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Big Oil Earningspalooza -- Who Stands Out?

Jason Hall, The Motley Fool

It's a bad time to drive a truck, but it's a great time to be a supermajor. In this week's episode of Industry Focus: Energy, host Michael Douglass and Motley Fool contributor Jason Hall take a look at this quarter's earnings from Chevron (NYSE: CVX), Royal Dutch Shell (NYSE: RDS-A) (NYSE: RDS-B), Exxon (NYSE: XOM), and BP (NYSE: BP).

Tune in and find out how all these companies did in terms of growth, earnings, and all those other big numbers (and, boy, were they big); how some of their past bets are panning out today; what investors should watch in these companies going forward; and, of course, which of the supermajors stands out from the rest in an environment where everyone's doing riding high.

A full transcript follows the video.

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This video was recorded on Aug. 2, 2018.

Michael Douglass: Welcome to Industry Focus, the podcast that dives into a different sector of the stock market every day. It's Thursday, August 2nd. We're talking about major oil company earnings. I'm your host, Michael Douglass, and I'm joined by Jason Hall. 

As a reminder, we've shifted the lineup here in Industry Focus a little bit. Sarah Priestley has left Industry Focus, I've joined the Energy and Industrials show on Thursdays going forward, and Shannon Jones has now taken over the Financials show for me. She's going to do really great things with that show. I'm really excited for her. And, Jason, I'm really excited to be here with you to talk about big energy companies.

Jason Hall: Me too. I think we can call them supermajors. We're going to talk about the big guys.

Douglass: Yeah, the really big ones. In terms of thinking about our conversation, we're going to talk about each of the big ones specifically. That's Chevron, Royal Dutch Shell, Exxon and BP. Then, we'll step back and think about general takeaways and the major conclusions we can draw. That's how we're going to structure things today. 

Let's start with Chevron. As we're probably going to say for most of them, pretty good earnings. Revenue was up 22% year over year. Net income and earnings per share more than doubled. Operating cash flow up nearly 50%. In general, a pretty good quarter for Chevron shareholders, and definitely a reflection of recovering oil prices.

Hall: It's funny, what happens when oil prices go up 48% year over year. If you look back, in the middle of the second quarter of the year, oil prices were up almost 60% from where they were during that same period the year before. As we go through this, you're going to see, that's what's driving the earnings and cash flows for the supermajors right now.

Douglass: It's funny, you look at these really big companies and you think diversification. Once you get to a certain market cap, there's this assumption that you do a lot of different things. To some extent, they do a lot of different things, but they're still very heavily levered to one thing, which is the price of oil. 

With Chevron, what we've seen here is, year over year, U.S. upstream basically swung from negative to positive earnings. That right there takes what was a big drag on profit and turns it around. International upstream is their biggest segment by a long shot, that more than doubled. In fact, it's bigger than the other three combined. 

Hall: It's going to continue to grow, too, because they have those major international LNG export facilities they're adding capacity to. So, that's going to grow. Here's a thread that we're probably going to see for the rest of them, maybe not as much for Shell, but definitely Exxon and BP -- we're going to hear about U.S. production, shale, the Permian Basin. We're going to hear a lot about that, because that's where there's a huge amount of production growth that's happening. It's filling a lot of global demand for oil right now.

Douglass: Right. And you see Chevron really focusing in on that upstream production and continue to divest on the downstream side, because they're really looking to take advantage of these soaring oil prices; and, frankly, the big opportunity with shale in particular, get low break-even price assets.

Hall: There's a couple of things. The break-even, especially the Permian Basin, Eagle Ford, a few other shale plays in the U.S., the ability to turn them on very quickly is huge, too. You think about these supermajors, they've generally had experience in offshore, they've had experience in the Middle East and traditional plays. They've been slower to move into shale because shale has been so expensive to produce, historically. The technology has gotten better, they've refined the processes a lot. With shale, you can start drilling a well and then literally within weeks, you can be at a point where you produce oil. With offshore, we're talking, at a minimum, years, and sometimes decades, for some of these major offshores. So, the ability to get a quick return is a huge thing that's driving a lot of the shale investment that we're seeing.

Douglass: And other thoughts specifically on Chevron? Or should we turn to No. 2, Royal Dutch Shell?

Hall: One thing I like about Chevron is -- when we get to Exxon, you'll hear a counter-story -- Chevron has done a really good job of focusing on LNG vs. natural gas production. That's been a big boost for its earnings over the past number of years. It spent a lot of money to get there, but it's a nice thing they've done that's worked out well.

Douglass: By the way, folks, that's Chevron, ticker symbol CVX. I'm going to try to do a better job of mentioning the tickers as we're getting started. 

