If you haven’t paid any attention to the stock market recently, you probably should take a look at what has happened over the past week or so. Each of the major US Stock indices has entered a correction which means that they are all down at least 10% from their most recent all-time highs. This statistic is not important on its own. However, it has led to there being quite a few deals on individual stocks throughout the market, as they have fallen faster than the overall stock market. Energy companies, otherwise known as Big Oil, or the Oil Supermajors have been leading this drop. The oil supermajors are the five largest western oil & gas companies. They are ExxonMobil, BP, Royal Dutch Shell, Total S.A. , and Chevron.
Although these companies are more properly referred to as energy companies, as they produce energy products from a wide range of sources, their stock prices tend to correlate well with the rise and fall of oil and natural gas prices. Today, WTI oil dropped below $38 per barrel for the first time in over six years. This doesn’t even take into account inflation that has occurred over that time frame. The drop of oil over the past year has led to each of the oil supermajors dropping steadily in price.
These are amazing prices to have the chance to buy the world’s best energy companies. BP and Shell are both offering dividend yields greater than 7.5%. That is insane. If the dividends aren’t cut and aren’t increased and you never reinvest dividends, you’ll receive back 75% of your original investment in dividends alone over the next 10 years. That is a very good situation to be in.
For some perspective, BP was priced at around $27 at it’s worst point after the oil spill in the Gulf of Mexico, and we’re almost back to those prices. If the stock market continues to drop energy companies much further, we could see that price revisited or even passed. Five years have gone by since that occurred in 2010. Profits have increased. The dividend has increased. Inflation has made that price in real terms higher than what $27 would buy you today.
The only reason that any of this is occurring is because the price of oil has dropped below $40 per barrel. This understandably will place a tight burden on the profits of these companies over the next year or so, or even longer until the oil prices increase. However, the oil companies are priced as if oil will be sold at $40 per barrel for the next 10 years. Oil is cyclical, it has it’s ups and downs, and these companies are cyclical. You can’t price them based upon trailing or forward looking 12 month earnings. It simply won’t work. By my estimates they are priced between 20-50% discount to fair value depending upon the long-term fluctuation in oil prices. If oil does stay at $40 or below for the long term this will be wrong, but I don’t consider that a likely outcome.
Warren Buffett is fond of buying companies that are undervalued while also being excellent companies. By my analysis, and even a back-of-the envelope analysis, these oil supermajors fit that bill. I can’t say whether they will go up or down in price in the next month, or year, or 3 years. However, by my estimation it is highly likely that you’ll be quite happy buying at these prices if you hold for 10 years or more. Especially if you choose to reinvest dividends along the way.
Disclosure: At the time this article was written I owned shares of BP, ExxonMobil, Chevron, and Royal Dutch Shell.
