ground, their earnings won't collapse.
Brilliant Brokerage Call of the Day
A few years back, Prudential Securities got out of the investment banking business. It was widely expected that without the typical conflicts of interest that other diversified investment companies faced, Pru's research department would be less biased, and therefore produce more valuable recommendations for their clients.
So much for valuable research. Prudential lifted its view on the energy sector to overweight today, and slapped a buy rating on shares of ExxonMobil (it was rated neutral before). Evidently their energy analysts see something fundamentally favorable to the big oil stocks, as of this morning. I'm sure Pru's clients are thrilled with such a timely call.