Friday, September 23, 2011

Why Integrated Oil (Chevron) Is Up and Drillers Are Down

When it comes to the stock market, not all oil companies are created equal. For instance, drillers like Transocean (NYSE: RIG) and Diamond Offshore (NYSE: DO) have fallen 18% and 14% respectively in 2011 while integrated energy colossus Chevron (NYSE: CVX) has only dropped 1%. Why?

The answer can be found by looking at what drives their profits. For example, offshore drillers operate platforms that float over oil deposits beneath the ocean floor. Companies like BP (NYSE: BP) pay offshore drillers a daily rate to drill in search of oil. The goal of companies that hire the offshore drillers is to find the oil and get it pumped out as fast as possible so they can minimize the day-rate they're paying.

Of course, BP and Transocean got into a bit of trouble back in 2010 when a Transocean offshore oil rig, the Deepwater Horizon, that BP had hired blew up. This led to a massive cleanup and a moratorium on drilling in the Gulf of Mexico. That moratorium on drilling cut way back on the number of rig-days that Transocean and its competitor, Diamond Offshore, got paid.

The financial results are not pretty. In 2010, Transocean's net income plunged 69% to $988 million thanks to the loss of that rigs income and the moratorium in the Gulf. And in the second quarter of 2011, Transocean's net income plunged 50% to $155 million while only 55% of its fleet was being used.

The numbers for Diamond Offshore are not that much better. Its net has fallen 31% in the last year while its revenues are down 9%. But in the second quarter of 2011, it reported higher profits of $267 million -- up 8%. The bad news, that spooked its stock, is that management forecast more rig downtime -- 1,004 days in 2011 and 869 days in 2012.

Chevron is a different story. It has many different ways to make money -- including the refining and marketing of oil. If Chevron can keep its cost of buying crude oil low enough and keep its refineries operating close to full capacity then it will likely make a big profit when it subtracts these costs from the price it gets from consumers at the pump.

That spread worked quite nicely for Chevron in the second quarter. Its profit spiked 43% to $7.7 billion on revenue that climbed 31% to $66.7 billion as higher oil and gasoline prices made up for a decline in oil production.

But that's all history. Should you buy any of these stocks? Consider Chevron but avoid the offshore drillers. Here's why:
  • Chevron: profitable company, expensive (?) stock. Chevron revenues are up 19% in the last year and it earns a solid 9.9% net profit margin. Yet its Price-earnings-to-growth ratio (PEG) is a high 3.95 -- 1.0 is fair value -- on a P/E of 7.9 on earnings forecast to grow 2% to $13.75 in fiscal 2012 after a 42% rise in 2011. If you think Chevron's 2012 earnings growth will be better, then the stock may be cheap.
  • Transocean: unprofitable company, expensive stock. Transocean revenues loses money: it has -1% net profit margin. And its PEG is undefined because it trades at a P/E of -129 but its earnings are forecast to rise 63% in 2012 to $5.75. If you like betting on a turnaround -- this could be one to consider.
  • Diamond Offshore: profitable company, over-priced stock. Diamond Offshore earns a whopping 29% net profit margin. And its PEG is undefined because it trades at a on a P/E of 8 on earnings forecast to tumble 20% in 2012 after a 10% decline in 2011.
If you had to bet on one of these, I'd go with Chevron. But if we have a recession coming up, then its earnings growth might be on the low end and that would make its stock over-priced. The offshore drillers look questionable unless demand for their services spikes.


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