To some people, Mad Money host Jim Cramer is an investing guru. And he certainly draws a fair amount of attention; not only does he host his own show on CNBC every weeknight, but he is also a regular on the station during the early pre-market and opening hours of each trading day, holding forth on his view of current events and their effect on the market. He built his reputation as a hedge fund manager in the late 1980’s, retiring from the fund he co-founded in 2000 with only one losing year under his belt. In the years since, he’s become famous for his appearances on CNBC as a market analyst and making buying and selling recommendations on his popular nightly show.
This week, I was interested when Cramer started giving his take on the oil market’s recovery after its collapse that began in mid-2014; at that time, West Texas Intermediate crude plummeted from around $107 per barrel to a low in early 2016 at around $27. It began to recover from that point, and entered a period of consolidation from mid-2016 to late 2017 in the mid-$40 range, but since then has risen as high as around $76 per barrel and as of this writing is just little below $70. Cramer seems to be pretty bullish on the oil industry in general, and there is some logic beyond the simple fact that it has risen more than 150% since finding its bottom at the beginning of 2016.
Global demand for oil remains high, and most analysts expect that demand to remain high for the foreseeable future, especially as long as the global economy generally remains mostly healthy. The balance between demand and supply is also impacted by geopolitical concerns like U.S. sanctions against Iran, and production issues on a regional basis in places like Venezuela and even in the U.S. Trade tensions between the U.S. and its trading partners, including Europe, Canada and of course China are also having an impact as traders try to figure out what impact tariffs could have on oil prices in the long term.
Cramer specifically pointed out the supply glut in the oil-rich Permian basin, where a major lack of transportation infrastructure is limiting oil producer’s ability to get crude from the region to market. While there are a number of projects underway to increase capacity, none are expected to come online until sometime next year at the earliest, and 2020 more likely. That means that oil from that region is actually trading at a significant discount compared to other regions in the U.S.
The interesting part of Cramer’s thesis is actually that his favorite oil stock right now doesn’t actually have anything to do with U.S. oil production; it’s BP PLC (BP), otherwise known as British Petroleum. He was pretty effusive in his praise of the London-based company that holds a significant minority stake in Russian state-controlled oil giant Rosneft, calling it “the cheapest of the majors” – that is, the select group of the largest multinational oil companies in the world.
As a value-oriented investor, I’m always looking out for good bargains in the stock market, and while I prefer to take the opinions of any analyst, no matter how popular or well-known, with a grain of salt, I also sometimes find it useful to use the information from those analysts and check it out for myself. My opinion often differs from theirs – and as you’ll see, I really disagree with Cramer on this one – but even then going through the analysis on my own leads me to identify other interesting opportunities in related companies or industries.
I decided to compare BP to a few of the other, global “supermajor” companies that it competes against to determine if Cramer’s glowing praise was warranted. I really don’t think it is; despite its massive presence on the global oil market, and some obvious fundamental strengths, the truth is that from there are some important warnings signs. What’s more, from what I consider to be a conservative, value-oriented perspective, the stock can really only be considered fairly valued at best, with really no basis for significant upside that I can see. On the other hand, I did find that the two U.S. supermajors, Exxon Mobil (XOM) and Chevron Corporation (CVX) actually have an interesting value proposition right now.
The Case against BP
Not suprisingly, there are some legitimate fundamental strengths that can be seen very quickly when you dig into BP’s profile. The company has a very manageable Debt/Equity ratio of .49, healthy liquidity with more than $22 billion in cash and liquid assets as of the most recent quarter, and very good free cash flow. Earnings and sales growth have both been healthy, whether you consider the trailing twelve-month period or the most recent quarter, and the stock carries a fat annual dividend yield of almost 7% that is higher than any other supermajor. The truth is that if you’re looking for a stock that could hold up reasonably well as a defensive position if the U.S. market begins to reverse, that 7% yield looks pretty attractive. The caveat, of course is that it isn’t a given the stock will continue to hold its current price level; since April, the stock has declined from around $48 to its current level just a little above $43.
Drilling into some of the other fundamental measurements that I like to use also gives me pause before taking thoughts of working with the stock too seriously right now. Return on Equity (ROE) and Return on Assets (ROA) are much lower than I would expect to see from a company of BP’s stature; ROE is is only 9.28 and ROA is 3.41. The company also operates with a razor-think margin profile, with Net Income of only about 2.5% of Revenues over the last year, and that improved only slightly in the most recent quarter to 3.6%.
The real clincher – and what honestly makes me wonder what Cramer’s logic really is – comes in analyzing the stock’s Price/Book and Price/Cash Flow ratios. BP has a current Price/Book ratio of 1.4, which matches the average for the industry and is actually 19% higher than its historical average of 1.14. That actually puts the stock’s target price at a little below $35 per share, implying a lot of downside risk that I think makes chasing after that fat dividend yield hard to justify. The stock’s Price/Cash Flow ratio provides a little more hope, but even then the best conclusion you can draw from that analysis doesn’t do much more than offer hope the stock could hold its current value reasonably well. The stock’s current Price/Cash Flow ratio is 6.56, while its historical average is only slightly higher, at 6.58. That puts the stock’s target price right about where it is already at right now.
The two U.S. supermajors with a better value proposition than BP right now
If we limit our analysis from this point only to focus on value-based criteria, both XOM and CVX look a lot more attractive than BP. Here are the numbers:
While these numbers don’t dive into the deeper details of the fundamental profile of either XOM or CVX, the immediate conclusion is that if these stock’s measurements are reasonably comparable to BP’s – or better – the decision of which supermajor stock you should be paying attention really isn’t that difficult. All things being equal, focus on the stocks with the best long-term opportunity. BP just doesn’t pass muster right now.