Hard Assets
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Summary:
Natural Gas, Metals
Barron March 23, 2013
THE BOOM IN U.S. NATURAL-GAS production gives local manufacturers access to cheaper energy and helps energy-intensive businesses like chemical producers and steel makers (see "The Next Boom," Jan. 28). Less apparent is how it's also fueling demand for a host of support services, like those from water-treatment companies, environmental consultants, and testing-equipment makers.
Fracking, or hydraulic fracturing, pumps chemically treated water through rocks to extract oil and gas. Roughly 70 billion to 140 billion gallons of water are used in the 50,000 U.S. wells each year, enough to fill 150,000 Olympic-size swimming pools, and all that water must be transported, treated, recycled, or disposed of. "Some of the best investment opportunities are in the suppliers helping the industry to operate more efficiently, reducing pollution, and meeting increasingly strict environmental controls," notes Simon Gottelier of Impax Asset Management. "We could be about to witness a modern-day equivalent of selling shovels during the gold rush."
Among Impax's investments are companies that supply and remove water for shale exploration, including Aqua America (WTR), American Water Works (AWK), Heckmann (HEK), and Veolia Environment (VE); and those that help inject and remove fracking water, like Xylem (XYL) and Gorman-Rupp (GRC).
Xylem, for instance, was spun off from ITT (ITT) in 2011 and is known as a pump supplier, but it also monitors pollution and treats water. Xylem reported no increase in 2012 revenue over 2011's, as customers put off spending amid global fiscal worries. At $28, the shares fetch 15 times projected profits—in line with the machinery sector and a discount to water-treatment stocks. Yet Xylem has a solid cash flow, a 1.6% dividend yield, and one of the broadest arrays of water services in a fragmented, growing industry.
It isn't just water. The noisy "Artists Against Fracking" coalition has not only managed to unite Yoko Ono with Paul McCartney, it's roping in a coterie of bold-faced names such as Anne Hathaway, Lady Gaga and Deepak Chopra. As fracking grows, federal and state scrutiny will intensify. Regulation limiting methane emissions—which can have 20 times the global-warming potential of carbon dioxide—also is becoming a big issue. All that should benefit engineers and consultants like URS (URS), Tetra Tech (TTEK) and Aecom Technology (ACM), not to mention hazardous-waste-disposal outfits like Clean Harbors (CLH).
A Vein of Hope for Gold Miners
Barron's April 20, 2013
The Bottom Line
With their shares at multidecade lows, the miners are minding costs and becoming more shareholder-friendly. They could rise 40% if gold rebounds. Political risk is a major hazard for miners.
After a sharp decline, gold-mining stocks probably are the most hated group in the market.
There are plenty of reasons for that. The metal has moved into bear-market territory, falling last week to $1,402 an ounce—26% off its all-time high of $1,900, hit in September 2011—including a jarring $134 drop on Monday. And despite the high prices of recent years, well above the less than $800 at which gold traded in 2008, the miners haven't been able to generate significant profits and free cash flow.
Many investors have given up on the miners, opting for direct gold exposure through exchange-traded funds such as the SPDR Gold Trust (ticker: GLD), which holds $50 billion of bullion.
But mining stocks now look enticing, trading at or near multiyear lows, and the companies are trying to become more shareholder-friendly. In the past year two of the top miners, Newmont Mining (NEM) and Barrick Gold (ABX), brought in new CEOs and vowed change.
"In my career, I've rarely seen a group less well-liked than the gold miners," says David Steinberg of DLS Capital in Chicago. He notes that the widely followed Philadelphia Stock Exchange Gold & Silver Sector index (XAU) trades where it was in the late 1980s. "Relative to history, these stocks are extraordinarily undervalued, but I don't know when sentiment will turn," he says. His firm owns Barrick, Goldcorp (GG), and Kinross Gold (KGC).
Gold stocks were out of favor even before the recent plunge. At $28, a leading U.S. exchange-traded fund, the Market Vectors Gold Miners (GDX), is down 27% this month, 39% this year, and is at less than half of its 2011 peak. Looking at the fund's three largest stocks, Goldcorp has slid 24% this year, to $28; Barrick is off 49%, to $18; and Newmont is down 29%, to $33.
Downside in these stocks seems limited, barring a further collapse in gold prices. They could rise 40% if gold rallies back toward $1,700, where it started 2013.
Among this group, Goldcorp probably is the safest play because it has the lowest mining costs, the strongest balance sheet, the best growth outlook, and the largest market value at $22 billion. It aims to boost its annual gold output to about four million ounces by 2017, from 2.3 million last year, while many rivals will struggle to simply maintain annual production.
Once the industry leader and the only gold stock in the Standard & Poor's 500, Newmont has been a huge disappointment; its shares are below where they stood a decade ago, when gold was at $400. Its attributes include a broad global portfolio that makes it less dependent on a single mine. One of its innovative moves is a dividend linked to the gold price. At the current price, the quarterly dividend would be 25 cents a share—a yield of 3.1%. (The yield in the table nearby is based on its most recent payout, which was keyed to a higher gold price.) Newmont shares are no higher than they were in the late 1980s.