The next company we're going to talk about is Royal Dutch Shell. If you're doing the ADRs here in the U.S., it's RDS.A. In a lot of ways, a similar story, in terms of your top and bottom lines. Revenue was up 37% year over year. Earnings got very close to quadrupling, [laughs] which is wild. Their integrated gas segment tripled, with natural gas being a big focus for them. As we've discussed with Chevron, a big growth opportunity there.

Hall: One thing to throw out there, there are actually two tickers. There's RDS.A and there's RDS.B, as well. The difference is the way that they pay the dividend for each of those. I think that most U.S. retail investors tend to gravitate toward the B share. When I've owned the company in the past, that's what I owned. I suggest investors take a minute to read the difference between those two and determine what's best for them, if you decide to establish a position in Shell. I just wanted to throw that out there.

Of all the supermajors, in recent years, I don't want to use the term "turnaround," but there's definitely a bit of a turnaround that's happened with Shell. This a company that, you go back a few years ago, it had a pretty high amount of leverage, its assets were really expensive in terms of the cost of production, it was just treading water. At the worst of the oil downturn, it made a big move and acquired BG Group, more of a natural gas focused-producer. It started selling off other non-core assets, brought its cost of production way down on the oil side, as well as the added production on the natural gas side. 

In terms of the supermajors, Shell has been my favorite for about a year. I think, in terms of its prospects, where it sits in the sector, I really like Shell a lot. It pays a great dividend, it has a solid yield. And, I mean, look at its cash flows. $9.5 billion in operating cash flows. As you said, basically quadrupled earnings. And it can continue to be profitable, even if oil prices don't necessarily trend higher.

Douglass: Yeah, because they've done a good job of divesting some of those non-core, higher-cost assets. One other thing that we'll note, this is a thing to note with this quarter's earnings, Royal Dutch Shell, when they bought BG back in 2016, there was a significant amount of share dilution as a result of that. They paid a lot of shares for it. They've just announced a $25 billion share buyback program to reverse a bunch of that dilution. 

Of course, here's the problem -- you're buying back those shares at a 40% premium or so to what you issued shares for BG back in 2016. So, of course, there's some element of inefficiency in the financial engineering there. But, at the same time, at the time, that was the way to get BG Group, and that's driven so much of their growth. It's an acquisition that made a lot of sense, even if that dilution is being reversed in a comparatively inefficient way today.

Hall: Right. I think it's also worth mentioning, you and I talked about yesterday, the share price was certainly much lower when it issued all of those shares. But in 2016, when it acquired BG Group, it was paying a discounted priced based on where the oil and gas market was, where the downturn was. Looking at it on paper, it's not as sharp as it might appear. It paid a fair price, even though it was using a discounted share price for a lot of its acquisition.

Douglass: There's some Buffett quote about that, right? Fair price, good business. [laughs] 

Hall: The reality is, when it comes to share issuance and share buybacks, companies are rarely super good at their timing. We have to acknowledge that.

Douglass: Yes. Certainly, folks who listen to all five shows have heard me on Financials talk about share buybacks and how poorly timed they can be. That's its own long conversation. 

Let's turn to Exxon. Interestingly, Wall Street, not exactly thrilled. And yet, revenue was up 27% year over year, net income up around 20%, operating cash flow fairly in line with a year ago. Not as strong of growth as we've seen from the other two, but still, by most measures, a fairly good quarter.

Hall: Exxon is interesting. To a certain extent, no good deed goes unpunished with Exxon. This a company that has historically generated some of the highest returns in the industry. It's return on invested capital has always been near the top, if not the top, of all the integrated majors. The past few years have not been that good for ExxonMobil investors, partially because of the oil downturn. But, this is a company that usually does things better than everybody else, and it's held to a higher standard. 

Right now, Exxon is dealing with, on the natural gas side -- if you look at its production, which has fallen a little bit, most of its production declined. This is probably the biggest thing that investors are complaining about. Almost 10 years ago now, it bought XTO Energy. It made it the largest natural gas producer in the United States. That was something a lot of people didn't know about the company, it's the biggest natural gas producer in North America. But natural gas prices have trended lower. A lot of the XTO assets were higher-cost production. It's a big producer, but it wasn't making much money in this particular area. As its production has fallen over the past few quarters, based on its strategy of getting away from those high-cost assets, it's affected the business. 

So, why is the company not growing production? Oil prices are in the 70s, pushing 80s, we're hearing people say we might see 100 before this is all over. The counter I have to that is, it seems to me, the best time, if you're going to make strategic changes, if you're trying to reduce your high-cost assets and shift your business toward better-returning projects, why would you do that when oil prices are high, and it has a lesser impact on your bottom line? That's my view.

