If you’ve been looking for value in the stock market lately, you may have been having some trouble. Now that June is upon us, lots of top stocks have already rebounded from their March lows.
But in the oil sector, plenty of stocks’ prices have been cut in half since the beginning of the year…or worse. The price of oil seems to be trending upward; maybe this is a buying opportunity.
Bargain shoppers, beware! Even though oil prices are indeed higher than they have been in months, that isn’t necessarily going to make winners out of oil stocks. Four stocks in particular to avoid in June are Halliburton (NYSE:HAL), United States Oil Fund (NYSEMKT:USO), Occidental Petroleum (NYSE:OXY), and Patterson-UTI Energy (NASDAQ:PTEN).
Here’s why these Motley Fool contributors say you shouldn’t be tricked into picking up shares of these likely underperformers.
Don’t jump on this bandwagon
John Bromels (Halliburton): Oil-field services giant Halliburton has been rolling out one piece of bad news after another lately. In March, the oil price crash hit the company’s shares hard. In April, the company announced a billion-dollar loss in Q1 2020, combined with drastic cost-cutting measures of approximately $1.8 billion for the remainder of 2020.
That wasn’t enough, though, to save the company’s dividend: On May 20, Halliburton’s board slashed its payout by 75%, to just $0.18 a share annually. That translates to a yield of about 1.5% at the company’s current share price. Surprisingly, though, that share price has been slowly rising since mid-March. It’s up 90.8% over the last two months.
Dividend investors may be relieved that the payout wasn’t eliminated entirely, and think the worst is over. But don’t be fooled. Halliburton is overexposed to U.S. oil and gas production compared to peers like Schlumberger. And the U.S. shale industry is in the most trouble with benchmark WTI crude trading just above $30 a barrel. Shale drilling requires oil prices above $50 at the very least in order to break even.
With dismal prospects and a newly lowered dividend yield, Halliburton is one rising tide you probably want to leave alone this month.
It doesn’t do what it sets out to accomplish
Matt DiLallo (United States Oil Fund): After plunging in March, oil prices have staged an epic comeback from their bottom. One popular vehicle that speculators have used to try to profit from this rebound is the oil ETF U.S. Oil Fund (USO). That’s a bad idea, in my opinion.
For starters, USO has done a terrible job tracking the price of the primary U.S. benchmark, WTI. Over the past month, WTI has rallied about 175%, while USO has only risen about 25%. That substantial underperformance is due to many reasons, including changes in its methodology by purchasing later-date oil futures contracts. They didn’t move quite as much as those expiring in the near term. Because of that, USO investors missed out on WTI’s massive rally.
Meanwhile, the company is facing new headwinds that could further hurt its ability to deliver results for investors. One of its brokers stopped buying futures contracts on USO’s behalf due to internal risk-management requirements. This action could force the fund to make additional changes to how it operates.
Finally, for USO to work as a profitable trade, oil prices need to keep rallying. While that’s possible, crude prices could soon face additional headwinds. One of the biggest is that U.S. drillers might soon restart their fracking operations, which could flood the market with more oil. On top of that, another spike in the COVID-19 pandemic would likely cause governments to impose new travel restrictions, dinging oil demand.
Given these and other potential issues, I wouldn’t touch USO with a 10-foot pole.
From bad to worse
Jason Hall (Occidental Petroleum): Oxy was a troubled company before COVID-19 sent the world into isolation and devastated the oil industry with an unprecedented drop in demand. The company’s ill-advised purchase of Anadarko Petroleum left it burdened with debt it couldn’t really afford before oil prices collapsed. Things were bad, and now they’re much, much worse.
The plan from the outset was to sell off parts of the Anadarko portfolio in order to make the math work and repay $6 billion in debt coming due next year that it couldn’t handle just with cash from its operations. A big part of that plan was a deal it reached with French integrated energy giant Total (NYSE:TOT) soon after the acquisition. Total was set to pay $8.8 billion to buy Anadarko’s operations in Ghana and Algeria, but took the opportunity to walk away when the Algerian government blocked part of the purchase.
This collapsed deal could prove to be the last straw for the company. Well-capitalized companies like Total will surely be buyers during the downturn, but not at mid-2019 asset prices when there will be plenty of distressed companies offloading anything of value for deep discounts.
Either way, Oxy management isn’t going to get top dollar for anything, and it needs cash to pay off those looming debt maturities coming next year. Factor in the reality that oil selling in the $30s still means Occidental Petroleum is burning cash at a high rate, and the story could go from really bad to even worse very quickly for the company.
The margin of error is getting terrifyingly thin
Tyler Crowe (Patterson-UTI Energy): The rebound in oil prices may have given some small reprieve to producers, but that hasn’t translated to an uptick in drilling activity for service companies. At current prices, producers are still losing money on each barrel produced (albeit less per barrel than a month ago). As long as oil prices are below the cost to produce and to replace lost production, drilling activity will remain at a standstill. That doesn’t bode well for onshore rig owner and fracking specialist Patterson-UTI Energy.
At the end of the most recent quarter, the company reported that its cash from operations was just enough to cover capital expenditures, but it had to tap its cash on hand to pay dividends. At the end of the quarter, management said it had 123 of its rigs in the field. According to the company’s April drilling report, though, rigs in the field were down to 103. While it hasn’t reported May rig numbers yet, we can assume that they will also be down significantly because the number of total active rigs in the U.S. has declined more than 22% from the beginning of the month.
What’s worse is that contract drilling is the better business right now. Management anticipates that it will only be running four of its fracking crews in the second quarter compared with 11 at the end of the fourth quarter.
From a business perspective, the company doesn’t have a lot of near-term debt maturities, and management has announced some significant cost-cutting to keep the lights on. Being able to avoid a Chapter 11 reorganization and being a worthy investment are two wholly separate things, though. The next couple of quarters are going to be brutal for Patterson-UTI Energy, and investors are better off sitting on the sidelines.