BARRICK IS THE RISKIEST of the three because it has the most debt, at $14 billion, isn't generating any free cash flow after heavy capital expenditures, and faces a big challenge with an enormous mine it is developing in a remote location at an elevation of 15,000 feet on the Chile-Argentina border. Chile has ordered Barrick to stop work on its side of the mine, due to environmental issues.
At a minimum, this probably will delay the mine's opening, which had been scheduled for 2014, and potentially drive up the cost, projected at $8 billion to $8.5 billion—already about double the original estimate. Barrick also faces pressure from the Dominican Republic for higher payments on the newly opened Pueblo Viejo mine, in which it has a 60% stake; the rest is held by Goldcorp.
JPMorgan analyst John Bridges downgraded Barrick last week to Neutral from Overweight, noting the company's "debt load and capital overruns are becoming problematic in an environment of weaker gold prices."
Last week the Wall Street Journal reported that Barrick is seeking to sell three of its Australian mines.
Barrick looks particularly cheap with a 2013 price/earnings ratio of five, but profit estimates could come down, due to lower gold prices. If gold rallies, Barrick probably has the most upside of the three.
Barrick is a poster child for the industry's woes, including higher operating costs, bad acquisitions, cost overruns on new mines, and political risk. Resource nationalism around the world is becoming a growing issue for miners. It's getting more difficult to get government approval for mines, and once they're operational, governments sometimes want to rewrite contracts and get higher taxes, knowing they have leverage.
One encouraging sign is that the industry is showing a new honesty about costs. In the past, companies emphasized "cash costs," which often were about $500 to $600 per ounce. But that ignored a slew of other costs, including those for maintenance and environmental remediation. Barrick, for instance, forecasts 2013 cash costs of about $635 an ounce and "all-in sustaining costs" of about $1,050; Newmont projects about $1,150.
LOW CASH-COST ESTIMATES are designed to impress investors with the industry's profitability. They also encourage host governments to shake down miners. "Governments are seeking to impose significantly higher taxes on us because they think we're making superprofits," said Goldfields CEO Nick Holland in a speech last summer. "The opposite is true."
Doug Groh of the Tocqueville Gold fund (TGLDX) estimates the industry's true all-in cost is about $1,350 an ounce, reflecting new mine development. Thus, miners aren't creating much value at current prices. Nonetheless, he sees reason for optimism, owing to "management turnover, better capital allocation, and reduced cost pressures." Further declines in gold price could lead to an industry shakeout that ultimately would be bullish.
Given the risks of individual stocks, a better option for investors could be an ETF like the Market Vectors fund or a gold mutual fund. Betting on junior miners, including those in the Market Vectors Junior Gold ETF (GDXJ), looks dangerous. Big miners, having been burned with bad deals, are less inclined to buy the juniors. The top-performing open-ended gold mutual fund in the past three years has been First Eagle Gold (SGGDX); Tocqueville is No. 1 over the past five years, according to Morningstar.
The monetary backdrop for gold looks favorable, as major governments around the world suppress interest rates and crank up the monetary printing presses. "Unlimited global monetary debasement is a reason to buy, not sell [gold]," tweeted Barron's Roundtable member and gold bull Fred Hickey of the High-Tech Strategist. The amount of gold in the world, an estimated 5.6 billion ounces worth $7.8 trillion, is a fraction of the global monetary base, and it's growing at just 1.5% a year.
Most investors have little or no allocation to gold and mining stocks. This could be a good time to get in. The metal and the depressed stocks offer a hedge against all the ills that can flow from monetary and fiscal profligacy around the world.
The Striking Price, Barron's April 20, 2013
GOLD'S 13% SWOON LAST WEEK was attributed to everything from Cyprus selling gold, to slower economic growth in China, to Ozzy Osbourne's having a drug-and-alcohol relapse.
But moves of this sort provide opportunities. Goldcorp stock (GG) is down 24% for the year and, according to most analysts, is the baby that was tossed out with the bath water.
With the shares trading at $28, you can buy the July 25 put and sell the July 31 call for even money. Each of these options is equidistant from where the stock is trading. This sort of break-even scenario occurs rarely in the equity markets, although we do see it from time to time in disjointed markets and in the high-volatility scenarios, such as those that the metal markets have just been through.
Barron's JULY 27, 2013
Refiner/Ticker RecentPrice YTDChg EPS2013E 2EPS014E P/E2013E P/E2014E DivYld MarketVal (bil)
HollyFrontier / HFC $44.15 -5.2% $5.32 $4.65 8.3 9.5 7.3% $9.0
Marathon Petroleum / MPC 72.05 14.4 8.11 9.40 8.9 7.7 1.9 23.4
Phillips 66 / PSX 59.42 11.9 7.35 7.06 8.1 8.4 2.1 36.8
Tesoro / TSO 54.55 23.8 5.14 6.66 10.6 8.2 1.5 7.4
Valero Energy / VLO 35.67 14.5 4.41 5.09 8.1 7.0 2.5 19.5
SATURDAY, JULY 27, 2013
A Well-Refined Opportunity | ANDREW BARY
HollyFrontier's refineries have a geographical advantage over those of its competitors. That could aid its profit margins and help support its 7.3% dividend yield. With a lush 7.3% dividend yield, HollyFrontier's shares are attractive at $44—down from a March high of $58. They could rebound to $55 to $60.
