For nearly three decades, Jennifer Stevenson has invested in the energy space. So while the most recent oil crisis was difficult, she didn’t shy away.
In the first quarter of 2015, more than 10 major energy companies announced layoffs—including Shell, Suncor and Cenovus—after the price of both West Texas Intermediate (WTI) and Brent crude oil dropped from more than $100 per barrel in the summer of 2014 to less than $50.
Stevenson, vice-president and portfolio manager at 1832 Asset Management in Calgary, Alta., found herself on the defensive. She focused on names “that paid a dividend, that looked to be sustainable, and that had a plan to get through [the] downturn.”
One reason she likes the energy sector is businesses there tend to spend more than they make in order to remain relevant, flexible and profitable over the long term. Also, despite the sector’s volatile and cyclical nature, some companies are “methodical [and] profit-focused, and [part of] growth industr[ies] that are funded with free cash flow. Some investors are starting to figure that out,” she says.
Stevenson reflects on two investments—one of which she made during the volatile months of 2015.
Royal Dutch Shell (NYSE:RDS.B)
Oil and gas giant Royal Dutch Shell was formed in 1907. Operating in more than 70 countries with more than 90,000 employees, it’s one of the world’s top 10 companies by revenue, according to Fortune’s Global 500.
Shell divides its operations into four categories:
- upstream, or exploration for new liquids and natural gas;
- integrated gas and new energies, which focuses on liquefying natural gas;
- downstream, or refining crude oil into a range of products, and;
- projects and technology.
Putting it through the process
At the beginning of the oil crisis, Stevenson started looking at a number of European companies. Shell, which is headquartered in the Netherlands, was one of the names she drilled into.
When analyzing a company, she typically looks at both the macro environment and the business’s fundamentals, in that order. Whether a company does exploration and production or builds pipelines, the macro side should be stable, she explains. “The less bullish your view on a commodity, the more resilient the company’s business plan has to be.”
In the latter half of 2015, when Stevenson started looking at Shell, she was cautious. Given oil’s volatility, Shell “was a little more controversial,” she says. This was partly owing to its purchase of U.K.-based BG Group for nearly US$70 billion in early April 2015, which was “almost right before everything fell apart.”
“That purchase added a whole bunch of debt to their balance sheet,” she says.
The upside was the acquisition turned Shell into a leader in natural gas, “a fuel for the future,” Stevenson says. The company’s balance sheet was overleveraged, but she forecast that it would streamline its asset portfolio and sell assets to pay off the debt.
Another consideration was that the company didn’t generate enough cash flow to fund its drilling budget and dividend, so it resorted to a “scrip dividend, which is basically a dividend you get in shares,” Stevenson says. This forced her to really consider whether oil prices—and Shell’s business—would improve.
Her answer was yes. While she expected some dividend yield compression in the near term, she found that compression was priced in. Overall, Shell had a “really great outlook” despite the risk of the medium-term oil downturn, says Stevenson.
She bought the stock during the last week of September 2015, after its price had dropped to around US$47 from a summer 2014 high of nearly US$85. She chose to hold American depository receipt (ADR) shares over Amsterdam stock for currency hedging purposes. (Both have great liquidity, she says, so the currency aspect is the only difference.) With the long-term benefits of Shell’s investment in natural gas, Stevenson was confident the company would see continued consumer demand for refined oil products like gasoline.
Shell has been a strong performer despite share price volatility between 2015 and 2017 (see Chart 1, below). While it hit a 2016 low of US$36.96 only a few months after Stevenson’s purchase, it was trading close to US$60 at the start of 2017. That was US$13 more than Stevenson’s purchase price.
Going into this year, what solidified her outlook was seeing more detail on the downstream business plan from CEO Ben van Beurden at Shell’s May 2017 annual general meeting in The Hague, the Netherlands.
He said the company would reduce debt, continue to pay dividends, and initiate US$25 billion worth of buybacks between 2017 and 2020, “subject to debt reduction and some recovery in oil prices.” As of Nov. 28, 2017, the company resumed paying only cash dividends and confirmed that buybacks would occur, pending cash-flow strength.
Stevenson characterizes van Beurden as “a downstream guy” who’s “used to having to […] make a profit when [there are] super skinny margins and high volatility.” So, the value of Shell’s refined oil products has been strong, she says.
Heading into summer 2017, Stevenson topped up her Shell position by adding the ADR to “some multi-sector portfolios that wanted more energy exposure.” The stock hovered between US$52 and US$58 between June and early August, and then rose above US$65 in early November.
Shell’s ADR has remained steady: on Dec. 4, the ADR closed at US$65.69, which is almost US$19 more than Stevenson’s purchase price.
She’s not planning to let go. For the next three to five years, she expects oil prices to improve. Shell’s increased free cash flow will create opportunities for growth and to remove the scrip dividend, she says.
The company’s valuation would need to surge before Stevenson would even consider cutting her position, she says. “[If] they remove the scrip and the market gets excited by that, and [if the stock] runs ahead of where it should be valued, we’d want to take some profit.”
