Is Oil Worth Investing In During COVID 19?
COVID 19 or the CoronaVirus, has caused many people to lose their jobs and has devastated many industries. Unfortunately, many people have been stuck at home due to the quarantine which has diminished the need to travel. This has negatively impacted many industries like automobile manufacturers and oil companies.
Despite this, oil could be a good investment long term and this guide will discuss whether you should invest in oil during this time.
Tread with Caution
Oil prices have declined by over 70% since January and even large companies like Royal Dutch Shell (RSD.A) and Exxon Mobil (XOM) have lost up to 56% of their value. This is a troubling sign since these larger companies have been around for decades. The West Texas Intermediate, which is the US oil benchmark, has dropped to $20 per barrel from $60 per barrel in early 2020.
On April 2020, this benchmark has slid to record level lows at $2 per barrel! These levels have never been seen before as the lowest price that oil has been trading was around $20 per barrel. Besides a lack of demand, oil manufacturers are struggling with another problem: running out of storage.
Large oil firms like Plains All American Pipeline and Enterprise Products Partners have required producers to provide proof that new oil shipments will have a designated buyer. The storage problem would also prompt existing producers to drastically reduce production from oil wells.
Rise in Bankruptcies
With these troubling times, it’s no surprise that bankruptcies are becoming more common. For example, Whiting Petroleum (WWL) has recently filed for Chapter 11 Bankruptcy. During these negotiations, Whiting Petroleum reached a deal that would only grant common shareholders 3% of the company.
This shows that other types of investors like bondholders, preferred stockholders, and the like would have priority over the company’s remaining funds. In other terms, common stockholders will lose 97% of their investment and will be lucky to obtain anything from the deal! Whiting Petroleum isn’t the only oil firm to go under, as Chesapeake Energy (CHK) isn’t too far behind. Chesapeake has been working with bankruptcy attorneys to consider drafting bankruptcy documents.
One main advantage of investing in oil companies is that they usually pay a high dividend which can generally range from 4-6%. This is much higher than the standard 2% and oil industry titan ConocoPhillips (COP) is currently paying an approximate 5% dividend yield.
Unfortunately, many companies are cutting or even suspending dividend payments during these tough times. Household brands like Boeing (BA) and Ford (F) have suspended their dividends, have high debt levels and are in financial trouble. Occidental Petroleum (OXY) used to have an impressive dividend yield of close to 8% but has cut it to 3.23% due to the crisis.
While dividend cuts/suspensions might seem scary, there are a few ways to determine if an oil company can sustain it:
- Debt loads. Be wary of companies that have high debt loads and debt to equity ratios above 1. The debt to equity ratio is calculated by dividing debt from shareholders’ equity. This will show you if a company is mainly being financed by debt or equity investments.
- Look for companies that have positive cash flow, positive profit margins and have cash reserves. Cash reserves will help a company stay afloat and fulfill its obligations to investors during tough times. It would be ideal to see a company increase its reserves over time.
- Low or negative interest coverage. The interest coverage ratio is simply calculated by dividing the EBIT or (Earnings before Interest and Taxes) by Interest Expense. Higher ratios mean that companies can easily pay creditors and lenders use this to gauge a company’s financial health. Companies that have low or negative interest coverage metrics will have a hard time meeting interest payments.
- Dividend payout ratio. The payout ratio is simply the dividend per share over the earnings per share. Look for companies that have ratios around 50 or less as this will make it more likely that the dividend can be sustained.
Types of Oil Companies to Invest in
It might seem risky or even downright foolish to invest in oil stocks with the current events. However, it’s possible to have solid long term investment returns with oil stocks and funds.
Some key factors to look for include:
- Diversified revenue streams. ConocoPhillips isn’t just an oil buyer, but it also creates petrochemicals. Petrochemicals are used to create in-demand products like plastics, medicines, furniture, appliances, and electronics. They’re also important to environmentally conscious industries as they’re an important component of windmills and solar panels.
- Sustainable dividends. Oil companies have higher yields than most, but what if it cuts or suspends its dividends? Be sure to look for companies that have low dividend payout ratios, manageable debt, positive cash flow, cash reserves and are profitable. It’s also important to see if the companies are mainly being financed by debt vs. equity and if they can pay their current bills.
Environmentally Conscious Firms
Pay special attention to companies that are environmentally friendly. Oil isn’t the most environmentally friendly product as oil spills can pollute the ocean and jeopardize the health of animals and humans. British Petroleum (BP) was responsible for a devastating oil spill that released over 5 million gallons of crude oil into the Gulf of Mexico back in 2010. It caused significant environmental damage and its stock dropped from $60 to $27 as a result. 10 years later and BP is still dealing with lawsuits from that incident.
Things have drastically changed in a few short months due to COVID 19. Our society has never seen anything like it as countries are closing borders and even domestic flights are grounded. These factors have caused many investors to panic and look for safe havens. Others have higher risk tolerances and see opportunities in down markets.
Oil could be a good long term investment, but be sure to conduct proper due diligence before investing.