HollyFrontier probably has been the biggest beneficiary among refiners of the boom in North American oil production, thanks in part to its access to cheaply priced crude produced in North Dakota, West Texas, and the Rocky Mountain region.
The Dallas company has shared that windfall with shareholders through a generous dividend policy that now results in a 7.3% yield at the current stock price of $44. The company's $3.20 annual dividend consists of a 30-cent regular quarterly payout, as well as a 50-cent special quarterly payout that has been in place for two years. The lush yield reflects the shareholder-friendly approach of the management team led by CEO Mike Jennings.
Jennings recognizes the refining industry is mature, thanks to flat-to-declining U.S. gasoline demand. With only modest capital expenditures needed to maintain its refineries and expand capacity at one facility, the company (ticker: HFC) has used its ample profits to reward shareholders with a high dividend and bolster its balance sheet.
Wall Street worries that HollyFrontier's outsize profits—and its dividend—are threatened by narrowing refining profit margins in recent months, spurred by a rise in domestic crude prices. Profit estimates for 2013 and 2014 have come down by about a $1 per share. So have HollyFrontier shares, which are off 25% from their record high of $58 set in March.
HollyFrontier now looks appealing because its profits may prove more durable than the Street now fears. The company owns a lucrative group of refineries and probably has the industry's best balance sheet. And the stock at $44 fetches just eight times estimated 2013 earnings of $5.32 a share and nine times estimated 2014 profit of $4.65 a share.
"THERE HAS BEEN a structural change in oil production with the growth in the middle of the country," says Matt Murphy, an analyst at Stelliam Investment Management in New York. "Refineries like HollyFrontier that are near those sources of crude production will continue to have an advantage because of access to cheaper crude supplies." Murphy values the company at $55 to $60 a share.
Formed from the merger of Holly and Frontier in 2011, the company operates six refineries with a total capacity of 443,000 barrels per day in Oklahoma, Kansas, Wyoming, New Mexico, and Utah.
It has net cash of $2 billion, or nearly $10 a share; that excludes debt at Holly Energy Partners (HEP), a master limited partnership established in 2004 to hold pipeline, terminal, and other transportation-related assets. HollyFrontier holds 39% of Holly Energy Partners units worth nearly $900 million, plus the general partnership interest in the MLP that could be worth another $300 million to $500 million.
The big investor focus in the past few months has been on the collapse in the price spread of Brent crude, an international oil benchmark, above West Texas Intermediate (WTI), the key U.S. crude grade.
That spread, which averaged nearly $20 last year, moved to zero recently and now stands at around $2. Marathon Petroleum (MPC) and Valero Energy (VLO) have pre-announced second-quarter profit shortfalls, which has prompted concerns ahead of HollyFrontier's earnings release due on Aug. 7. HollyFrontier is expected to have earned about $1.40 a share, down from $2.39 a year earlier.
The WTI/Brent spread has been viewed as a proxy for U.S. refining spreads because HollyFrontier and several of its peers have been able to purchase crude at prices linked to WTI and sell their products, mainly gasoline and diesel fuel, at prices tied to Brent. As that spread has narrowed, refining stocks have come down.
There have been many explanations for the tighter spread, including increased pipeline capacity out of the middle of the country, additional refining capacity in the Midwest, and temporarily reduced oil output at a Canadian oil-sands facility. Murphy says that even if the WTI/Brent spread stays tight, HollyFrontier should still possess an advantage from low-priced crude since its refineries are near oil production and therefore benefit from a transportation advantage.
HollyFrontier's 30-cent regular dividend looks safe, but there's concern about the sustainability of the 50-cent quarterly, given lower profits. The company easily covered both the regular and special dividend in 2012 when profits were more than $8 a share.
"We view our regular dividend as sustainable through the cycle, and we'd like to grow it steadily over time," says CFO Doug Aron. The regular dividend provides a 2.7% yield. What about the special dividend? "We would expect to continue the special dividend program until our earnings stream or balance sheet wouldn't support that distribution."
Given HollyFrontier's current earnings power and balance sheet, the special dividend could be around for a while.
Sharing the Profits
HollyFrontier's generous dividend reflects its high profitability and strong balance sheet.
Refiner/Ticker RecentPrice YTDChg EPS2013E 2EPS014E P/E2013E P/E2014E DivYld MarketVal (bil)
HollyFrontier / HFC $44.15 -5.2% $5.32 $4.65 8.3 9.5 7.3% $9.0
Marathon Petroleum / MPC 72.05 14.4 8.11 9.40 8.9 7.7 1.9 23.4
Phillips 66 / PSX 59.42 11.9 7.35 7.06 8.1 8.4 2.1 36.8
Tesoro / TSO 54.55 23.8 5.14 6.66 10.6 8.2 1.5 7.4
Valero Energy / VLO 35.67 14.5 4.41 5.09 8.1 7.0 2.5 19.5
(E=Estimate. Source: Thomson Reuters)
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