Charts of the Month - May '23

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Let the Games Begin

Oil M&A is back!

It’s been a while since we’ve seen big M&A moves in Oil & Gas, but that’s all about to change.

After sequential record-breaking years by U.S. super majors Exxon and Chevron, cash balances are approaching historic levels and now, their wallets are beginning to open up.

One way to de-risk the incredibly expensive and time-consuming job that is oil exploration is to pay a premium to buy operating companies with proven reserves that are already drilled, pumping, and are cash flow positive.

And that's exactly what Chevron is doing, as it was announced last week that they're acquiring the exploration and production (E&P) company, PDC Energy, for $6.3 billion.

Here’s a historical look at Chevron’s cash balance, cash flow, and notable M&A transactions.

“With great cash comes great opportunity.” – Me.

A closer look at some of Chevron’s fundamental shareholder value metrics paints a rosy picture and post-PDC acquisition, these metrics should improve further, given that the acquisition is (from the announcement):

• Complementary to Chevron’s operations in important U.S. production basins

• Adds 10% to oil equivalent proved reserves for under $7 per barrel

• Accretive to earnings per share and return on capital employed (ROCE)

• Expected to add $1 billion to annual free cash flow (2.6% accretive to current FCF).

Assuming no growth and no synergies (which there will be both), the deal pays for itself in just over six years. It’ll likely pay for itself in much less time than that.

Other E&P names that are being floated around as potential targets are Pioneer Natural Resources (PXD) (rumored to being looked at by Exxon) and Devon Energy (DVN) (rumored to be looked at by both Exxon and Chevron).

O&G M&A bankers must be salivating right now… almost as much as their counterparts on the FIG restructuring teams (thanks SVB and First Republic!).

Jobless Claims -> Recession?

Roger put on something of a masterclass in last week’s Research piece, explaining the various data sets for jobs and unemployment, how they should be interpreted, weighed, and their predictive power when it comes to identifying the ‘most anticipated recession in history’.

I’ll let him do the heavy lifting on this one:

“Simply put, current jobs data should be taken with a large dose of salt. There are, however, signs from faster twitch jobs data that suggest we may now be at a turning point.

• Continuing Claims (number of individuals that continue to file for weekly unemployment benefits): Since 1970, a six-month change in continuing claims that’s at or above 25%, has always been coincident with a recession. The six-month change recently spiked to over 40%. We still must caveat that this data is also working through the post-pandemic distortions, but it does imply that we may already be in, or on the verge of, a recession.

• Initial Jobless Claims (number of individuals that filed for the first time for weekly unemployment benefits): Initial jobless claims are currently at historically low levels, but the surge in early May to an 18-month high suggests that the absolute lows are now in place. Historically, those lows have occurred about 10-20 months before the onset of the recession. If September 2022 is the low for Initial Jobless Claims, then we are now 8 months beyond that and approaching the historical window of recession.

It may still be too early to position for a recession, but we should be prepared. Since 1970, the S&P500 has made a tradeable low either within, or just after a recession, with no exceptions.”

Home Depot – Take a Deep Breath

There was a lot of noise made earlier this month about Home Depot’s “worse revenue miss in about 20 years”. It made for a lot of click-baity headlines that extended to other retailers (Target, Wal-Mart, etc.) and all but proclaimed to readers that the post-COVID consumer rally is finally dead.

And fair enough – contracting revenues from retailers is a good way to proxy measure the health of the consumer, and in an economy that’s ~70% consumer-driven, that’s not noise, that’s signal. Coupled with the charts from Roger above and a clearer picture of a slowing economy is beginning to unfold.

However, let’s not confuse earnings ‘miss’ with ‘bad’ earnings.

A miss simply implies that a forecast (read: guess) set by analysts wasn’t achieved.

‘Bad’ considers many other factors, and to accurately assess good or bad, you must objectively look at the totality of the financial statements, the underlying operations, and the forward guidance given by management.

Yes, Home Depot missed.

But given the post-COVID level up in revenue growth, while maintaining operating margins in the high mid-teens, I believe a more accurate headline would have read something like this:

“Home Depot misses revenue target, but quarterly results are still far ahead of pre-COVID levels.”

Financial statements matter way more than financial media headlines. I guess that means I’ll never get a job as a CNBC headline writer, but I can live with that.

Drawdowns from Peak Search Interest

”Don’t believe the hype” – Chuck D.

Diego covered this fascinating chart in his latest Markets Update.

