energy

• Tom Lee's Equity Strategy

Apr 16

We want to revisit the progress of Israel in its battle with COVID-19. That nation now has vaccinated 62% of its population. And even with mutations being present in Israel, they have seen a drastic reduction in COVID-19 cases. The latest 7D average is a mere 26 cases per 1mm residents when it was 952 only 3 months ago. As we said before, COVID-19 looks to have been largely obliterated from Israel. The takeaway for me is that Israel’s experience does strongly argue for the effectiveness of vaccines. That nation solely relied upon Pfizer for its vaccinations. North Dakota and South Dakota have a better “daily cases per 1mm” vs. Israel at this same point and could be “obliterated by June.” Tireless Ken and his team overlaid Israel’s case results compared to North and South Dakota. Those two states have among the highest vaccination rates in the US and also the highest overall combined infections + vaccinations. And as our clients know we have looked at ND and SD as templates for the rest of the US. SD has 42% vaccine penetration so far and ND has 37%. SD daily cases are 227 per 1mm, while Israel was 803 at the same point. ND is well below Israel at the same point as well, as you can see when we overlay. Source: FSInsight, State health depts. The 7D delta in daily cases has turned negative in the past few days. After surging to +16k on Tuesday it has since retreated and as far as we know this is an organic drop. Hence, if this persists, we could see the case trend resume its downtrend. US hospitalizations are rolling over and US deaths also seem to be rolling over. Michigan is now leading states in the largest decrease in cases from 7 days ago at -1,516. Louisiana had the most new daily cases, but it was only 349. Vaccinations seem to be working and hopefully these positive trends resume. The 7D moving average for shots/cases is about 50 to 1 and this impressive figure is likely to surge even further in coming weeks. In total, about 125 million Americans have received at least 1 dose of vaccine. This is a good pace and as we noted previously, implies 50% of the population by May. STRATEGY: Epicenter stocks endured a month-long sell-off, but oil is arguing an upside breakout is ahead, Energy secular bull market could be forming. Source: Bloomberg, FSInsight Over the past month Epicenter stocks have underperformed the broader market, evident in the chart below. Economic momentum remains strong and the increase in EPS estimates steadily over the past few weeks shows the Street is still in the process of raising their forecast and outlook. There seems to be a few reasons that even in the midst of this ‘beat and raise’ environment that Epicenter and Cyclicals are still struggling. Some investors think that the good news is already baked in, and thus, Growth stocks should lead. We would counter that Epicenter/Cyclicals are projected to have 2022 EBIT >50% to 100% above 2019 levels. However, the stocks are only at their 2019 levels. The lull in interest rates rising, reason some investors, should cause Growth to continue leading. We would counter that interest rates are falling partially due to crowded positioning for the higher rate (aka “buy the rumor, sell the news” but the bottom line is this; higher growth (which is forecast by pretty much everyone) necessarily means higher rates. Finally, some investors posit that cyclicals are mere ‘rentals’ and that Growth stocks are the mightiest of the equity asset-class. Part of this is likely simply because many managers are comfortable with Growth and it’s made them rich. Paradigm changes are scary and one of Wall Street’s main weapons, historical data, is of relatively limited use compared to more normal times. Perhaps the most important thing to consider is that cyclicals have the capacity for positive surprise. To me, it seems like most investors are more comfortable buying Growth/FANG after the recent pullback. So again, we see consensus being overweight Growth, and underweight Epicenter. While the future is uncertain, we remain confident being on the other side of the consensus is the right call here. We believe we might be able to discern something about the path of Epicenter based on oil prices. WTI is currently $63 and if it goes to $70-$80 by summer what groups would lead? Based on the tight linkage between oil and Energy stocks we know they would do VERY well and likely lead the market. If oil rises meaningfully, you can expect Epicenter to follow suit. If oil strengthens to $80 this summer, XLE’s implied level would be $71, which is roughly 45% upside. The linkage between WTI and XLE is very close. In fact, they have moved in tandem for the most part. In other words, if the WTI prices do indeed strengthen, we could see a significant rise in Energy equities. Energy seems to be a very good buy here. Let’s look at the bigger picture. When you zoom out you see that Energy stocks might be finally ending a 12-year bear market in place since 2008. The current bear market is the worst ever for the sector, and secular bull markets in Energy typically have an average length of 9 yrs. If Energy is indeed bottoming, as you can see from our analysis the implied upside is 322% over the 9 yr. average which is 30% CAGR per year outperformance vs. S&P 500. As we’ve said supply/demand dynamics are good. Figure: Way forward ➜ What changes after COVID-19Per FSInsight Figure: FSInsight Portfolio Strategy Summary - Relative to S&P 500** Performance is calculated since strategy introduction, 1/10/2019

