Investors Alley

2022 was a terrible year for the media industry companies.

This was because competition among streaming services has come to an all-time high and consumers are getting pickier about their number of subscriptions. On top of that, companies are contending with lower ad revenue and more cord cutting.

When Netflix (NFLX) reported it lost subscribers in the first quarter of 2022—the first time in more than 10 years—the news sent a shockwave throughout the sector. The company blamed heightened competition, and began exploring a cheaper, ad-supported option for customers. Since then, other media companies have followed suit.

The video streaming market is currently being reshaped after last year’s collapse in investor sentiment toward these companies.

Both Netflix and Disney (DIS) have changed chief executives and stripped subscriber growth forecasts from their results. The focus now is solely on profitability, which may put Netflix ahead of its competition…

Netflix is staging a recovery from the share price slump suffered at the beginning of last year. In April 2022, its market capitalization was 70% below its 2021 peak. However, after a series of positive results, the company’s stock has regained some of its lost luster.

In the fourth quarter of 2022, Netflix added 7.66 million net subscribers, well ahead of guidance of 4.5 million added, to reach 230.75 million subscribers. This marked the second straight quarter of subscriber growth, and a 4% year-on-year increase. That’s quite a change from the two quarters of subscriber losses at the beginning of last year which led to the steep selloff in the stock.

The stepping down of founder Reed Hastings is highly symbolic of the company’s move away from a growth-at-all-costs strategy. The new management team, with co-CEOs Greg Peters and Ted Sarandos, is taking some steps to improve the company’s cash flow. For example, Netflix has plans in place to cut down on password sharing.

While this may lead to cancellations over the short-term, it’s a smart longer-term strategy. Despite the risk of losing some customers, the move should turn out to be cashflow positive.

Netflix estimates around 100 million people use its service without paying for it. That huge number is why many Wall Street analysts are confident a large chunk of money will come to Netflix once these viewers become monetized. FactSet reports that estimates for Netflix’s free cashflow will more than double to $3.15 billion this year, and then rise again to $4.7 billion in 2024.

The biggest problem for Netflix’s cashflow though remains the cost of developing content and using technology. In 2022—despite trying to keep costs in check—the company spent 19% more on technology and development.

To bring this under control, Netflix has been experimenting in Japan with the usage of generative artificial intelligence (AI). Earlier this year, it produced an anime show called Dog & The Boy, which caused an outrage among some because it incorporated AI-generated art.

Netflix’s Outlook

While Netflix’s outlook is improving, there is no denying the U.S. streaming market is saturated. That means if any further growth does come from Netflix, it will come from overseas. Already, Netflix has more customers outside the U.S. than inside the country.

A particularly strong region for Netflix is Asia. The market research firm Ampere Analysis explains that: “[Asia-Pacific] is likely to represent Netflix’s biggest growth potential in the future, accounting for over 60% of net additions to its global subscriber base over the next five years.”

Although that pricing in places like India is far below pricing here in the U.S., Morningstar forecasts that—on the international side—increased customer penetration will generate average revenue growth of 11% in Europe, 7% in Latin America, and 15% in the Asia-Pacific through 2027.

Overall, Morningstar forecasts average revenue growth of 9% for Netflix, with the operating margin expanding to 25% in 2027 from 21% in 2021, after dipping to 18% in 2022.

Netflix has been targeting $3 billion-plus free cashflow in 2023, versus $1.5 billion in 2022, as the five-year build of the studio to produce a majority of original titles (60% of content assets) are now past the most capital-intensive part of the process.

The main takeaway is that Netflix is now a company that has swapped its role as a disrupter for that of being the dominant incumbent… it is now the only profitable big streaming service in the world, with a subscriber base of 231 million and annual content budget of roughly $17 billion.

All of the factors discussed make Netflix a speculative buy anywhere in the $290 to $320 range.
Regulators recently seized Silicon Valley Bank due to concerns about its financial health and compliance practices, leading to investors losing confidence.As a result, funds and investments tied to the bank could be vulnerable to significant losses and market volatility.But this new AI investing tool can help you figure out if your investments are at risk, what to do about it, and find new opportunities for you to invest in.Click here to see how.

Normally sleepy regional banks have been wildly active in options trading after the SIVB crisis from last week. First Republic Bank (FRC) is a regional bank that investors have been very concerned about, with the stock down over 70% in a week. Despite bankruptcy concerns, some options traders Brokers don’t typically advertise “Income Accelerator Accounts…”

It got bumpy out there all of a sudden.

Although I was surprised that Silicon Valley Bancorp (SIVB) lit the fuse, I am not shocked that something blew up. Every time the Federal Reserve has a rate increase cycle, something blows up.

Signature Bank (SBNY) and Silvergate, on the other hand, were not that much of a surprise, as I have been highly critical of all things crypto for a long time.

What I am surprised by is the cries of contagion and fraud surrounding the SIVB blow-up. Silicon Valley Bank made a bet that rates would remain low. It was stupid, but not fraudulent.

Here’s why there’ll be no mass bank crisis.