Whether or not she did that would depend on her analysis of the company at that time. If the company “monetized more assets, paid down its balance sheet, removed the scrip,” and clarified what it was planning to do with its free cash flow going forward, says Stevenson, she would compare the company’s relative valuation with those of its peer group. If you focus on predetermined analysis and valuation thresholds, “you can make a mistake.”
But she still wouldn’t exit completely. At the very least, she would continue to hold Shell in her energy portfolio that’s focused on income and dividends.
Chart 1: The fall and rise of Shell’s ADR (NYSE:RDS.B), 2015 to 2017
Despite oil market volatility, portfolio manager Jennifer Stevenson of 1832 Asset Management is confident about Shell’s leadership and outlook.
Source: Shell.com (all prices are in U.S. dollars).
Chart 2: The fall and rise of WTI and Brent oil prices, 2015 to 2017
Compared to summer 2014 highs of more than US$100 per barrel, the prices of U.S. and Canadian crude have remained below US$70 for the last three years.
Source: Business Insider commodities charts (all prices in U.S. dollars). Oilprice.com and Alberta government economic data for news highlights.
Source Energy Services (TSX:SHLE)
Headquartered in Calgary, Alta., Source Energy Services (SES) is an oil field logistics expert and supplier of proppants: materials used to aid in oil extraction, such as pure Wisconsin white frac sand. It operates in British Columbia, Alberta, Saskatchewan and Wisconsin.
The company supplies and ships chemicals and other materials to high-demand shale basins and well sites, and operates a network of terminals.
SES was founded in 1998 and completed its IPO on April 13, 2017. Nearly 17 million shares were offered at $10.50 per common share, for proceeds of approximately $175 million.
Putting it through the process
SES caught Stevenson’s attention prior to its IPO. There was a lot of talk around whether or not the company would go through with the offering because, at the time, it was in the middle of purchasing multiple assets from Michigan-based Sand Products Wisconsin for US$45 million, she explains. As it turned out, SES did both.
When analyzing SES, Stevenson noted its “tiny” market cap of about $600 million. It’s led by a small management team and employed approximately 220 workers across North America, according to the company’s final prospectus, dated April 7, 2017.Still, there were positive signs, Stevenson says, including new management and a refocused business plan heading into the IPO. For example, the company was looking more closely at “the market for their [frac] sand, [and at] the cost of sand manufacturing and extraction.”
Why? The frac sand market had been through “super hype” in the U.S. due to concerns about a lack of premium sand, she says. SES offered that kind of sand as well as a solid sea and rail system for transporting it from Wisconsin to Alberta and B.C.
Stevenson didn’t miss out on investing. She went in on the IPO at $10.50, in April 2017, after starting to actively monitor the company in February when “they were out to the market about the IPO.” At that time, “the sell-side chatter was that the sand market was still hot and that [SES] would raise a bigger IPO, at a higher price” than the $175 million it ended up with. The money would allow it to pursue further acquisitions and expand its business more rapidly.
Forecasts for the IPO price went from the $17-to-$20 range to as low as $13 throughout February. Following that, the IPO was postponed, says Stevenson, leading to a drop to the final opening price of $10.50.
She wasn’t deterred. Even though things changed quickly, “we decided we still liked the outlook for the northern Michigan white sand market,” despite the challenges and competition that SES and that market were facing. “We decided we needed to still have an attractive price, and that $10.50 level was still right in our range.”
Before taking the leap, Stevenson also talked with the customers and management, and compared SES to U.S. companies she owned. “If we’re going to buy something that’s either small-cap or an IPO, we need to find the business outlook really compelling,” she adds.
The IPO was oversubscribed, says Stevenson. By the end of May, the stock was trading below $9, where it remained until the end of September.
The macro outlook for the frac sand market continued to deteriorate, on the backs of weaker oil prices and companies “lowering their drilling budgets,” says Stevenson. As well, there was demand for other products such as cheaper brown sands.
This made it hard for a small-cap company like SES “to show its unique qualities in the face of overall market negativity,” she adds.
SES’s stock closed at $9.08 on Dec. 4, after hitting a post-IPO closing high of $10.30 on May 12. But for Stevenson, it didn’t matter. She had already sold the stock in early September, when it dipped close to $6.50—about $4 below her purchase price at the IPO.
She doesn’t regret the decision, saying, “It’s small-cap, it’s less liquid, [and] the outlook was becoming much more challenging.”
It was a small position for Stevenson, and she only held the stock in one of her portfolios. Rather than stay invested, she decided to focus on bigger companies that are more clearly driven by industry trends.
Stevenson says SES has few peers in North America. As a result, “it gets lumped in with other sand companies that have [different] challenges,” and it often has to compete with U.S. players.
But would she invest again if the tide turned?
“It’s always hard to come back to something where you’ve said you were wrong; that’s just a mental hang-up that people have, especially investors,” she says. But, she adds, if the company’s fundamentals remain strong and demand for its product grows, “we could revisit it.”