A few energy companies have shown strength even when oil prices were at per barrel. A closer look reveals sound management decisions and strong asset management underpin those good results.
For example, EOG Resources Inc. (EOG) said it could remain profitable with oil prices as low as per barrel. (See also: EOG Sees Profit Even If Oil Prices Fluctuate.)
Management has made some bold moves. EOG acquired Yates Petroleum, giving the company a presence in the Delaware Basin that will allow for larger rigs. In addition, EOG has focused on premium sites that have high productivity with lower costs. This move paid off long before oil rose to . Moreover, the company forecasts that even if oil reaches per barrel, its return on equity (ROI) will be 100%.
In contrast, Denbury Resources Inc. (DNR) has been struggling with cash flow and debt problems. The company does not have enough cash flow to service its current debt. In addition, Denbury made a deal on its debt that hides interest liability. The deal treats debt interest as new debt so the company does not have to count interest as an expense on its books.
None of this means that EOG is a guaranteed winner and DNR cannot recover. It does mean investors need to understand company health when buying energy stocks and should not simply assume that all energy companies will do well if oil prices rebound.
If indeed the market sees better oil conditions six months ahead, now is the time to perform due diligence on energy companies.
On October 23, Saudi Arabia’s oil minister, Khalid al-Falih, expressed optimism that the recent decline in oil prices is coming to an end. He based that optimism on what he sees as a better balance between supply and demand.
Put this announcement in the context of the International Energy Agency forecast that the current oil oversupply will end sometime in 2017, and a rough timeline for rebounding oil prices starts to emerge.
The stock market tends to respond to potential changes about six months before they actually occur. That could mean a rally in the energy sector soon if a majority of buyers believe oil prices will rebound before mid-2017.
So what is an energy investor to do? Can you simply throw a dart at a list of energy stocks and expect any pick to do well in a rally?
Due diligence still counts. While some struggling companies may indeed join a rally if it develops, long-term gains still depend on company fundamentals such as increasing revenues, income growth and the ability to service debt.