Thanks to The Big Picture, I ran across a very interesting Bloomberg interview excerpt with Jim Chanos. The interview is apparently set to be released on June 25th, and in the mean time, Bloomberg released a video excerpt. I'll reference the full video when it comes out but for now, check out the video referenced at The Big Picture blog or, for a shorter one on Ford (F), visit Bloomberg.
Chanos suggests that it has been a tough sledding this year. He implies or says outright that he is short automakers (not clear if it's just Ford or others as well); stocks related to the China bust thesis; for-profit education companies; and most interestingly, oil & gas supermajors. His justification for shorting the oil & gas supermajors is very insightful to me (bolds by me):
Chanos: "“[Decision to short oil majors] predates [the Horizon Deepwater rig], and it has to do with financing. If you look at some of the biggest oil companies in the world — and I’ll let you use your own imagination as to which ones those are, there’s a small handful. If you look at their cash flow statements relative to the income statements, you will see companies that haven’t replaced reserves in years and haven’t seen any increase in revenues in years and yet their capital spending eats up all of their cash flow, meaning they are borrowing their dividend. They are in effect liquidating. And investors don’t realize that. It’s one of the reasons why – and the market does [realize it] to some extent – that’s why the yields are so high. But they’re not earning, in economic terms, in many cases, those yields. And if people did a careful analysis of the cash flows of some of the biggest, most well regarded, integrated oil majors, I think they would be surprised at what they’d find"
Wow, shocking. Who knows if what he says is as bad as it seems but I never would have expected supermajors to be in such a bad situation. I don't follow the oil & gas sector very closely anymore so I'm not sure which companies are increasing their reserves and which one aren't. In any case, I took a quick cursory look at sort of found what Chanos was talking about. The American supermajors seem to be ok but the European ones seem a bit questionable. However, do note that I'm just looking at Morningstar data, which is aggregated data and it's not clear if some numbers are being slotted into incorrect categories.
As an example, consider Royal Dutch Shell (RDS.A; RDS.B):
I don't know if Royal Dutch Shell increased its reserves but if not, its dividends are unsustainable. If reserves didn't increase that basically means that the capex that is used in the FCF calculation is likely all maintenace capex: the company needs to spend that much just to stay alive. That's why the dividend is unsustainable.
I also took a quick look at the only supermajor I ever owned, Petrobras (PBR):
In the last 3 years, Petrobras appears to be paying out more in dividends than free cash flow (note that the dividend number for 2009 shown in the image above is likely incorrect; it is likely the line below which is around -$6.6b.)
When I was following in the industry about 5 years ago, Petrobras was one of the few supermajors that was actually increasing its reserves. Given their big discoveries off the coast of Brazil in the last couple of years, it is likely that they are still able to increase their reserves. So I don't think the fact that they pay out dividends by borrowing money is necessarily a bad thing. It all comes down to whether the returns they earn on their capital investment (i.e. future earnings off the oil drilling) is higher than the dividends paid out.
I think 2009 may be an exception given the volatile commodity market. So we shouldn't draw conclusions from that year. Yet, I find it surprising that these oil companies couldn't afford to pay their dividends in 2007 and 2008 (this is assuming that their spend most of their capex to maintain the business, rather than grow.) What I have done is a very crude, very quick, assessment. One really needs to look into the details and figure out if the company is indeed not growing reserves, and paying out dividends using debt. Tags: energy, insightful, Jim Chanos