Earnings season is upon us. Again. Which means news flow has picked up to a rather torrid pace.
Dominating the headlines are the usual suspects. Netflix (NASDAQ:NFLX). Facebook (NASDAQ:FB). Alphabet (NASDAQ:GOOGL). Essentially, big tech.
The reason is clear. Big tech is where the action’s been in the stock market for a whole bunch of years now.
Which is why I’m not really paying those big-tech earnings much attention. Sure the companies are doing fine, but everyone knows it. What insights could one possibly glean? Even though, admittedly, Facebook’s recent tumble was a bit of a surprise.
Instead – in my lifetime pursuit of being more like Wayne Gretzky – I’m trying to skate to where the puck is going.
And one corner of the market where the puck hasn’t been in a very long time is the energy sector.
Remember it?
You know, that group of companies that continues to occupy about 20% of the S&P/TSX Composite Index, yet nobody wants to outwardly acknowledge exists since the price of oil plummeted several years ago.
Well, the price of oil’s been in the $70/bbl range for some time now, and if the second quarter results that have been released thus far are any indication, you’re going to start hearing a whole bunch more about this forgotten collection of companies.
By the numbers
Check it out.
Let’s turn our attention to one of the global behemoths to use as somewhat of a bell weather.
Royal Dutch Shell (LON:RDSa) (NYSE:RDS.A) reported second quarter results yesterday and once you get past the sheer magnitude of the figures conveyed (especially related to even the biggest of Canadian energy companies) you start to realize where this is all headed – provided the price of oil stays where it is.
Over the past 12 months, Shell has generated a whopping US$33.8 billion in operating cash flow. It’s spent US$20.9 billion on capital expenditures. Leaving it with free cash flow of, let’s call it, $13 billion.
Free cash flow is essentially the walking-around-money of the corporate world. The more of it there is, the more fun it is for a company’s shareholders. Because where you find free cash flow, you generally find shareholder friendly activities. Like dividends and share buybacks.
What you also find is a company that’s very capable of reinvesting in itself. Which should also result in shareholder fun.
This is also where things get really interesting for the investing prospects across the industry.
Before we go down that rabbit hole, though, I mentioned share buybacks, right?
Given Shell’s current free cash flow profile – thanks in large part to a more than supportive oil price – alongside its quarterly release the company announced a $25 billion share buyback program.
That’s real money. And a real indication that management believes that literally buying stock in themselves is one of, if not the best use of the cash flow the company is generating.
The real story
Now, back to that really interesting point from above.
In somewhat of a trickledown situation, as producers grow more flush with cash, that cash ends up in the hands of industry participants as the producers expand their web. After all, the business model of a producer is based upon a declining resource. That resource must be replenished or they die. Simple as that. Cash to shareholders is great, but cash spent to replenish and exploit new reserves is a big part of the equation.
Enter the energy service companies.
These are the companies, sitting by the phone, waiting for the production companies of the world to call for the services they offer.
And these companies have started to demonstrate the benefit of an industry on the mend as well.
Sticking with the big, global theme, let’s consider Halliburton Company (NYSE:HAL) and Schlumberger NV (NYSE:SLB), the heavyweights of the energy services industry.
Both have shown that the worst of the downturn is increasingly in the rear-view mirror with plenty of room to run – again, provided the price of oil remains at the current level.
Closer to home, it’s the energy service companies of the Canadian market that most have our attention.
As they, too, stand to benefit from an ecosystem that’s significantly improved – even though nobody else seems to care.
Indeed, we’ve gained our exposure to the energy sector within Stock Advisor Canada, our members-only flagship advisory service through a collection of Canadian energy service companies.
A collection that appears to be acting like somewhat of a coiled spring right now.
One of these company’s reported this week and it was the most positive release we’ve seen since we originally made the recommendation back in February 2016, just as the sector was bottoming.
Yet, how’d the market digest this release?
Sure, it was up over 5% but that’s really a pittance relative to where its headed as these results start to jolt ignorant investors into action. This company is still almost 50% down from where it was before the downturn and we see no reason it can’t double from here.
That same story exists for all of our energy sector recommendations, and across the entire industry really.
If oil sticks around that US$70 mark, we’re in somewhat of a “shooting fish in a barrel” type scenario.
Iain Butler,
CFA
Chief Investment Advisor, Motley Fool Canada
Disclosure: Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool’s board of directors. David Gardner owns shares of Alphabet (C shares), Facebook, and Netflix. Tom Gardner owns shares of Alphabet (C shares), Facebook, and Netflix. The Motley Fool owns shares of Alphabet (C shares), Facebook, and Netflix.