Douglass: The other piece of that is, when oil prices are high, people are willing to pay up for those higher-cost assets. If your break-even is $100 and oil prices are $40, people aren't going to pay much for those assets. But, things get interesting for other investors when prices are at $120. Of course, that's not a prediction, that's just an example.

Hall: [laughs] I'm writing this down, Michael.

Douglass: [laughs] Five years from now -- no! No, no, I've done some predicting of the future in the banking industry, and we'll see how that turns out. That's all I'm going to be pegged to right now.

Hall: What's the saying, pundits don't predict because they know, they predict because they're asked? I read that somewhere.

Douglass: [laughs] So, in this case, I got voluntold into a prediction. That's not a prediction, just to be clear, no question about it.

Hall: I promise I won't hold you to it. At least not for two years. I want to give a hat tip to Tyler Crowe, one of our colleagues who covers these supermajors really closely every quarter. He and I and Matt DiLallo, another one of our Energy colleagues, we have a long-running conversation. The way they look at ExxonMobil is, it's positioning itself for 2020 and beyond. Guyana, Mozambique and Brazil, that's where it's really investing some long-term capital in developing some new oil and some LNG, as well. Over the next two years, we'll see what happens. I think if you look long-term, and you're a long-term bull for oil and natural gas, ExxonMobil is really interesting right now if you're looking for investments.

Douglass: Alright, Jason, let's turn to BP. Just like everyone else, revenue was up a lot year over year, earnings were up a lot year over year. In this case, revenue was up nearly 40%, and earnings were up -- I kid you not -- twenty-fold. That's off, to be clear, a very low per-share base. Operating cashflow up 29%. A big upstream swing toward profitability. That's one of the big pieces of the story here for BP.

Hall: Historically, BP has always focused on offshore. We can go back to the Deepwater Horizon and all that stuff. Even after that, the company is still focused on offshore. It makes big investments offshore. It takes forever for those assets to be produced. When they start pumping oil, the cash costs are very low, they get really good returns, and it's taken the company basically a decade to get to where it is now.

Speaking of predictions, I made a silly prediction a few years ago, as BP's cash stockpile started growing, that it was going to make a big move into onshore assets. I was joking around, but what did BP just do? Spent $10 billion to buy a big chunk of Permian Basin assets. The idea is, those are quick-turn, relatively low cost, and it's a great way to swing your oil production, when there's opportunity. So, that's what's going on with BP.

Douglass: One thing we should note about BP, it has a significant equity stake in Rosneft, which is a Russian energy company, and they've had more than a double on profitability from that equity stake. Just something to consider and be aware of, as well. It's one of those things I think most people don't know about BP, that to some extent, they're invested in this other company.

Hall: You mentioned the equity stake in Rosneft, I think it's important for investors to remember, that equity stake shows up on the books. When it gains in value, the company shows a gain, but it doesn't actually get cash flow. It owns an equity stake in the company. The value goes up as value to BP's assets, but it doesn't actually put extra money in the bank. That's really important. 

This carries over to all of the supermajors. You want to look at operating cash flows, not just GAAP earnings. There are so many different things that can move the needle, in terms of earnings, up and down that might be non-cash, based on something that happened, capital investments two years before, but now it's a non-cash thing that they're booking. So, be aware of that. That's an important thing to factor in. Cash is king with these businesses, that's definitely the key.

Douglass: And the differences between earnings and cash are always critical to know and be aware of. It's king in this industry. In other industries, it's not necessarily, but knowing the difference is always important for getting a clear understanding of the investment thesis and what's going on with the business. 

Let's take a step back. We've talked about these four supermajors, and to some extent, we've already given some guidance as to what our general takeaways are going to be. Obviously, one of the first big things here is, rising oil prices lifts all boats. Not shocking, especially given that a lot of these companies have fairly flat, or even, in some cases, down, oil production. It's just, when the prices go up this much, profitability ensues.

Hall: It's really interesting, what's happened over the past few years as we've come through this. You go back to 2014, oil prices were $110-120. Early 2016, we were in the low $20s. Oil prices fell by almost $100 a barrel at one point over a 2.5-year period. Here we are today, and oil prices have moved up 60% over the past year. 

It's really impressive, if you look at the discipline that these companies are showing. They're not racing out to blow up their production, because you get the boom-bust cycle. The discipline has been really interesting. It actually kind of started with OPEC. It controls a third of global oil production, hasn't pushed its production way up as oil prices have gone up. So, there's this really great discipline that's carried over through the entire industry. It's great for the oil companies, it's great for investors. It might not feel so good at the pump for the rest of us, but it's definitely been good for profitability in the industry.

