The Oil Crisis and Its Investment Implications

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Stefani Kostadinova's picture

Just a year ago oil was being traded at over $100 per barrel—a number that had been the “normal” average in recent years. However, with supply from the Middle East growing and the U.S. shale revolution adding up to that growth, the situation started to change. As supply was rising, demand was falling in Europe and China, two regions where the economy has been slowing down, and so prices began to fall as well. The bleak economic outlook of oil became even grimmer, as the situation in Greece worsened and European economies’ confidence began to decrease. The deal with Iran to curb the country’s nuclear program and lift economic sanctions further exacerbated the problem by increasing supply from Iran and thus overall oil supply even more. As a result, prices have been in the 40s and 50s for the past few months. With Saudi Arabia concerned about its market share and refusing to cut prices, some are saying that perhaps these lower prices are “the new normal.” 

In my opinion, now would be an appropriate time to invest in oil—as low prices demand cuts in capital spending, suppliers’ charges should lower as well because of this postponing in investment. It is possible that we may soon see cost deflation and maybe even a turn of the tide, namely rising prices. Nevertheless, it is not simply enough to invest in any company. While it is true that prices are low for everyone, some companies would be better equipped to survive the current situation than others. I believe that one such company is PTT Exploration and Production Public Company Limited, a Thailand-based company involved in oil production and exploration, working on both domestic and overseas projects.

As we can observe from the company’s relative wealth chart, PTTEP has consistently managed to keep its CFROI level above its discount rate. This signifies that the company has been creating economic value for its shareholders. Based on this past trend, one can assume that since it has been able to keep its CFROI levels high through differing economic times, the company will probably be successful in doing so in the near future as well. In recent years, PTTEP’s CFROI levels have been lower than the peak levels between 2001 and 2008, but this is not that big of a surprise, considering the fact that the company was founded in 1985 and could be experiencing the fade effect. Nevertheless, its CFROI levels, even in recent years, have been high and above the discount rate. The forecasted CFROI level for 2015 is predicted to fall by 1.63% from current levels, with an expected rise in 2016 by 0.14%. As indicated by the black bar, the CFROI in the next five years will probably decrease slightly to 7.25%. The market-implied CFROI, however, is -0.62%, indicating that the company is largely undervalued with an upside of 184%. These data from the HOLT Lens indicate that even amidst the current turmoil in the oil market, PTTEP does not seem to be likely to suffer much from the low prices. Its CFROI levels are predicted to be higher than those of many of its peers, including companies with large market capitalizations such as Royal Dutch Shell, Exxon Mobil, and BP. If we take a look at PTTEP’s asset growth, the data are not as favorable. There is not a consistent pattern of growth but rather a number of drastic increases and decreases, which is mirrored by most companies in the industry. This could be explained by the nature of their business, as finding new capital investments for oil and gas companies is less consistent and predictable than that for companies in other industries. Nevertheless, for the last three years PTTEP has managed to keep its asset growth levels above the level of normalized growth, with a slight drop predicted in the next few years. This is to be expected, considering the current price of oil and the need to cut costs, including capital spending. Even so, the market-implied asset growth is much lower than the HOLT valuation implied growth, indicating once again that the company is currently

undervalued.

As indicated by the chart above, sales growth has been low in recent years, but it could possibly increase, if oil demand starts to move to its pre-crisis level. Margins and asset turns have remained relatively stable for the last few years, with turns decreasing slightly since 2013. This is reflected in the company’s CFROI levels, which seem to be moving in response to changes in sales growth and asset turns. In my opinion, the CFROI for 2015 is likely to stay close to its current level as the HOLT Lens predicts. This seems logical, since sales could not grow much this year due to weak oil demand, asset turns seem unlikely to improve, and operating margins have been pretty stable and will probably be close to 2014 levels. In the future, however, if sales and the oil price were to increase again, PTTEP could see its CFROI levels and share price increase, as it has managed to create economic value for its shareholders so far. It is quite debatable, however, whether the price of oil will rebound to the levels it enjoyed during the first half of 2014. If OPEC continues to take no action and refuses to cut supply in order to preserve its market share, prices will remain low and U.S. production will probably decline because of its high breakeven cost. With Europe and China trying to implement economic reforms to get their economies back on track, it is possible that their economic growth might speed up. Supply has already started to decrease, albeit slightly, and in my opinion, it is likely that it will continue to do so. Demand could also increase if the global economy starts to improve. While prices will probably not go back to over $100 a barrel in a week, a gradual increase could take place after a while. Even if it takes some time, PTTEP seems able to handle the current challenging period.

Furthermore, by taking a look at the HOLT Scorecard Percentiles, one can observe that PTTEP is at the high end of the graph, indicating that it is generally more attractive to investors than most of its peers. According to the HOLT Valuation Percentile, it is the leader of its peer group in terms of the attractiveness of its stock price. In addition, as was discussed

 

above, PTTEP has on average higher CFROI levels than most of its global and regional peers, as indicated by the charts below.

Considering its historically high CFROI levels and its ability to consistently keep them above its discount rate, I believe that PTTEP will continue to create value. Its operating margins are stable, its sales and turns seem unlikely to worsen, and its stock is currently with an upside of 184% according to the HOLT valuation. In addition, the company is doing better than most of its peers and will probably continue to do so. Bearing all this in mind, I would suggest that PTTEP is likely to not only survive the current oil turmoil, but also to outperform the market in the future.

 

References: 
 "Credit Suisse HOLT Lens ™." Credit Suisse HOLT Lens ™. Web. 26 July 2015. 
 "PTTEP." PTTEP. Web. 26 July 2015.