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What Happens If The Energy Multiple Mean Reverts

Tyler Durden's picture




 

While most market participants are aware that earlier today the price of WTI traded at fresh six-and-a-half-year lows, fewer may be aware that the decline in the price of the S&P 500 Energy sector (shown in blue in the chart below) has been hardly as dramatic. In fact, as of today, the 506.4 trading price is only the lowest since June of 2012, or a three year low. The reason for this "buffered" delay in the falling price of energy stocks is simple: forward P/E multiples (shown in red) have soared. The relationship is laid out in the chart below.

 

What almost nobody knows is what the energy sector's forward EPS are as of this moment. The answer: at 19.3 in sector forward earnings, down from 50 recently in keeping with the collapse in the price of oil, one has to go back all the way to the summar of 2004 to find a comparable earnings profile for the energy space (the only difference, back then earnings were soaring, now they are crashing . What is more stunning, is that not even during the peak of the 2008 financial crisis did energy earnings drop this much!

 

This means, quite simply, that the reason energy stock prices are where they are is entirely due to the PE multiple, which at 26.3x, has only been higher once: during the dot com bubble.

Which brings us to the topic of this post: if energy investors tire of awaiting the price of oil to rebound as energy earnings remain stagnant at decade lows of around $20, and if as a result they decide to finally punish the energy sector multiple, and take it down to its 15 year long-term average of 13.6x, nearly half where it is now, what would happen?

We present the answer on the chart below: it shows the current price of the S&P energy sector juxtaposed with where the sector would be if one applied a 13.6x multiple to every EPS data point in its history. Not surprisingly, it reveals an energy sector trading at 262.3, about 50% below the current price. It means that the current energy sector price of 506, which is 93% higher to the implied price, has a long way to drop if and when multiple mean-reversion finally sets in.

 

What could catalyze such a mean reversion? Goldman's David Kostin gave us the answer over the weekend:

"In prior tightening episodes, the P/E multiple has contracted by an average of 8% during the first three months following an initial Fed hike."

A rate hike which many expect will take place in September, or at the latest December. And that is 8% for the entire market, which means it is very likely that the PE multiple for the most battered sector, energy, will contract far more.

And worst of all, until this moment the primary reason for the generous energy sector PE was the continuing easy access for energy companies to junk bond financing.  As we noted earlier today, this is no longer the case as financing to US shale companies has completely dried up, when this year's dead cat bounce proved to be a fleeting mirage.

This also means that the next round of capital raises for energy companies will come by way of massively dilutive equity issuance, which if there is again no surge in oil prices, will be promptly followed by the terminal source of funding: DIP loans.

We leave the question of how capable the rest of the market would be to ignore another 50% tumble in energy stock prices, open to discussion.

 

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Mon, 08/17/2015 - 13:20 | 6436033 Deathrips
Deathrips's picture

WTI 20s on deck

 

RIPS

Mon, 08/17/2015 - 13:33 | 6436089 Burt Gummer
Burt Gummer's picture

Ron Paul - "The United States Is About To Collapse"

https://www.youtube.com/watch?v=FebGaCyNhys

Mon, 08/17/2015 - 13:48 | 6436146 Bunga Bunga
Bunga Bunga's picture

$10, it will be like 1999.

Mon, 08/17/2015 - 14:45 | 6436383 Hype Alert
Hype Alert's picture

The only thing the market has going for it is the "hope" the FED delays liftoff.  Either way, Sept will be volatile and at some point, the understanding of the hopelessness of FED's situation, or ultimately our situation, really is will sink in and then the fun begins.

Mon, 08/17/2015 - 13:28 | 6436048 JustObserving
JustObserving's picture

You can thank the Nobel Prize Winner for destruction of oil companies - another unintended consequence of his war on energy and Putin:

Stakes are high as US plays the oil card against Iran and Russia

John Kerry, the US secretary of state, allegedly struck a deal with King Abdullah in September under which the Saudis would sell crude at below the prevailing market price. That would help explain why the price has been falling at a time when, given the turmoil in Iraq and Syria caused by Islamic State, it would normally have been rising.

The Saudis did something similar in the mid-1980s. Then, the geopolitical motivation for a move that sent the oil price to below $10 a barrel was to destabilise Saddam Hussein’s regime.

http://www.theguardian.com/business/economics-blog/2014/nov/09/us-iran-r...

Many believe that oil at $10 a barrel in the mid-1980s, engineered by the Saudis at the request of Washington, played a crucial role in the breakup of the Soviet Union.

