Dot-coms may be dropping like flies, but oil stocks are riding high. Industry-wide rises suggest a sustainable resurgence in the fortunes of the sector, with oil companies suddenly the unlikely poster children for an old economy love-fest.
Many oil stocks have enjoyed significant rises with big names like Exxon, Shell and BP Amoco reporting hefty profits. But are these improvements the sign of a thoroughbred’s return to consistent form or just a short-term flush of success while the course favors this particular mount? And how has this affected IR managers, who – for the past few years – have been so accustomed to shouting into the deaf ears of buy-side analysts?
Texaco’s vice president of IR, Elizabeth Smith, admits the last few months have been rather nice. ‘It’s clearly easier to do your job when there is an appreciable interest on the other side. People are actually interested in making investments rather than just listening to you politely,’ she explains. ‘People were saying the stocks are cheap and no one is listening. Now that the stocks have outperformed, people are a lot happier.’
Texaco may be atypical because it is in the middle of an acquisition and a lot of interest in the stock is coming from arbitrageurs, which obscures the view of its underlying stock performance. But Smith is also optimistic about industry fortunes generally, citing recent research reports that talk of an improvement in the oil stocks and a return to prominence for oil on the all-important S&P 500.
No one can say for certain where the money for oil is coming from, but Smith agrees that the drop in technology has definitely helped the resurgence. At times of opportunity like this she believes the IR department should focus on seeking out new investors – the portfolio manager who didn’t have an interest in the stock previously – and get them on board.
However, it’s not easy to compare oil company IR activity during the current upturn with how it was a few years ago. Five or ten years ago there was no internet, no web conference calls and no ability to post information on the company web site.
Little shift
Michael Balboa, global strategist at Greenwich Securities, would beg to differ with Smith over any possible shift from technology to oil. He says there may have been ‘over exuberance’ in internet technology stocks but there has not been any massive rally in old economy stocks such as oil. ‘Last October, November and December was the bottom for new economy stocks and, yes, a lot of the oil stocks came off pretty sharply. But the average oil stock is off about 15 percent from its high since October and the Nasdaq is off about 20 per cent since the same period. The difference between the two is not really that dramatic,’ he explains.
Ironically, while the dot-com bubble may have burst, Balboa suggests that certain new economy companies may actually be enjoying the benefits of an oil industry resurgence – particularly those software companies that have aided oil company moves to streamline and rationalize.
He attributes this resurgence to current market trends. ‘With Opec cutting production, non-Opec oil countries have had a huge opportunity to take advantage of increasing their production at higher prices. There has been increased consolidation with fewer names, so some investors are going beyond the top five or ten oil companies and looking at some of the independent mid-caps as bigger future players.’
In fact Balboa currently has energy as a ‘sell’ in favour of technology. What’s more, he does not believe share buybacks like those initiated by Shell and BP are any indication of a sustained resurgence in oil. ‘Share buybacks have been going on for a long time – especially with US-based companies because it’s a tax efficient tool; shareholders don’t have to pay tax on it. If anything, you don’t really want to buy oil companies that are buying back their shares because it means that they haven’t got any good projects to invest the money in.’
‘If a company decides not to pay back the dividend and just buy back shares, it’s probably good but if they decide to continue to pay the dividend and also announce that they are going to buy back shares, then the question remains, Why aren’t they finding any good projects? And why are they not buying companies? There are so many cheap companies out there.’
Peter Hitchens, oil and gas analyst at HSBC James Capel, thinks he can answer this. He claims that the current oil stock resurgence is all to do with the cyclical nature of the market. ‘If the oil price goes up too strongly, the oil companies have too much money and they invest too much in the upstream side. As a result there’s too much production – something we witnessed in 1995,1996 and 1997 when the oil price started moving ahead.’
Then the oil price crashed and the industry spent 15 months on $15 a barrel. A couple of companies were on the verge of bankruptcy and everyone ‘shaved back’ their capital expenditure, which meant that the production declined and the oil price went up to $30.
Over a barrel
Hitchens explains: ‘The oil companies have done all their investment calculations on the basis of $15 a barrel, only to find prices at $35 a barrel. Cash is rolling in; they’re just wallowing in it. But they can’t actually spend it because they have done all their planning on $15. So a project that might come out at $20 which could ‘fly’ in the current environment can’t actually be sanctioned because they basically have to plan on the basis of $15.’
What’s more, the oil companies can’t build up net cash because the market is focused totally on return on average capital expended (ROACE) and they have to keep debt levels reasonably high. ‘You either make an acquisition or you return it to shareholders. The big boys can’t make many acquisitions – Shell is trying – but you can’t really do a major acquisition because you own a monopoly, so what else can you do? The answer is to return capital to shareholders. In the long term it’s cheaper to buy back shares than to pay dividends,’ Hitchens adds. It’s not a question of the oil stocks leading the charge for the old economy, he says, it’s more a temporary blip in the cycle.