• Signal from Noise

Mar 20

This week we wanted to highlight a stock from our Power Epicenter Trifecta list. This list identifies the strongest stocks within our more extensive 'Trifecta' Epicenter list. We have added a 'power rating' to the stocks in the trifecta list to find stocks with the strongest price appreciation potential. Thus, the criteria for stocks within this list are positive views from a Global Portfolio Strategy perspective, a Technical perspective, and a Quantitative perspective. The trailing one-month return must be greater than the 12-month return, it must have outperformed the S&P 500 for the last six months, and its price must be above the 50 and 200 days moving average at the time of selection. We also wanted to make sure the first company we highlighted would be a good buy for at least the medium-term horizon. We landed on the largest oilfield services company in the world, Schlumberger ($SLB). This company's unique competitive advantages and position as one of the focal points for the digitization and modernization of the Energy Industry and its efforts to respond to climate concerns make us think this is a great pick. It has powerful economies of scale, the best capital efficiency in the industry, and a diversified geographic footprint and customer-base that expose it to many high-growth projects. In addition to this, Schlumberger has very impressive and noticeable earnings revision momentum. Source: Seeking Alpha Many Americans aren’t acquainted with the particular culture in the American Energy industry. Houston is the industry's capital in the United States, and the wider community can regularly feel the flagship industry's cyclical nature. Boom and bust is more so a part of Houston's life than other places and has been for a while. A big deal in the region is the pomp and circumstance of elaborate, very socially important holiday parties. Various executives of major energy firms all mix at these sometimes ornate, sometimes less so, galas. In bust years the menus are subdued, the champagne and liquor are a few notches down, and the holiday cheer isn’t quite as palpable. It might be beer and barbeque instead of caviar and cognac. In boom years, ornate displays of the energy-derived wealth like shellfish and caviar bars displayed on ten-foot mock-oil derricks are commonplace. Outsiders would have no trouble determining where the funds for the party came from. Due to its ubiquitous place in the industry if its' a party associated with an oil company, then you'd be hard-pressed not to find dozens of Schlumberger’s employees around. For the company, which had to layoff thousands of employees and suffered from the worst down-business cycle in memory, it appears that the trough has been reached. It's a great time to buy this stock in our estimation! We think you’ll certainly want to own this name for the coming recovery and beyond. This company, definitely an old dog, has learned some serious new tricks and has exposure to potential high-growth areas both in renewables and the older oil-centric segments. Suffice to say, the Holiday parties this year were subdued, if they occurred at all. Our bet is by Christmas this year, the gaudy menus and luxury items will be back in full force along with a significantly higher share price for our pick this week. If you live in Houston, you know; the bad years have always been followed by good years, and usually the worse the year, the higher and sweeter the comeback. We think this once-in-a-generation low that was disproportionately felt by the Energy industry will give way to an epic upcycle.  While there is much debate and uncertainty to the provocative claim that a commodities supercycle may be beginning, there is definitely a super-cycle coming in CAPEX by the Energy industry. No company is better positioned to benefit than Schlumberger. Schlumberger Has Best Competitive Position in Oilfield Services and Not Highly Correlated to Oil Price We have covered the massive implied opportunity in Oilfield Services in our previous work on Energy. Schlumberger is the largest holding of this fund at nearly 20%. Many investors may not like oil majors because their profitability is closely correlated to the oil price, which is influenced by many uncontrollable and unpredictable factors. One of the benefits of owning Schlumberger is that their services are needed pretty much equally if the oil price goes up or down. The trough of this capital cycle is so severe that revenue is virtually assured to expand significantly.  At its core, oilfield services companies have their revenue determined by the capital and operating expenditures at energy companies that conduct exploration and production. The capital cycles of upstream producers are, of course, influenced by the price of oil. Still, the recent-drop off in capital expenditures by those companies in the upstream segment has taken a massive hit as these companies tightened their belts to survive the worst down-cycle in the Energy business that has ever occurred. The company survived this down-period with significantly less revenue but managed to pull off $700 million in free-cash-flow in the 4th quarter. The momentum is clearly to the upside. We picked one of the Energy companies on our Power Epicenter list with many characteristics that distinguish it from some of the things many investors don’t like about Energy. We think the tired and inaccurate narrative that Energy is a broken, flawed industry with people running for the doors is shallow and not grounded in the reality that the Energy industry pulls off some of the most technologically impressive tasks the human race is capable of, much of it not possible without Schlumberger’s assets or employees. Ford and GM's experience shows that cutting-edge technology can be deployed by new and exciting Growth companies but also by established industries far later in their lifecycle. Schlumberger