Hot or cold? When I'm a buyer, I'll take cold every time.
I'm naturally drawn to the market where investors are selling in
droves. Bargains are rarely found in the hot market, where buyer
enthusiasm runs rampant.
are enticingly cold right now: offshore drilling and oil
refining. I like both sectors, and I like two particularly frigid
energy stocks within the sectors.
Offshore drillers are suffering from a glut of rig supply and
a dearth of rig demand. At least that's the perception. Credit
Suisse expects that the large
that drive offshore activity are unlikely to commit the requisite
capital to keep rigs fully employed.
could be foreshadowing the future. The energy giant is expected
to reduce capital spending roughly 6% to $39.8 billion this year.
From 2015 through 2017, ExxonMobil's CAPEX is expected to ratchet
down to $37 billion each year.
If other energy giants follow ExxonMobil's lead, the dayrates
on rigs could fall. Indeed, analysts at Barclays forecast
that rates for ultra-deepwater drilling rigs - those that demand
the highest rates - will drop by 16% over 2014.
This icy outlook has certainly put a chill on my favorite
Diamond Offshore Drilling
, which is down over 30% in the past 12 months.
The above chart has warmed me to Diamond Offshore. I've seen
this game played before: Wall Street deflates offshore drillers
when utilization rates fall, and inflates them when rates rise.
But the time to buy is when rates are expected to fall, because
expectations are priced into the drillers' shares.
Negative expectations are surely priced into Diamond's share
price, perhaps excessively so. Diamond recently updated the
status of its fleet, and it was "OK" - not spectacular, but not
Despite the chilly outlook, Diamond is expected to earn $4.50
a share this year, and $5.85 next year. That produces a forward
P/E multiple of 7.7, which is on the low end of the 10-year range
of 5 to 38. At the same time, Diamond continues to earn
enough to service its $3.50 annual dividend, which yields 7.8% -
a multi-year high.
Refining is a similarly cold market, which is why Calumet
Specialty Products Partners (
) is also in the icebox. Calumet refines oil and manufactures
specialty waxes, lubricants, and oils. It sports a unit-price
chart similar to Diamond Offshore Drilling. In other words,
it sports a buying opportunity.
Calumet's low unit price is the byproduct of a perfect storm
The crack spread - the difference between the cost of oil
input and the refined output - is at the forefront. The
crack spread has declined through most of 2013. In the final
quarter of 2013, it averaged $16 per barrel of oil compared to
$30 per barrel in the same quarter in 2012. A declining
crack spread leads to declining operating margins. By the
end of 2013, Calumet's operating margins had constricted to 2.3%
Compliance costs have also contributed to Calumet's woes.
Because Calumet forgoes ethanol in refining many of its products,
it must purchase credits - known as renewable identification
numbers (RINs). The cost of these credits soared in 2013. Calumet
spent $29.6 million on credits in 2013 compared to $3.8 million
Major periodic maintenance costs, though necessary, were
another inconvenience. In 2013, Calumet spent $67 million
in maintenance and repairs to its refineries. This compares to
$14.3 million in 2012. To be sure, much of this maintenance
was scheduled, but the timing was suboptimal, given the fall in
margins and rise in regulatory costs.
When these negatives are aggregated, the impact becomes
apparent on the bottom line. In 2013, Calumet generated a
$0.17-per-unit loss compared to a $3.50 profit the year
I don't expect another perfect storm in 2014; I do expect
cash-flow growth. Thanks to recent acquisitions - Royal Purple
among them - and organic CAPEX, Calumet management forecasts a
surge in cash flow. The partnership will generate between $190
and $215 million in additional adjusted EBITDA annually over the
next three years.
If we add $200 million to the $242 million in adjusted EBITDA
generated in 2013, we get $442 in adjusted EBITDA for 2014. This
is more than enough to cover Calumet's $2.74 distribution per
unit, which yields over 11% on the current unit price.
Buying into the cold market isn't for the faint of heart. But
if you can muster the fortitude, it frequently leads to strong
investment gains once investor sentiment thaws.
Disclosure: Stephen Mauzy owns Diamond Offshore Drilling
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