'The biggest losses in at least 16 years'...
'The biggest losses in at least 16 years'... 'Only a matter of time' before this dividend is cut... A relative bright spot in the resource sector... Cheap, hated, and starting an uptrend now...
This morning, we received further confirmation that times are tough in the oil sector...
Blue-chip Big Oil firm Royal Dutch Shell reported third-quarter earnings – or rather, losses – of $7.4 billion before the U.S. markets opened today... its largest quarterly loss in at least 16 years. This compares to a third-quarter profit of $4.5 billion last year.
Along with "impairment" charges of $3.7 billion – where the company was forced to reassess the value of its oil and gas reserves based on lower price forecasts – Shell also wrote off more than $4 billion for scrapping several large projects.
It booked a loss of $2.6 billion after walking away from its Arctic exploration project in Alaska (where it spent billions to drill one "dry" well) and another $2 billion for giving up on a major oil sands project in Canada. (Shell's executives clearly didn't read our warnings about "oil mud.")
Even when adjusting for this $8.2 billion in impairments and write-offs, the quarter was terrible. In this case, Shell earned an adjusted profit of $1.8 billion... well below analyst expectations of $2.9 billion and an incredible 70% less than it earned in the same quarter of last year.
The news wasn't a surprise to our colleague Matt Badiali, editor of the Stansberry Resource Report.
Matt has been warning about potential problems for the major oil companies for several months. As we discussed in the October 20 Digest, he believes the impossible could now become a reality: the dividends these companies pay could be in jeopardy.
Matt shared his latest thoughts on the situation in a private e-mail to us this morning...
Shell formally announced that it "wrote off" $8.2 billion in what it calls one-off charges. It basically wasted investment capital on the Arctic exploration off Alaska and its Carmon Creek project in the Canadian oil sands. Neither project had any hope of profitability without oil prices doubling from where they are today.
The oil giant officially booked a $6.1 billion loss, compared with a $5.3 billion profit over this period last year. Even if you ignore the $8.2 billion write-down, Shell's profit fell 70% year over year. The only thing that saved its quarter was its "downstream" segment – refining and sales. That turned a $2.6 billion profit.
The company did say that it would still pay its $0.47-per-share dividend – more than $2.3 billion. That's less cash than it paid in the past, because the company also has a program that allows it to pay some dividends as shares, instead of cash. That saved the company more than $1.1 billion.
It's insane for shareholders to take more shares instead of cash. But some are doing it... the share count is up by 80 million since the end of March. Just remember, the company had to borrow another $5 billion in long-term debt just to make the payments.
As Matt explained, it's "only a matter of time before the dividend gets cut"...
The idea that the company can continue to issue shares and borrow money to pay its bills is crazy. It's like putting your electric bill on your credit card because you can't pay it off right away. Eventually, it's going to catch up with you in a big way. That's what I expect to see with Shell. The looming debt bomb, as well as a looming $70 billion acquisition of London-listed liquefied natural gas ("LNG") experts BG Group, could end up being a huge mistake.
We saw something similar happen to ConocoPhillips (COP). In 2006, ConocoPhillips acquired Burlington Resources for $35.6 billion. The merger was all about natural gas prices. Thanks to the collapse in natural gas prices, the company wrote off a huge $34 billion in January 2009. That was a huge hit to the third-largest U.S. oil company, which eventually broke apart in 2012. I see the decline of ConocoPhillips as a precedent for what's going on at Shell today. If you own shares, consider taking that cash and walking away now.
Switching gears to a brighter spot in the resource sector, gold-mining giant Barrick Gold (ABX) reported better-than-expected earnings yesterday.
It also reported a quarterly loss due to impairment charges. The world's largest gold producer lost $264 million, or $0.23 a share, compared with a profit of $125 million, or $0.11 a share, in the third quarter of last year.
But underneath the headlines were some encouraging signs...
Adjusting for those charges, the company reported $0.11 earnings per share, beating analyst estimates of $0.07. The company also lowered its debt by $1.6 billion in latest quarter alone. And it plans to spend an additional $1 billion from its sale of a Chilean copper mine to help pay down a total of $3 billion of debt by the end of 2015.
Barrick also produced slightly more gold in the third quarter than it did in the previous quarter of last year.
But the most impressive number was that Barrick's all-in sustaining costs – that is, the total cost to produce each ounce of gold – were down to $771 an ounce in the third quarter, versus $834 an ounce in the same period of 2014.
Like many companies recently, Barrick made some serious missteps and took on way too much debt. But despite another year of falling gold prices, the company is still profitable. It's making money at today's gold prices, and has been successfully paying down its debt.
If gold prices move higher from here – or even if they just stop falling – the company should do even better. In other words, if things go from "bad" to "less bad" for gold, shares of Barrick could soar. And high-quality companies with lower costs and less debt could do even better.
Our colleague Steve Sjuggerud agrees... He summed up his bullish argument in the October 22 edition of our free DailyWealth e-letter, titled "Gold Stocks Have NEVER Been This Cheap"...
Most investors know that gold is far from its 2011 highs. But I don't think folks understand how far gold stocks have fallen.
The benchmark gold-stocks index – the NYSE Arca Gold Bugs Index (HUI) – is down 75% in four years. Meanwhile, the price of gold only fell 30% in four years. That's a big divergence. And it has led to a major extreme in the gold-to-gold-stocks ratio.
As Steve explained, the "gold-to-gold-stocks ratio" is simply the price of the HUI divided by the price of gold. When the ratio is low, gold stocks are cheap relative to the price of gold. Recently, the ratio hit an all-time low.
Of course, this isn't a perfect "value" measure for gold stocks. It doesn't take mining costs into account – or any other business costs, for that matter. But it does offer a simple, big-picture view of the industry.
Importantly, the two major bottoms in this ratio led to incredible returns... in 2000 and 2008. If you had bought gold stocks at each of those bottoms and held for three years, you would have made 418% and 226%, respectively.
We can't know exactly when we've hit bottom. But this shows how much gold stocks can soar when they get going. And after a 75% decline, these kinds of gains are absolutely possible when the next move higher begins.
It's clear gold stocks are cheap today. Many investors have lost money on gold stocks and have given up on them completely, making them hated. And now, gold stocks – as measured by the Market Vectors Gold Miners Fund (GDX) – are up 20% in the last month. It looks like they are finally in an uptrend.
As you probably know, those are Steve's ingredients for a "perfect investment"... and it's why he recently invested $100,000 of his own money into gold stocks. He put together a presentation sharing the full details. You can view it by clicking here.
New 52-week highs (as of 10/28/15): Activision Blizzard (ATVI), Chubb (CB), National Beverage (FIZZ), Lancashire Holdings (LRE.L), McDonald's (MCD), Altria (MO), Travelers (TRV), and Alleghany (Y).
In the mailbag, a compliment on Dan Ferris' recent DailyWealth essay on reducing risk. Send your e-mails – good or bad – to feedback@stansberryresearch.com.
"Dan, really, really well written piece. Over the years I have concluded that most investors are just plain nuts. In truth I am thankful for that because when they are nuts I make money. But for me there was a point where cash in my account was a bad thing. In fact at one point available margin was a bad thing. Well, I made a million and lost a million. I am sure you have heard this many times. But now that I am an investment grown up I look at volatility as an opportunity for bargains. Stupid earnings selloffs are becoming a favorite. Exactly what you have said about cash is the best that I have read to date. Thanks for that." – Paid-up subscriber Jeff Spranger
Regards,
Justin Brill
Baltimore, Maryland
October 29, 2015
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