By Martin Currie analysts and fund managers
A year ago, the oil price – having spent much of the first half of 2014 around US$100 per barrel – was in freefall. Twelve months on the slump shows no sign of ending. The impact has been calamitous for many companies with direct exposure to the oil industry, but elsewhere there have been clear beneficiaries.
Oil and oil services
With US supply at the centre of this crisis (a result of a resurgence in US oil production thanks to shale oil), it is from here we also expect the solution. Shale oil is short cycle in nature and this, coupled with a reduction in capital spending, will lead to a new balance being found (at higher oil prices). Stockpicking is tricky in this environment. Any company exhibiting three key characteristics – balance-sheet strength; capital efficient growth; and exposure to low break-even acreage – will be well positioned for an upturn in the oil price while maintaining flexibility for opportunistic mergers and acquisitions (M&A).
Industrials
The industrials sector has been one of the hardest hit by the fall in oil and gas prices and the dramatic fall in industry investment levels that have followed. As oil companies have rapidly reined in their investment plans over the last 12 months, demand for these products has collapsed and revenues of companies that make them have been under significant pressure. The collapse in the oil price has also negatively impacted broader investment levels in the regions that are heavily exposed to oil and gas. Our focus remains on companies that have protective moats, pricing power and can demonstrate sustainable competitive advantages.
Consumer
Many fast-moving consumer goods (FMCG) staples were expected to see gross margin expansion due to lower raw-material prices and reduced packaging and transportation costs. The reality has turned out to be somewhat different.
Whether a consumer name benefits from the lower oil price depends a great deal on where they are based, and the extent of their global operations. As a general rule, countries which are net importers of oil, such as the US, Europe and India, have seen a benefit. Other countries, such as Canada, South Africa, Brazil and Malaysia, which are all net exporters of commodities, have all been hurt. GDP in these countries is so dependent on natural resources (such as oil) that, in this environment, it is harder for any sort of consumer bounce to take place.
Emerging markets
The impact of the oil price change has been severely felt in some emerging markets – many developing economies have, at their heart, a reliance on strong commodity prices. But, while it is true that countries like Brazil and Russia have been hard hit, what might not be as obvious is that Russian oil companies today remain rather insulated from the oil price fall in US dollar terms. With the depreciation of the ruble, Russia has effectively lowered production costs of national oil output. Investors though cannot ignore the fact that the US dollar values of these profits are down materially – and any company which has taken advantage of cheap US dollar funding now faces a larger hurdle to repay it.
Is the current environment enough to make us reconsider our holdings in oil-exposed companies? At the moment, the answer is still no. There are a huge variety of potential outcomes within the asset class and we are actively monitoring developments – maintaining exposure to companies where we find compelling stock-specific attributes at an attractive valuation that, importantly, will be able to sustain operations as the low oil price persists.
North America
The decline in the oil price over the last year will, on balance, be positive for economic growth, but there are a number of cross-currents to consider. Energy extraction alone is a very small fraction of GDP, but it has been a strong contributor to economic growth in recent years as it has driven job creation and significant investment in adjacent industries.
Though valuations are intriguing, we still think it is too early to be investing in the oil service sector given over-capacity and weak pricing. Outside of that, we think that opportunities are emerging in consumer-exposed companies. To date, the windfall from lower energy prices hasn’t translated into higher consumer spending, but we remain optimistic that this will happen given recovery in labour markets, a stronger housing market and improving consumer confidence.
Europe
Oil service companies in Europe have also suffered from the oil price crash and huge cuts in capex from oil companies. These businesses have been slow to change their business models as they are geared for growth. The opportunities for investors are certainly there in the European market. The weaknesses in both emerging markets and the problems caused by a low oil price should play out by the end of year, or early in 2016, and we should then expect to see significant growth for European companies as they are aided by the low oil price and the low euro.
Australia
As a whole, Australian energy companies have underperformed the broader market over the past 12 months, as the oil price fall has not been offset by a weaker Australian dollar. Relative performance within the sector has been variable and those with high operational and financial leverage have underperformed the lower-cost, larger producers with better balance sheets.
All companies are cutting costs, including discretionary exploration expenditure, to improve profitability and debt-service ability. Capital expenditure in the sector is set to fall dramatically.
This cost cutting will impact future growth.
Summary
Oil production in the US has reduced this year, a trend we expect to become more pronounced over the next few months. The decline in commodity prices in general means there are a raft of potential investment opportunities out there.
As ever though, when we look to identify high-quality companies with sound finances and healthy cash flows, it is essential to focus on every aspect of their fundamentals. With this in mind, it is important to acknowledge that exposure to oil prices is only one aspect with which we can assess a stock’s long-term prospects.
This article shares the views and opinions from various analysts and fund managers at Martin Currie
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