"Tremendous Bargains" in Energy

04/28/2014 10:00 am EST

Focus: ENERGY

Frank Holmes

CEO and CIO, U.S. Global Investors, Inc.

US Global Investors CEO Frank Holmes and energy analyst Brian Hicks see long-term value in the energy sector. Here, they discuss the outlook for the sector, along with same favorite plays in refining and oil services, and highlight opportunities in the related markets of chemicals and shipping.

Steve Halpern: Joining us today is Frank Holmes, CEO and chief investment officer of US Global Investors, a leading mutual fund group well known for its expertise in both global investing and resources. How are you doing today, Frank?

Frank Holmes: Outstanding.

Steve Halpern: Well, it's good to have you here. You've recently said that energy stocks appear to be a tremendous bargain compared to the overall stock market. What's your outlook for the energy sector?

Frank Holmes: Well, we're extremely bullish, and then, for your listeners, I've got a special treat, I have Brian Hicks who played D1 college football, left tackle, and, as a quarterback, I needed a left tackle and he's outstanding.

He has his MBA, has a CFA, and has trotted all over the world, was an energy analyst on the south side, and has done a spectacular job here at US Global, so, he'll participate on some of your specific questions and when it comes to the companies that you are interested in, Steve.

But we're, on a big picture, looking at the world and seeing how things are evolving, when you do some simple hard core fundamental analysis of price-to-book and price-to-cash flow, and you look at these global indices like the MSCI Global Energy Index, these stocks are trading at when oil was $10 a barrel.

It's just unbelievable how inexpensive they are, and, we've seen a big rebound in the past couple of months, in particular, the past month, and we think there are two reasons for that.

One is the fundamentals, that they're so inexpensive and investors are seeing lofty levels in the huge NASDAQ run, and now they're looking for value and the value proposition, our energy names, and two, I think it's accelerated with Putin, the drama that's taking place in Russia, I think that people are recognizing, and Canadian oil stocks have had a spectacular run and they look like they can trade much higher.

And the same thing has taken place in America, that this breakthrough is epic on fracking, not only job creation—because we're in San Antonio and the Eagle Ford is just south of us—and we see the multiplying effect of jobs in the community, housing in the community, even charitable community giving is up dramatically from the multiplying effect of looking for energy.

So, we're very bullish and for many reasons. Growth in production, growth in dividends and yield, they all are, the stars are aligned.

Steve Halpern: So, let's look at some particular stocks. The Global Resources Fund is positioned for these currents you've outlined with some holdings such as Pacific Rubiales (TSX:PRE) and Valero Energy (VLO). Perhaps Brian would like to explain the attraction to these stocks and why they're in the portfolio.

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Brian Hicks: Sure. Thanks, Steve. We're extremely excited about energy right now. There are so many opportunities and just generally speaking we're seeing “transformational growth” and that's really the phrase that I've been using pretty much for most of this year.

And it's coming from the shale plays, it's coming from international oil developments much like what we're seeing with Pacific Rubiales, and there's also a side benefit to that as well that Valero is capturing.

With this crude oil that we're producing now, we're up to eight million barrels a day, it's creating a bottleneck at various hubs, whether it's Cushing, or now on the Gulf Coast, and you're seeing WTI prices trade at a discount to global Brent prices, and that's widening the margins for these refining stocks, such as Valero.

Valero is benefiting with these wider margins by being able to sell their refined product, gasoline and diesel, internationally. Refined product sales over the last few years are up over 60%, so this has turned into a high growth opportunity as well.

The company is generating a lot of free cash, they're buying back their stock, and more and more oil keeps coming out of these shale plays and it's saturating these hub areas and you're seeing wide discounts to the global prices, which is enhancing margins.

Frank Holmes: Another perspective on that, Steve, is that there are two tier price levels. Brent is predominantly the rest of the world and there's the sweet Texas oil.

And the price differential, it's so much cheaper in America for this oil because of all the success of exploration, and that means the input price to Valero is cheaper domestically, and then we refine our product and we're exporting to all these emerging countries this refined product.

So Valero has these huge juicy spreads because the input is so much cheaper than buying Brent, and we're also seeing that with natural gas. In Europe, natural gas is $10 and here it's less than $5, so the chemical stocks have had a spectacular run because the input costs from America are so much more attractive.

Steve Halpern: Now, are there any chemical names that you would highlight?

Brian Hicks: Yes, we like LyondellBasell Industries (LYB). It's a company that is generating a lot of free cash flow at these levels, it's a commodity chemical company. It was recently—within the last couple of years—it was an IPO from a private equity group, and it's done tremendously well.

Currently they're buying back stock every day in the market as part of their share buy-back program. They pay a dividend that continues to rise and these Ethylene margins that they're realizing look like they're sustainable for some time, so it's, really, a cash generating machine.

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Steve Halpern: Now, I also noticed among the top holdings of the Global Resources Fund are some well known large-cap names such as Schlumberger (SLB) and Halliburton (HAL). Could you briefly tell us about these positions?

Brian Hicks: Yes, sir, we really like the oil services and equipment group right now. Schlumberger is reaching a new 52-week high here recently and is benefiting from increased activity levels that are going on internationally, both in the deep water, and some of these other large conventional areas throughout the world.

They're the technology leader, they keep coming out with new products that's expanding their margins.

And then Halliburton is benefiting from a resurgence in North American activity levels with these long horizontal wells that are being drilled for these oil and liquids plays, whether it's in the Permian, Eagle Ford, or Bakken.

They're a pressure pumping company, so, they're seeing the intensity of pressure pumping pick up and it's really increasing the utilization rate that they're working at and the company is firing on all cylinders.

Steve Halpern: Now, before we leave, I just wanted to ask about one other related area, and that's shipping within the energy and commodity sector; you've noted in recent research that the prices to ship commodities around the world are at the lowest level you've seen in some five years. Could you tell us a little bit your outlook for this sector?

Brian Hicks: Sure, yeah, it's an interesting dynamic that's taking place right now. We think it's an inflexion point for shipping.

You're going to see, in 2014 and 2015, the increase in ship supply is going to be lower than the amount of ships that are being taken off the market because of obsolescence or not meeting certain environmental standards.

So, you're seeing the supply and demand tighten up, at the same time, on the dry bulk side, you're seeing increased market share in iron ore, sea borne iron ore that's being produced in Australia and shipped to China, ore coming from Brazil, so that's helping to tighten the supply and demand fundamentals.

Currently the Baltic freight rate, the Cape size rate, they've all come back down to support levels, but what's interesting is the equities are reacting better than the underlying Baltic freight rate so that's an indication to us that this divergence is telling us that better things are to come.

You're also seeing on the forward rate, fixed forward rate, they're higher than current spot rates so that's also a positive indicator. We like not only the dry bulk but we like oil tankers as well. We like (LNG), we think that's a growth opportunity.

Steve Halpern: Well, thank you both, Brian and Frank. We really appreciate you taking the time today and joining us.

Frank Holmes: Thank you.

Brian Hicks: Thanks a lot, Steve.

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