Learn Lessons from Baron Rothschild about Oil Stocks

The price of crude oil this past week traded to new lows based on growing concern about global growth prospects, coupled with new supply from Iran. The bluest of blue-chip energy stocks buckled under the selling pressure to where the situation is rapidly taking on the look and feel of a sector under total capitulation. Every attempt to “buy the dip” has only been met with yet another trapdoor-like sell-off that now has numerous former energy sector darlings evaluating whether to continue as “going concerns.”

I haven’t seen many articles drawing comparisons with the dotcom era, but it’s not a stretch to go back about a year ago and consider just how euphoric all the oil and gas honchos were about how the sky was the limit for U.S. energy production and the vast fortunes that would be made for investors who leveraged into the energy boom that would replace dependence on foreign oil and create millions of jobs.

Well, someone forgot to tell the military infrastructure and political communities that getting out of the Middle East once and for all was a good thing. And when it became clear that Saudi Arabia can extract crude at a cost basis of $10 per barrel for light sweet crude (i.e., the Mobil One of crude oil) versus U.S. producers’ average cost of $35-$60 per barrel, the Persian rug was pulled out from under the global oil export market to where the domestic energy situation has gone from one where CEOs have been touting how this is just a temporary setback to one of wondering if crude is going to trade down to $32 or lower. The latter view is held by the leading energy analyst at Goldman Sachs.

At present, West Texas Intermediate Oil is trading at $42.50/bbl, a new low for the cycle and a level that is forcing many a perma-bull to throw in the towel. Stocks of many prized oil companies have lost as much as 80% of their boom period highs, and it will be no surprise that some previously formidable market leaders will file for bankruptcy as a function of being too leveraged when the bottom fell out. Pride before the fall: it’s a lesson that keeps repeating itself time and time again, yet few fail to learn.

Baron Rothschild, an 18th century British nobleman and member of the Rothschild banking family, is credited with saying, “The time to buy is when there’s blood in the streets.” He should know. Rothschild made a fortune buying in the panic that followed the Battle of Waterloo against Napoleon. But that’s not the whole story. The original quote is believed to be “Buy when there’s blood in the streets, even if the blood is your own.” This is contrarian investing at its heart: the strongly held belief that the worse things seem in the market, the better the opportunities are for profit.

Based on corrections of many other sectors during the past 30 years in which I have been associated with the markets, the energy sector is right about at a level of capitulation where investors that have available buying power should be giving serious thought to crafting a defined portfolio of dividend-paying energy stocks that have been unduly hammered by the wholesale sell-off. I suggest targeting the stocks of companies that are most vulnerable to a crash in oil prices. I’m talking about oil pipeline Master Limited Partnerships (MLP), the toll takers of the energy business.

Whether oil prices are up or down, the pipeline operators are much more tied to end-user demand or how much oil is pumped through their pipeline networks that span east, west, north and south of the United States, supplying all the refineries and facilities that provide most of America’s energy needs. The list of America’s top-tier pipeline operators that are truly on sale as a result of being sold off in sympathy with the sector includes:

• Kinder Morgan (KMI), Yield 5.91%
• Enterprise Products Partners LP (EPD), Yield 5.36%
• Williams Cos. (WMB), Yield 4.60%

There is no doubt that these three companies don’t pay the juiciest of yields, compared to the too-many-to-name competitors and junior players that will undoubtedly outperform if and when the energy patch recovers. However, when we don’t know where the bottom is for oil prices and just how much carnage will be exacted on the entire energy sector, we can know with a fairly high level of certainty that these three market leaders will not just survive but be in a position to further dominate the energy transfer space going forward.

Buying equal amounts of each MLP and the tax-favored benefits of owning MLPs provide an investor a blended tax-free yield of about 5.5%, or roughly 9% for those in the highest 43.5% tax bracket for ordinary income. It is a rare occasion when the best of the best in any given sector trade at discounts of up to 50% from market highs and pay out attractive dividend yields. If there isn’t blood on the streets in the energy patch, then we’re awfully close. Maybe now is the time to think and act like a Rothschild.

In case you missed it, I encourage you to read my e-letter column from last week about the next energy wave. I also invite you to comment in the space provided below.