Are Your Oil & Gas Stocks Ready For A Painful And Prolonged Oil Crash?

Yesterday evening, Bloomberg ran an article with the alarming title of Oil Warning: The Crash Could Be the Worst in More Than 45 Years.

The article discussed views from Morgan Stanley’s analysts that the current slump in the price of oil (the commodity’s current price is less than half its mid-2014 peak of more than US$100 per barrel) could be way worse than what happened in 1986, when the price of crude oil tanked by two-thirds from peak-to-trough.

Morgan Stanley’s analysts also think that the current “slump could last for three years or more,” according to Bloomberg.

Experts have historically had a dismal track record when trying to predict the future price of oil, so it may be wise to take the views from Morgan Stanley’s analysts with a pinch of salt.

But nonetheless, the analysts’ warnings can still serve as a good reminder for investors in oil & gas stocks that it pays to prepare for bearish scenarios.

Because the price of oil is so hard to predict, it’d make sense for an investor in oil & gas stocks to seriously consider the things that can go wrong; it’s no use owning shares of a company that can thrive in an environment with oil at US$100 per barrel if it simply can’t survive unscathed for long in a scenario where oil drags along at US$50 per barrel or lower.

With this in mind, some key questions to think about would be:

1. How heavily indebted is this oil & gas company?

A high level of borrowings exposes a company to financial risks and the situation is made worse with the possibility that interest rates may climb in the future. Pricier debt and a weak business environment can be a highly combustible (even fatal) mix for a heavily-leveraged company.

2. How adept has the company been at producing cash from its business?

The past is not a perfect predictor of the future. But when you’re pitting an oil & gas-related company that has had the ability to produce operating cash flow from its businesses in the past few years when the price of oil was higher versus another firm that has struggled to produce cash, the odds are higher that the former will be able to at least eke out some cash in the future in an environment of lower oil prices.

The ability to produce cash even in adverse business conditions can be an invaluable lifeline for a company that’s trying to weather through a storm.

There were 54 oil & gas stocks listed in Singapore’s stock market as of 4 November 2014 according to stock exchange operator Singapore Exchange. A new kid on the block, NauticAWT (SGX: 42D), joined the fray when it got listed and started trading just yesterday.

Looking through this group of 55 companies, I had compiled a list of firms with negative operating cash flow in calendar years 2013 and/or 2014 and had a net-debt (total cash minus total borrowings) to equity ratio of at least 100% based on their last-reported financials. The five with the highest leverage are Linc Energy Ltd (SGX: T16), Vard Holdings Ltd (SGX: MS7), Vallianz Holdings Ltd (SGX: 545) Cosco Corporation (Singapore) Limited (SGX:F83), and Swiber Holdings Limited (SGX: AK3).

Share Net-debt to equity ratio
Linc Energy 427%
Vard 222%
Vallianz 209%
Cosco 161%
Swiber 146%

Source: S&P Capital IQ

Just to be clear, none of the above is meant to say that the quintet are necessarily in trouble or that they’d make for a lousy investment going forward. But, their current financial picture does warrant some heavy scrutiny from investors.

A Fool’s take

It should also be noted that the other 50 oil & gas stocks that were not mentioned are not necessarily safe either.

With the unpredictability that’s inherent in the price of oil, investors should ponder the ability of all oil & gas businesses to weather a prolonged slump in the price of the fuel, just in case what the Morgan Stanley analysts are warning about does come true.

Meanwhile, if you'd like to discuss more about oil & gas stocks or investing in general in person, you can even come meet David Kuo and the rest of the Fool Singapore team on August 15! Please join us at Invest FAIR Singapore on 15 August. (Suntec Centre, Booth B-16). Come chat with us at our booth, and see our MAS-licensed Director, David Kuo, give his official SGX investor presentation.

You won't want to miss this! Add Invest FAIR Singapore to your calendar today.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore writer Chong Ser Jing doesn't own shares in any companies mentioned.