Streetwise
Lauren Rudd
Sunday, June 29,
2008
Same Church Different Pew
You could almost once again hear the collective sigh of relief
on the part of the nation’s consumers and suppliers after the latest Energy
Information Administration (EIA) report showed that crude oil inventories rose
by 800,000 barrels to 301.8 million barrels for the week ended June 20. The news
immediately sent the futures contract for light, sweet crude for August delivery
down $4.86 to $132.14 on the New York Mercantile Exchange, although the contract
ended the day down only $2.45 to close at $134.55.
There was only one small problem. Exactly the same thing
happened during the last week of June one year ago, only then the same news of
an increased supply for the week sent the August futures contract for sweet
crude down $1.04 to $68.50. In retrospect, the futures contract price for August
delivery has just about doubled in one year.
The increase in crude supplies came as gasoline demand, which
has fallen as rising prices force motorists to adjust their driving habits, fell
2.1 percent over the past four weeks as compared to year-ago levels.
Nonetheless, a year ago, the pump price for gasoline was $2.998, according to
AAA, where as today it is right around $4.00 per gallon, a 33 percent increase.
Furthermore, according to the EIA, world energy demand will
increase 50 percent and oil prices could rise to $186 per barrel over the next
20 years. Nuts, my projection is that crude will exceed $150 per barrel this
year. And 20 years from now...my calculator begins to overheat doing the
calculation.
The EIA stated in its long-range forecast that the steepest
increases in energy use will come from China and other developing economies,
including some in the Middle East and Africa where energy demand is expected to
be 85 percent greater in 2030 than it is today. Does anyone want to guess what I
will be writing about one year from now?
Where is all this leading? Simply put, despite small
perturbations, the demand, and subsequently the price, for crude oil and its
derivatives will increase. Furthermore, the supply is limited and bringing that
supply to market is becoming increasingly difficult and expensive. Therefore,
higher prices at every point in the supply line are inevitable. So, if you would
like a small piece of the pie, you might want to continue to look at energy
companies as possible investment candidates.
One company that continually pops out as an investment
candidate is Smith International, a company that I wrote about a year ago for
the first time. Smith is a manufacturer of premium drill bits, drilling fluids,
and related products. Its Services division offers drilling-related services.
M-I SWACO, which is 60 percent owned by Smith, sells fluids used to cool and
lubricate drill bits and prevent pipes from clogging. The Wilson division
provides pipes and fittings, while its Technologies division produces drill bits
and other drilling equipment.
More importantly, the company’s share price has quadrupled
over the past ten years, while the S&P 500 index hasn't quite doubled. My target
for the stock a year ago was $69 per share against a price back then of $58. The
stock recently closed at $79 per share, providing you with a capital
appreciation of 35 percent.
On April 22, Smith reported first quarter net income of $175
million, or 87 cents per share, on revenues of $2.37 billion. The Company’s
results for the comparable prior year quarter, net of a four-cent non-recurring
tax benefit, were $152.7 million, or 76 cents per share, on revenues of $2.11
billion. The intrinsic value of the shares, using a discounted earnings model
with a discount rate of 15 percent, is $183; where as a free cash flow to the
firm model yields an intrinsic value of $132.
My current earnings estimate for 2008 is $4.00 per share and $4.80 per share for
2009, with a current 12-month target price on the shares of $90, for an annual
gain of about 15 percent. There is also a dividend yield of 0.60 percent.
