Big Oil, Big Headaches, and Big Opportunities

Posted by Money Morning

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imagesA three-day rally in crude prices last week is giving investors hope that the collapse in oil prices is over, and the market is reacting with strong moves to the upside in “Big Oil” stocks.

However, it may be too soon to draw either a correlation or conclusion; oil inventories and futures markets suggest that oil prices could easily head back down before stabilizing later this year (we saw a glimpse of this early Wednesday). The share price drops have significantly affected the “Oil Patch” sector, with the Energy Select SPDR ETF (NYSE Arca: XLE) down 26% since peaking at $100.93 on June 20, 2014.

Is an oil price rally for real, or just a head-fake we need to ignore for now?

The answer may just surprise you… and help you profit.

Big Oil Revenues Are Dropping Faster than Oil Prices

It should come as no surprise that lower oil prices are hurting the earnings of big oil companies.

Exxon Mobil Corp. (NYSE: XOM) reported a 21% decline in fourth quarter (12/31/14) revenues and profits due to lower oil prices. The company earned $6.57 billion in the quarter, its worst showing since the first quarter of 2010, on revenue of $87.28 billion.

A year ago the company earned $8.35 billion on $110.86 billion of revenues. On a per-share basis, Exxon’s fourth quarter earnings were down 18.3% to $1.56 per share for the fourth quarter but were up year over year by 3.1% to $7.60 per share.

Meanwhile, Chevron Corp. (NYSE: CVX) earned $3.5 billion in the fourth quarter (12/31/14) on $42 billion in sales, and $19.2 billion for all of 2014 on $200 billion in sales.

These figures were sharply lower than a year earlier when the company earned $21.4 billion on $220 billion of revenues. On a per-share basis, the company earned $1.86 per fully diluted share in the fourth quarter of 2014, down 28% from a year earlier.

For the full year, Chevron’s per-share earnings dropped by 8.6% to $10.14 per share. Clearly the earnings decline was back-loaded as oil prices collapsed over the back half of the year.

The falling price of oil foreshadowed the downward momentum of share prices, with investors watching the slow, but steady, trend lines sliding ever lower.

Indeed, since peaking at $104.38 on June 23, 2014, Exxon Mobil stock has dropped to $89.58 on February 2, a 14.2% hit.

Similarly, Chevron stock peaked at $134.85 on July 24, 2014, and has since fallen to $106.06 on February 2, an even larger 21.3% pounding.

The pattern is similar for many of the majors – lower oil prices equal lower stock prices.

Here’s How Big Oil Responds in Crises

The oil majors are responding to the collapse in the price of their primary product by reducing or suspending stock buybacks and cutting capital spending.

Both of these moves will have serious ramifications for the markets and the economy.

When it comes to capital spending, the majors are still committed to huge projects around the world that they can’t cut back, but will make major adjustments as necessary.

Already we saw Exxon Mobil spend $6 billion less on capital and exploration projects in 2014 than the year before, reducing those annual expenditures to $38.5 billion from $44.5 billion.

We can expect that figure to be even lower in 2015.

However, Exxon Mobil is moving ahead with new projects in Romania and Argentina, and capturing new acreage in Canada, Africa, and the North Sea. It is also moving ahead with longstanding projects in Russia, Abu Dhabi, and the Gulf of Mexico designed to boost oil and gas production.

Chevron said it would cut its spending by $5 billion but will still shell out a hefty $35 billion on major projects, including shale projects for which it is committed, in 2015.

Other majors are also reducing their CAPEX spending by large amounts, while still spending big bucks. ConocoPhilips (NYSE: COP) is lowering spending on new oil and gas projects by 15% and Occidental Petroleum Corp. (NYSE: OXY) by 33%. But these companies are like giant tankers sailing the world and can’t quickly change course when they encounter a storm. They have to plan for what happens when calm seas return.

While capital expenditure programs are difficult to simply cut on a whim, stock buybacks are much easier to cut back on a dime.

Exxon Mobil announced that it was reducing its stock buyback program by two-thirds to $1 billion this quarter (it bought back $3.3 billion of stock in the final quarter of 2014) while Chevron announced that it was suspending its share buyback program for 2015 after buying back $1.25 billion in the fourth quarter and $5.0 billion in all of 2014.

Stock buybacks have been major factors in supporting stock prices over the past couple of years.  Their absence will be significantly felt, especially if oil prices remain weak in the months ahead.

After muddling through a gain of just over 2% in the past year (well below the S&P 500’s 17.2% gain over the same period), Exxon Mobil stock now trades at 12.2x earnings and pays a 3.0% dividend. Chevron stock suffered just north of a 1% drop over the past year, and is slightly cheaper at 10.8x earnings but pays a higher 4.0% dividend.

As always, the question is when to buy stocks that have dropped as much as these have over the past seven months. Given the poor earnings announcements, cutbacks in capital spending, and slowdowns in stock buyback programs, it is too early to dive into the beaten down stocks of the oil giants with fresh money. Investors expecting a near-term pop may be disappointed since oil prices are unlikely to recover quickly.

However, Exxon Mobil and Chevron stock are trading at reasonable valuations while still paying attractive, and increasing, dividends. Investors are unlikely to be hurt if they’re already in the stock, and plan to own these shares for a period of years.

For those of you already in the stock as long-term shareholders, hang on… It’s going to be a bumpy ride!