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By Jeremy Glaser and Christine Benz | 01-22-2016 06:00 AM

Be Selective in Perilous Energy Sector

Exxon's capital-spending pullback is just one more reason for investors to be prudent when considering beaten-down energy names.


Christine Benz: Hi, I'm Christine Benz for Morningstar.com. Welcome to The Friday Five. What do the earnings of a bellwether energy company say about the sector's prospects? Joining me to discuss this and other market news from the past week is Morningstar markets editor Jeremy Glaser.

Jeremy, thank you for being here.

Jeremy Glaser: You're welcome, Christine.

Benz: Let's start with ExxonMobil. Discuss their earnings and talk about what they might say about the prospects for the energy sector at large.

Glaser: ExxonMobil has said this, and now they are showing it clearly with their actions. They expect oil prices to be low for a long time. Even if they have somewhat of a bullish case that oil will eventually come back somewhat--if not all the way to where it was--they are getting used to this world where we are going to have very low oil prices for a while, and they are doing this by cutting capital expenditures and suspending their share buybacks.

This is unusual for them to cut capital expenditures. Allen Good, our energy analyst, sees Exxon as a company that's prided itself over time on being able to invest fully throughout the oil price cycles, so they would be ready to take advantage of when oil prices rise, because they'd have that capacity and they put that groundwork in.

So, the fact that they are stepping away from that, not out of financial necessity but out of prudence, is a sign that management really does see that oil prices are going to be low, and they were not just paying lip service to that.

Like I said, Exxon is positioned well to handle this for quite some time financially, but they are definitely making those changes in order to be fully ready.

Benz: In terms of our analysts' outlook for the energy sector, it's obviously a broad basket, but do they see value there at this point?

Glaser: It's very individual stock by individual stock, individual company by company. There are firms like ExxonMobil that do have the financial wherewithal to handle very low oil for a long time. It's in 4-star territory now, but we think it looks more attractive.

But others might be more exposed and might have less financial stability that could get into trouble with very low oil prices, and they see some concern there. It's definitely a sector right now that you've really got to be very cautious about selecting the right stocks or picking a manager who understands energy and is not just buying everything, and overloading on energy. This probably still isn't the time. We just aren't seeing the kind of values we would want to see for any kind of outsized exposure to the sector.

Benz: Chipotle is a name that has been weighed down by food-safety worries. It weighed on its most recent earnings report. Let's talk about that and, on a forward-looking basis, what we're thinking about Chipotle.

Glaser: Chipotle had a rough quarter, and we knew that going into the actual reporting, given the E. coli issue they have been having and all of the bad press about these food safety issues. The question is less, were they going to see this downdraft in sales? Obviously, they were. It's more about when does that start to turn around, and how do you think about the long-term value of Chipotle?

We don't think it's going to turn around immediately. RJ Hottovy, our analyst, thinks 2016 is going to be a rough year for Chipotle. Even if all the problems are behind them, and there are no new cases of food poisoning, you're still going to have investigations into the company, and that's going to be dominating headlines and consumers' minds. But he thinks that once you get into 2017 and beyond, there is still room for growth. This is not a company whose growth days are behind it. Consumers will see the investments they are making, and he thinks that the brand equity they have built up and the competitive advantage they have will allow them to return to growth, but probably not until a few years from now. He thinks that's opened up an opportunity for long-term investors. If you can ignore some of the short-term pain, some of the short-term volatility, you could be rewarded in the end.

Benz: Alphabet, which is the parent company of Google, briefly overtook Apple in terms of market capitalization. Let's talk about what's going on there.

Glaser: It really is Google that's driving those results. Google had another strong quarter. Revenue growth was up by 18%, and that's including the currency impact; it was even above that on a currency-neutral basis.

Also, they are showing that they are relevant in mobile. If you think about Google, desktop search was their first big product, and they have shown that they have moved past that. … Their investment in Android and the success of Android is helping them have a big mobile presence as well. That's obviously increasingly important. They are seeing good ad growth there.

This quarter was the first time that we got a breakout of what the Google business looks like but also these "Other Bets…"

Benz: Driverless cars.

Glaser: Exactly. All of these types of businesses. As we expected, it's a very small part of the business, less than 1% of revenue. There is more cost there because they are investing a lot. But it's nothing that seems like it's going to move the valuation one way or another. There were no big surprises in seeing this split out, but it is still nice to see this additional disclosure. It helps focus on the key drivers of the core business and not have to worry about trying to back out some of these other investments. So, it is nice to see this additional disclosure.

Benz: Within the cable sector, there has been a lot of handwringing about people cutting their cords, getting rid of cable TV. Do Comcast's latest earnings indicate that they are bucking that trend?

Glaser: Comcast had a good quarter, and I think you can add this to our ongoing series of "Wide Moats in Action." They were able to use their competitive advantages and really convince people to sign up for video service. They had net adds in cable, something they haven't seen in a while, and also lots of new Internet subscribers. Overall, in terms of the subscriber base, it was the best quarter they have seen since 2006 and bucks some of those big trends.

But Mike Hodel, who is our telecom analyst, doesn't think this is a sign that they are immune from cord-cutting or that the industry as a whole is turning a corner. We had bad video results or not-so-great video results from the likes of AT&T and Verizon. I think this is a sign of Comcast showing its strength, and showing that some of its new technology is exciting for consumers; they are signing up for it, and closing some of the gap that had existed for some time. Overall, it's a strong quarter from Comcast.

It's not a cheap stock right now, but it's … a company that's always traded at a premium valuation, and it's probably as cheap as it's been for quite some time. The intrinsic value keeps building. So, if you have been looking for a while, maybe this is an OK entry point, but it's certainly not inexpensive by any stretch of the imagination.

Benz: We had a peek into the auto sector this week with some January auto sales figures as well as GM's earnings report. Let's talk about that and what those two sets of figures say about the health of the auto industry.

Glaser: The auto industry remains healthy. It's been a bright spot for a while now. When we've been worried about other parts of manufacturing, auto sales have continued to be strong, and that seems to have continued into 2016.

There was some inclement weather in January; there were fewer selling days, so it's not exactly an apples-to-apples comparison. But overall, the seasonally adjusted selling rate looks like we're on pace for 2016, at least as of now, to be similar to 2015--flat--which would be great given how strong those results in 2015 were.

We're just not seeing signs that the auto industry is on the downslope yet. A lot of that is being driven by light trucks--SUVs, pickups--as cheap gas is getting people out there to buy those big [vehicles]. Actually sedans are seeing a little bit more weakness. But overall, it looks pretty healthy, and we saw that in GM's results as well--a strong quarter for them. Even with some of the currency headwinds and other things that are out there, they still had a very good quarter.

Dave Whiston, our GM analyst, thinks there is even more room for improvement in terms of profitability at GM, and he sees the shares as undervalued.

Benz: Jeremy, it was a busy earnings week. Thank you so much for being here to share your insights.

Glaser: You're welcome, Christine.

Benz: Thanks for watching. I'm Christine Benz for Morningstar.com.

 

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