Douglass: Right. Something we've talked about already, a lot of emphasis on shale. As you noted, it's a quick-turn, very profitable even at low prices. There are a lot of reasons to really like that as an investor. Interestingly -- this is something we were talking about before the show -- there's this issue where there's not enough infrastructure in the area to get all the oil created out of the region. You actually have this pretty substantial difference in prices near these fields vs. the rest of the country.

Hall: The interesting thing is, if you look at ExxonMobil, which has a pretty large refining presence in the U.S., that's actually a benefit and for some of the other regional refiners and more pure-play refiners, because they're able to buy that Permian oil for cheaper, because of the glut. Then, gasoline prices, jet fuel prices, are based on Brent, which is a little more of a global standard. There's something called a crack spread. Refiners in the refining operations for some of these supermajors are actually benefiting because it's deflating the price of oil in the Permian right now. 

That's something investors should really watch. The midstream companies are investing billions to try to get pipelines out into the Permian. There's going to be a ton of pent-up demand for oil to come out of that. I think we could see investments in production in the Permian two or three years from now be even greater as the infrastructure finally gets rolled in to get these things on the national pipelines.

Douglass: Yeah, and a nice opportunity for the mid streamers, in general. I suspect that's going to be its own episode in the not-too-distant future.

Hall: Maybe we should do a show on that.

Douglass: They're all part of the same industry, we might as well. One of the other things, Jason, that you pointed out, when we were chatting about this, it's really interesting to see the differences between Shell and Exxon right now, in terms of divergent strategies and how that's paid off, or not, as the case may be, for both of those companies.

Hall: Absolutely, it's what a difference the timing makes. That's what it boils down to. Shell made that big, bold move to buy BG Group when it did, at the bottom. That scared a lot of investors off, the stock price was way down. I think, at one point, Shell's dividend yield was 9.5% for a couple of months because of fears that it wouldn't be able to meet its debt obligations after acquiring BG Group, so it was going to have to cut its dividend. Fast forward to today, it's hugely profitable, massive cash flows, going to throw a ton of money back at buying back shares, the dividend is really sustainable. It's funny. At the same time, Exxon has just muddled along. Who would have thunk it?

Douglass: We're an investing podcast. Thinking about these four companies, which one is your favorite coming out of earnings? What are the key things you think people should be watching and looking out for in that company's execution in the coming year?

Hall: If I was going to buy right now, if you were going to throw a couple of thousand dollars in my brokerage account for me and say, "Buy one of these four stocks," I would probably buy Chevron. I think it's in the strongest position now and long-term, in terms of bringing its production costs down. Its cash flows are really good. It's in a position to continue growing production while it's still selling off assets. I think it's hitting on all the major things you want to see from one of these majors right now. And, oh, by the way, it's yielding 5.5%. That's good.

I think I would put ExxonMobil at a No. 2 right there. There's a lot of uncertainty. The market's disappointed, so the market's disappointment is priced in to where the stock is right now. You fast forward two or three years from now, investors should probably do really well if they'd bought ExxonMobil today -- with the caveat that sometime between now and 2020, the stock price could continue to trend down. It could have periods where it goes down. Production is going to continue to decline as it intentionally doesn't invest in assets their higher-cost, because it doesn't do itself any favors; and, as it sells off some of those other assets. And, its long-term projects haven't started to come online to offset those volume declines. So, especially if oil prices fall, if oil prices fall 10-15% from here, Exxon's earnings aren't growing anymore, they're going to go the other way. With that reality in the short-term, I think there's opportunity in the long-term.

BP, let's see if they can do this thing in the Permian. It's never really been their strength, in onshore. This is their first big move into shale, and it's a big move. So, let's see if they can really generate returns from that. Some investors think they overpaid for what they just bought by a pretty substantial amount. Only time will tell.

Douglass: Their goal is to get break-even price for production down to $35-40 a barrel by 2021. If they achieve that, that gets very interesting.

Hall: I mean, that's two and a half years out there. There's hell of a lot that could happen in the oil and gas market in two and a half years.

Douglass: It's definitely an exciting time to be in this industry and watching the transitions as oil prices finally recover. I, at least, didn't think they would be as depressed for as long as they were. I certainly thought things would turn around maybe a year or two sooner than they have begun to. It's good to see that moving forward, and investors returns matching those.

Folks, that's it for this week's Energy show. Questions, comments, you can always reach us at industryfocus@fool.com. As always, people on the program may have interests in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so, don't buy or sell stocks based solely on what you hear. This show is produced by Austin Morgan. For Jason Hall, I'm Michael Douglass. Thanks for listening and Fool on!

Jason Hall has no position in any of the stocks mentioned. Michael Douglass has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.