Simon Henry, head of global IR at Royal Dutch Shell, says that what has buoyed the sector over the last two to three years has been consolidation and the extraction of costs. Indeed, while buoyant oil prices clearly aided Shell’s $13.1 bn profits last year, group chairman Sir Mark Moody-Stuart specifically cited ‘higher efficiencies and better service’ for such a good result and for the decision to initiate a share buyback programme.
‘Yes, the oil price has helped our upstream results, but more important to me is that efforts of the last two years have produced a powerful underlying improvement in performance. The strong cash flow resulting from all this is supporting a dividend increase in excess of inflation and a significant share buyback program which we are starting immediately,’ Henry comments.
He points out that even though Shell has not consolidated as much as Exxon or BP, it has still ‘taken out a measure of cost’. This saving is ‘at least as significant’ as the rationalisation brought about by the big acquirers, he claims.
‘I also think there has been a fundamental shift in cost competitiveness, driven by the level of competition since the advent of lower oil prices in 1999. Capital discipline among the big boys has greatly improved and there is a much tighter focus on what, where and how capital is spent. All of this does tend to drive returns.’
Henry believes it’s entirely possible that big dividend payers with either steady or growing dividends are attracting investors to make the switch from dot-coms. At the very least investors seem to view sectors like oil as safe havens.
While unable to comment specifically on Shell’s stock, he adds, ‘There’s a view that oil prices have peaked after 18 months and this has filled the coffers of the major companies. It’s believed there will be a switch away from cost cutting and rationalization and toward an appropriate growth strategy.’
In short, this means that the level of risk could be factored back into investor expectations – something that wasn’t there when everyone was cutting costs.
Award-winning IR
Nevertheless, Shell’s head of global IR believes good quality IR has helped win back investors. The profile and level of professionalism of IR within the oil industry has improved beyond recognition – a fact illustrated by BP picking up five awards at last year’s Investor Relations Magazine UK Awards. Shell hasn’t been left out, either. The Anglo-Dutch giant has twice picked up the award for most improved IR in as many years.
‘Certainly the profile [of IR] within the company and at companies within the market is much higher. More effort has been exerted largely because, back in 1998, we had a particularly demanding year at Shell and at other companies,’ Henry comments. ‘We had over £4.5bn of write-offs and nearly made a net loss in 1998. We reacted by making fairly bold statements about what we would need to achieve to put us back on a sound financial footing. We have had a very concerted communications program built around the progress made on those targets, all in order to increase the level of trust in the management of the company.’
Henry’s counterpart at BP Amoco, Greg Coleman, does not think we are witnessing anything like the sort of resurgence that might be expected given the record profits being recorded in the sector.
The $14.2 bn profits recorded by BP last time around did not prove sufficiently pleasing to trigger a more bullish response. ‘The oil sector has significantly improved performance in the 1990s compared with the 1980s but people will take some time to recognize that dot-coms do not earn money. The resurgence is more apparent in exploration and production companies but I would guess that their earnings are more volatile than the integrated oil and gas companies like ourselves,’ Coleman says.
Profit motive
But in terms of IR, big profits may be an easier story to tell for BP and others. ‘Our investors enjoy us being very profitable and competitive. Dividends are more secure and options for further performance and growth are apparent,’ Coleman explains, adding ‘As for questions about petrol prices, we do not make money retailing gasoline, so we have spent quite a bit of time explaining the structure of our industry to the press and general public.’
Though high petrol prices have been dominating headlines in recent months, this is more of a concern for consumers and for the public relations department than it is for investor relations audiences – especially when it comes to institutional investors. And contrary to expectations, Coleman doesn’t see any tangible signs that investors are switching their allegiance from dot-com stocks to oil and other sectors. But then such a switch is hard to track anyway.
That’s not the view taken by David Carey, director of IR for Gulf Canada Resources. He believes we are witnessing a renewed interest in oil stocks due to the continued outperformance by the oil and gas sector compared to other sectors of the market. ‘The continued excellent operating results being posted by the oil and gas industry are a big part of the new interest, especially when compared with other sectors of the market which continue to issue earnings warnings. I think that the recent energy problems in California have also helped focus the minds of investors on the energy industry as an essential industry,’ he says. Carey adds that oil and gas companies make up a larger percentage of the S&P 500 and the TSE 300 than they did a year ago – due in large part to the dramatic reduction in value of many technology stocks. The growth in index tracking provides further momentum as investors increase their weighting in oil stocks.
The shareholders Carey is seeing today are happier than in the past with their investments in Gulf stock, but he doesn’t think it makes his job any easier. To him, when investors come flocking back to feast on a return to form, the job is just as difficult as it was in the times of famine, when no-one came knocking at the door.
All of which suggests that the oil companies will have to keep drilling home the message if they are to strike a rich field of investor interest over the longer term.