will profit from the inevitable rise in CAPEX and investment in modernization and efficiency of oil production, however, it also has an impressive renewable portfolio that is much more than PR. It's at the forefront of clean hydrogen production and just launched a carbon capture project with Chevron and Microsoft. The company is also developing a lithium extraction plant in Nevada The New Energy section is not an American Petroleum Institute going through the motions type of deal; the company is making real breakthroughs and real money in renewables. These are encouraging prescient moves from management, but the company also has enormous growth opportunities in modernizing a lot of existing oil infrastructure to get more efficient production. The interruption in upstream capex means that there could be unexpectedly high demand for the business's margin expanding digital services segment.  Schlumberger is the largest Oil and Gas Equipment Services company with a market cap of  $39.59 billion. Like Exxon, this number significantly understates it’s true size and influence. It’s currently trading well below its enterprise value of 54.89 billion. It announced its 4th quarter earnings and beat on EPS by $0.05 and on revenue by $288.33 M. They have had 15 upward revisions to EPS estimates by sell-side analysts in the last 90 days. All four revenue segments saw sequential growth this quarter for the first time since COVID-19 roiled markets. We Still Think There Will Be Energy FOMO: SLB Will Benefit Many institutional investors seem to have an overly pessimistic view of the Energy sector. Why shouldn’t they? Many got burned over the last years. It's almost like the industry needed an epic do-or-die restructuring. Oh, wait! That is precisely what happened. However, Schlumberger is far less dependent on oil prices for profitability and performance than, say, an oil major. It had a unique industry position as the largest oilfield services company and the most geographically diversified. It operates in many high-growth markets that don’t want the participation of oil majors but still need the vital oilfield technology they usually bring. SLB's most significant portions of revenues come from the Middle East and Africa, followed by Europe, followed by North America. Schlumberger is more dependent on business cycles within the Energy industry, particularly capex, which plummeted with demand over the last year. Source: Bloomberg As you can see the R squared for SLB is .112, for XOM it is .251 and for CVX it is .632. Coincidentally, this shows part of the reason why we prefer Exxon Mobil to Chevron.  We picked one of the Energy companies on our Power Epicenter list with many characteristics that distinguish it from some of the things many investors don’t like about Energy names. We also think SLB will be attractive to institutions when they eventually chase the outperformance occurring in the sector.   SLB Compared to Peers Source: Seeking Alpha You can see from the comparison that maturity pays off despite the current investor obsession with the new-fangled. May we suggest that this pick is a little bit of both, leading in cutting-edge energy technologies but with the established footprint, scope and size to leverage massive economies of scale. Their astute financial management is of course also appealing. An upgrade of their debt could be forthcoming with the latest quarterly results and positive revision momentum. Schlumberger has kept a relatively steady and uninterrupted profit margin partially due to its decision to divest from shale and to focus on its plethora of high-growth international assets. Like Ford and GM, SLB is becoming less dependent on assets to derive to revenue (although this is, of course, still primary) and more reliant on software, big data, and digital solutions it provides. Its revolutionary project with the Egyptian government is a prime example. Similarly, Schlumberger possesses several financial strengths and advantages over competitors that should begin to distinguish it in terms of returns as demand for its services picks up. If you include severance in free-cash-flow, it had an impressive annualized FCF yield of around 9% during the last quarter. If this is the yield in the nadir of a down-cycle, you can expect it to be significantly higher when the ‘true-up’ occurs with Energy industry capital expenditures. The relative financial stability of SLB compared to peers, as well as its geographic diversification should make it a prime pick for institutions when they eventually pile into the space! Source: Seeking Alpha Risks and Where We Could Be Wrong Schlumberger (SLB) is an established Oilfield Services company with deep relationships and penetration throughout the industry. If prices skyrocket, it could lose out on some of the high, but also high-risk, margins that can come out of a shale boom, although it does still have exposure through stock it owns. Right now, its geographic diversification is a strength but it could potentially become a weakness in the event of political instability or continued escalation of the war in Yemen as it’s largest geographic segment is the Middle East and Africa. Recent unsuccessful Houthi attacks on Saudi oil facilities highlight this major risk. However, the company is mature and has the ability to pivot. There is a risk that it overspends on unproductive capital projects in renewables. However, we think this name makes a great compliment in a portfolio to one of our other main energy recommendations, Exxon Mobil that does not have this risk as acutely. Anything related to coronavirus and demand concerns will continue to push off the restart of the Energy industry capex cycle, which will postpone the company’s return to pre-COVID EPS and revenue levels. We think the price is headed toward the neighborhood of 2014 highs over the medium-term, rather than back to COVID-19 lows.