 

Mon, 08/17/2015 - 13:38 | 6436078 KnuckleDragger-X
KnuckleDragger-X's picture

SSDD, this isn't going to matter much longer. The middle east is circling the toilet and America is dedicated to making it worse. Ketchup-Boy would sell his sister if the price is right and he's got President Zippy's whole heart backing to fuck everybody.....

Mon, 08/17/2015 - 15:57 | 6436670 Totentänzerlied
Totentänzerlied's picture

Another believer that O, the dummy puppet, controls not only oil prices but terrestrial geology and thermodynamics.

Mon, 08/17/2015 - 13:24 | 6436054 Iam Yue2
Iam Yue2's picture

"if and when multiple mean-reversion finally sets in"

 

if, or when

Mon, 08/17/2015 - 13:28 | 6436064 Handful of Dust
Handful of Dust's picture

Does this mean over 100,000 petroleum engineers are out of luck? How about the >422,000 petrol-related workers?

 

I guess it's part of Barry's robust, "Jobless Rekovery?"

 

 

Warren Buffett sells off stake in Houston energy companies

 

The Wall Street Journal notes that Berkshire Hathaway has been selling off shares in energy companies amid the oil slump, though it slightly increased its Phillips 66 holdings in the first quarter.

 

http://www.bizjournals.com/houston/news/2015/08/17/warren-buffett-sells-...

 

He didn't get the Medal of Freedom from Barry for nothing.

 

Mon, 08/17/2015 - 13:30 | 6436079 ZippyBananaPants
ZippyBananaPants's picture

Maybe somebody lobs a rocket at somebody else, just suppose that happens, maybe we would see a spike in oil prices?

Mon, 08/17/2015 - 13:34 | 6436086 Deathrips
Deathrips's picture

In our brave new world, lobbing missles is bullish for the dollar.

Things that are infinate, are priceless.

RIPS

Mon, 08/17/2015 - 13:43 | 6436136 Kilgore Trout
Kilgore Trout's picture

I am fixin` to revert to mean. No more Mr. Nice Guy.

Mon, 08/17/2015 - 13:55 | 6436162 michigan independant
michigan independant's picture

SWF asset strips.

Lender Goldman Sachs (through its J. Aron & Co. commodities unit), transferred a third of a pre-petition secured claim to TPG and retained the rest. The two filed a motion in with the Delaware Bankruptcy Court on March 4, 2008 alleging Deutsche's actions in arranging the DIP unfairly subordinated the duo’s claims, failed to obtain the contractually required consent, and failed on the legal standard of providing “adequate protection” for prepetition lenders. Deutsche objects to all of the above, and further asserts that J. Aron was estopped from its claim. The reason? It had, separately, already agreed to roll up 5% of its debt in an agreement offered to all secured lenders, but unrelated to the DIP. This separate rollup had been put in place to counter claims to European assets.

Every DIP is a bespoke contract because every capital structure (not to mention more prosaic business, industry, and economic issues) is different. Executives, lawyers, and accounts need to be aware of the terms shaping the market, because DIP terms are molding the bankruptcy process and spawning litigation, as claimants leapfrog one and other in the claims structure, expose themselves to a variety of conflicts of interest, and negotiate with distressed investors. PE firms, hedge funds, and collateralized loan obligation (CLO) are all hungering for the quick capital gains that rollups provided and the high-rates of returns attached to DIPs. Will the addition of these short-term investors, the enhanced bargaining power of priming liens, turn the established, and still rather contentious, bankruptcy process into an acrimonious nightmare? In any event, DIP terms will continue to be extremely creditor-favorable as long the credit crisis continues. Distressed and restructuring firms need legal knowledgeable bankruptcy counsel now more than ever.

Published: March 17, 2008

TPP will negate common law since who defines subordinated debt structures is the game afoot in my opinion.

Mon, 08/17/2015 - 15:06 | 6436483 KingOfMilwaukee
KingOfMilwaukee's picture

This is ridiculous. On a price to book and price to sales level, the energy sector is already at 2009 levels. The reason the PE seems high is because earnings are dropping and the numerator in the PE ratio is low. The PE ratio is going to keep going up and up until it approaches infinity, as earning for the whole sector drop to zero. It does NOT mean that the area is over-priced.

In this case, buy when the PE approach infinity (or goes negative). Buying at a low PE is a loser's game in energy, historically.

Mon, 08/17/2015 - 16:41 | 6436834 Totentänzerlied
Totentänzerlied's picture

A far better question: What happens when civilization's EROEI mean-reverts.

ZH remains far too focused on energy's worthless derivative, money (legal tender, currency, credit, debt).

The concept of thermodynamically imposed conservation all the way back down the EROEI curve has not not dawned on the masses - a war of spectucular violent denial will come first.

Do NOT follow this link or you will be banned from the site!