This is simply a reminder that trends, especially the ones that grab the most headlines, are more often than not aberrations away from larger trend lines that will eventually revert and either 1) fade off into nothing, or 2) find their own longer-term, more sane trend lines.

Commodities Ratio to S&P

If you’re new to my writing, you’ll have not yet realized that I am long-term bullish commodities, especially oil. Like really bullish.

And after listening to Grant Williams interview Mike Rothman of Cornerstone Analytics this past weekend, I’ve somehow found a way to be even more bullish.

Mike’s primary thesis at the moment (which hasn’t changed in the past year), and this is me paraphrasing heavily, is that the chasm between the paper market for oil (traders) and the fundamentals picture (supply/demand tightness) has grown to the point where the current price of oil is trading as if inventories are several hundred million barrels higher than where they actually are.

Quoting Mike here, “The old rule of thumb is markets trade on the perception of reality and people like me get paid to figure out what’s real. And when the gaps get wide, those typically tend to prove out as the best investment opportunities.

You go back a few years ago and you think about what the consensus was expecting. It was expecting a big inventory build in 2021, a big inventory build in 2022, and another big inventory build in 2023. Everybody knew OPEC wouldn’t cut. Everybody knew US production was going to just zoom back, that the OPEC plus countries, meaning the non-OPEC participants weren’t going to really reduce their production, etc. And inventories have been drawn down dramatically, the largest in history, and they’re going to draw again this year if our model is in the ballpark, which frankly we think we are.

So what’s really setting up when you think about where we are today and then where the market is headed is we see this further additional tightening of the physical balance… this reminds me a little bit about the 2003, 2007 period when we saw what was called a fear-based model evolve in the oil markets where people kept thinking and believing that we were going to have a glut, that there was going to be this huge supply response, that demand wasn’t going to do anything but contract. And of course they realized at some point how wrong they were and began to hoard inventories as oil prices actually rallied.”

This chart, the most preferred for anyone in the “the commodities super cycle is just beginning” camp, is worth revisiting.

It may or may not also be my laptop screensaver…

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% of Global GDP under sanctions

I’ll leave the more granular interpretation of this chart to Jacob, but here’s my stab at it.

The rise of the multipolar world, something we’ve covered multiple times and was touched on once again in last week’s Research piece when discussing the faint glimmer of hope in easing U.S. – China relations, implies at least somewhat, rising tensions between the old and new world orders.

The current (old) world order, that of the Washington Consensus (where the U.S. and to a lesser extent the EU, governed the globe) is being challenged almost everywhere you look. The obvious headline grabbers are China, Russia, and Iran. But you also have India and Indonesia playing both sides (East and West), Turkey constantly jabbing the EU and NATO, the whole BRICS movement trying (no matter how futile it may be) to upend the current USD-based monetary system, and on and on it goes.

So, what does the old-world order do to stave off these assaults on their power? Sanction them.

In the past, when major powers tightened their grip, countries acquiesced as there were fewer alternatives for the lesser powers to trade with and to attract foreign investment.

But one of the advantages of a more connected and open globe is that now, when the powers decide to tighten their grip, alternatives exist.

Boycott Russian oil? Russians have plenty of options to sell elsewhere.

Tariff Chinese steal? Indo, India, and Brazil are happy to buy it.

Sanction Chinese microchips? They’ll retaliate in kind.

The world is more malleable today than at any other time in human history, and for most, that’s a good thing. But for the powers that be, malleable is harder to get a grip on.

Defense Contractors

And when sanctions don’t work the way they’re intended to, your grip is fully clenched, and you still can’t retake control, there's one last extreme measure you can resort to.

Like it or not, war is as much a part of human nature as eating. And it’s also big business. Very big business.

In 2021, the U.S. Department of Defense (DoD) had a budget of $705 billion. Of that, ~$320 billion went to defense contractors.

Of that, the big dogs, Lockheed, Raytheon, Boeing, Northrop, General Dynamics, and L3, soaked up nearly $220 billion of those outlays.

Revenue concentration is what’s most interesting here.

Lockheed, Northrop, General Dynamics, and L3 all generate 80% or more of their revenue directly from the DoD. Lockheed is basically a captive government contractor at 96% of revenue.

This is not advocating war. Far from it. It’s simply the recognition that war always has, and more likely than not, always will exist. Our trajectory is more dystopian than utopian, no matter what the WEF tries to tell you. And these contractors will be the primary beneficiaries of the continued splintering of the old world order.

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• What Erdogan's (likely) return means for investing in Turkey

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