• Alpha City

Mar 5

Is anyone else tired like me after this week’s trading action in the S&P 500?  The market started the week quite strong and rallied up about 2.7% to nicely reverse last’s week down performance.  However, during the middle of the week, fears of rising interest rates began to spill over into equities and caused some down action that pulled the index down nearly 5%, which was disproportionately impacted by even larger declines by in many growthier names within Consumer Discretionary and Tech.  Investors then turned their attention Fed Chairman Powell on Wednesday and his words during an online event did not calm the bond market and further pressured stocks.  After flirting with a bigger selloff, the S&P 500 found energy on Friday from both the positive release of the monthly employment data release and some dovish Fed comments to end the week up for day and slight gain for the week.  Lots of running to make so little progress.  At the beginning of the week, we released the results of our monthly deep dive into our sector (GICS-L-1) work and have updated our FSI Sector Allocation recommendations (please see the sector section of our website).  We wanted to end the week by reiterating the main conclusions that our allocation methodology has been suggesting: 1.      Traditional defensive area (HC, Staples, Utes and RE) will likely continue their underperformance of the S&P 500 and are thus Below Benchmark sectors. 2.      Continue shifting toward Epicenter/Value/Cyclicals/Financials and away from Growth/FAANG 3.      Do not completely abandon Growth/FAANG names, and this week’s severe price corrections with CD/Tech may be creating an opportunity to selectively add some exposure.  Getting more granular, our analysis has resulted in us upgrading the Financials and Energy sectors, which were the third upgrades for both sectors over the past five months. Despite the recent market volatility our tactical indicators are favorable, which has us aligned with our ongoing medium-term bullish stance. Also, we have lowered Consumer Discretionary from Above Benchmark to Tilt Above, however, our work still shows that there are still many favorable individual stocks within the sector.  It should be noted that the sector is being overly impacted by nearly 50% weighing of AMZN, TSLA, and HD. Based on our indicators and read on the macro environment the most important underpinnings for the overall equity market and our continued expectations for even higher highs are still in place. Although there has been some anxiety coming from the bond market, it is our view that the Fed is still likely to hold on for an extended period and the recent upward move in rates was overdone. It is our expectation that a favorable liquidity environment will endure for the foreseeable future. Notwithstanding rumblings from the ‘Bond Vigilantes’, the rate backdrop remains near record lows and supportive of further equity gains. The real rate on the 10-yr when accounting for inflation is near-zero. We continue to reiterate that the earnings revision data for the broad equity market, which is a major part of our investment process (and has proved its worth in adding value over 20 years), is still quite healthy. Our expectations are that this remains the case as analysts and investors start shifting their focus to economic recovery and a powerful corporate profit cycle. Thus, we encourage investors to remain focused on the long-term the; 6 month, 12 month and 18 month time horizon for which readings are still overwhelmingly positive. When looking for risks that are out there and what we watch closely, the first and main potential concern is sudden and sharp increases in interest rates and inflation expectations may remain problematic for the short-term and may return from time to time throughout the year. There are other issues that could obviously cause increased volatility like a fourth wave of COVID-19 or increasing ubiquity of the new viral strains. The bottom line this week is that the current bout of volatility is likely creating an opportunity for investors to raise exposure in areas and specific stocks that may have begun to run away from us and to move further into the most favorable ideas that our research is flagging.  Most preferred sectors: Financials, Industrials, and Materials with Information Technology, Energy and Consumer Discretionary better than neutral Neutral sectors: Communication Services Least preferred sectors: HC, Utilities, Consumer Staples and Real Estate

• The Wall Street Debrief

Feb 27

The S&P 500 was essentially flat on the week. It closed at 3,906.71 last Friday and this afternoon it ended the week at 3,811.15. This decline of about 2.5% was very unevenly distributed though. As my colleague Tom Lee pointed out in his note this morning Epicenter sectors all gained despite the high-flying Growth stocks weighing down the major averages. All eyes were on Washington early in the week as Federal Reserve Chairman Jay Powell made bi-cameral appearances to address monetary policy. As we predicted last week, he stuck to the script, was very dovish and did his best to assuage markets, although they may not have been fully convinced from the looks of it. We’ll give you the scoop below in our Fed Watch note and try to explain to you why Jay Powell can so confidently get up in front of Congress and tell them he’s not afraid of inflation even when debt markets seemed to be doubting him. You see the correlations that previously justified preliminary action to prevent inflation from overheating have long-since broken down. The breakdown of the correlations that long underpinned monetary policy have occurred throughout multiple business cycles, rate environments and political administrations. The return on 30-YR US Treasury Bonds minus inflation has declined over the decades. It averaged 5.9% in the 1980s and fell all the way to 1.6% in the 2010s. Some think the aging of the workforce in developed economies could be the culprit of the declining natural rate of interest. As Baby Boomers increased their savings as they approached retirement their savings rose, which all else being equal will push rates down. Some economists cite inequality, others cite the slowing growth rate of productivity or the internationalization of labor markets. Whatever the culprit, or combination thereof, one thing is clearly the result of this undeniable secular trend is that it has facilitated a very welcome ‘free lunch’ of sorts in terms of borrowing. Since rates have been nearly as low as they can go, and economic growth is expected to pick up substantially, the current levels of debt do not appear unsustainable because they are highly unlikely to crowd out private sector spending as long as the rate of economic growth is high enough. That’s why we can be on the verge of passing a $1.9 Trillion stimulus package and the 10-YR only spikes to 1.6%. You see what we did there? Glass half empty to glass half full. We have a lot to be grateful for. We passed a somber milestone this week; over half a million Americans have now perished because of COVID-19. The only other mass-casualty event in US history that now exceeds the human toll from this monstrous scourge is the American Civil War and it took four painful years to reap such numbers. Compared to that defining event the economic and social interruption has been mild; certainly much more mild than the doomsayers were predicting back in February and March. The reality of our situation is this; we are bruised, we are battered, and we have suffered a global depression that was utterly unimaginable only 12 months ago. Many companies failed and bankruptcies have certainly occurred in large numbers for smaller businesses. However, many publicly traded companies have proved their meddle in a way never seen in the modern age. JP Morgan Economist Bruce Kasman now estimates that the economic recovery in the United States will now likely supersede the one that has recently occurred in China. Imagine that, higher growth rates over here than over there. We’re truly entering a situation that most people alive have never witnessed. We have been advocating Energy as one of our favorite sectors for 2021. So far, our call has been dead-on and we want to show you some of our analysis that supports why we are still likely in early stages of a secular bull market for the Energy sector and a mean-reversion to more a historically appropriate weighting in the S&P 500. As my colleague will discuss below, it seems that institutions are still vastly underweight energy despite its outstanding performance on a weekly and YTD basis. That means there’s all the more alpha for those willing to jump into the ring. Remember, on the institutional side, if you come back to your investors with sub-par returns compared to your competitors, then you very well may not have any investors left soon. So, the pile-up that will occur into energy as the great chase—of returns that is—will likely result in some very significant upside for those who got into the trade early. We released an article on Six Flags, which just reported earnings and seems well-positioned for the re-opening. I, for one, think a lot more people could use some rollercoasters, funnel cake and fun than ever before. Our Lead Digital Asset Strategist, Dave Grider also released a report on IOTA 2.0, an alternative Distributed Ledger Technology platform. Be sure to check both articles out!