But if you’re worried, and want to wait this out, here’s how to do that safely while scoring big yields…

A rare set of circumstances specifically related to early-stage venture capital companies and social media panic led to the deposit run that blew up SIVB.

The clickbait crew has been out in full force. I have seen lists of 20 banks that will fail next, containing some of the strongest banks in the United States. People who know nothing about banking are taking data from the headlines and trying to pinpoint the next Silicon Valley Bancorp situation.

There is no next – it was a unique situation.

Anything next will be caused by social media-inspired panic.

On Wednesday, we got some add-on fear from Swiss bank and perennial source of drama Credit Suisse Group AG (CS), when its biggest investor, Saudi National Bank, announced it would not be injecting more capital into the struggling institution.

Again, this is no surprise. I have been negative on the Swiss bank for a long time.

Last year I sent around a report on European banks to buy. Credit Suisse was not on the list.

Management has done so much wrong I would be hard-pressed to think of a single positive comment about Credit Suisse. Its troubles should have little to no impact on a community bank in the middle of America. These banks have been selling off anyway.

So have real estate investment trusts (REITs), business development companies (BDCs), insurance companies, and even energy stocks.

As an aggressive and patient investor, I am buying selected banks that pass my stringent criteria and adding to my stake in financially solid REITs.

Energy stocks and other companies with strong fundamental conditions are also being considered.

I might be making different choices if I were 10 or 15 years older. People more concerned about the return of capital than the return on capital, and those that value a high sleep-tight factor, might look towards the corporate bond market. BB+ and BBB bonds offer a very attractive combination of yield and safety right now.

Prices may fluctuate while you own the bonds, but as long as the company does not fail, you get back full face value at maturity.

Most of the bonds I am tracking trade at less than face value. The bonus here is that if the Fed does start lowering rates before your bonds mature, you could see double-digit price gains on top of the interest payments.

Vici Properties Inc. (VICI) owns one of the largest portfolios of casinos and gaming-related properties in the United States, and produces huge cash flows. Even during the coronavirus pandemic shutdowns, Vici never missed a payment. The REIT has bonds due in each of the next three years that will yield more than 6% if held to maturity.

Advanced Auto Parts Inc. (AAP) has been in business for 95 years. It is a safe bet they will be around to make good on their bonds maturing in 2026 and 2029. The yields range from 5 to 5.5%.

Marathon Petroleum Corp. (MPC) has bonds available, yielding anywhere from 6 to 7.5% over the next decade.

Radian Group Inc. (RDN), one of the four major mortgage insurance companies left, has bonds that mature in 2028, with a yield to maturity of 7.5%.

Right now, the developing opportunity in financial assets is extraordinary. I talked to a collection of investors and bankers nationwide this week, and they are all excited and active buyers of banks and REITs.

For many people, however, there is a time when being risk-averse and clipping coupons makes a lot of sense. BB-and-above bonds represent an opportunity to lock up high yield for several years.

You still have a potential kicker if the Fed begins lowering rates while you hold the bonds.

Or, in the worst case, you get reliable cash flows and your money back at maturity.
Silicon Valley Bank, Signature Bank, First Republic Bank, and now Credit Suisse… The Fed’s interest rate hikes are putting more and more pressure on weak banks.Your investment portfolio could be exposed.But this revolutionary new AI investing tool can help you figure out if your investments are at risk, what to do about it, and find new opportunities for you to invest in.Click here to see how.

With the collapse of Silicon Valley Bank, the hit to financial sector stocks has been brutal. As a reference, the iShares U.S. Regional Banks ETF (IAT) dropped by more than 30% in a few days. During a follow-up webinar with my newsletter subscribers, I discussed how steep market corrections have been showing up more often…

And how market drops like these are by far the best way to build your income and wealth.

Let me show you…

Psychologically, it’s hard to watch the value of your portfolio go down for an extended period. A ten percent drop is uncomfortable. If prices drop by 20%, fear takes over, and many (most) investors bail out, locking in their losses. They don’t often understand that steep declines occur about every other year. Using the S&P 500 benchmark, here is a quick history:

September to December 2018: The market took 95 days to drop by 19.8%

February to March 2020 (the pandemic): The market took 33 days to lose 33.9%

January to June 2022: It took 164 days to drop by 24.5%

The 2022 bear market, from which stock prices have not yet recovered, hit a lower low in October, but the period from June 2022 until the present has been marked by failed recoveries and modest declines.

This year, the banking sector crashed, which—as I noted above—took down the regional bank ETF by more than 30%. That crash affected the full range of financial business companies, including business development companies (BDCs) and real estate investment trusts (REITs).

In less than four and a half years, investors have gone through four broad market or sector-specific, gut-wrenching selloffs. These market events seem to be coming with very short intervals in between.

I don’t think individual investors will be successful in timing the markets for capital gains. Disruptive events are too unpredictable. The latest include a pandemic, large bank failure, and the failure of the Federal Reserve to recognize that inflation was not transitory.

If you invest to generate dividend income, these stock market disruptions become attractive opportunities to pick up high-yield investments at even higher yields. For example, in “normal” times, Starwood Property Trust (STWD) is priced to yield 7.5% to 8%. During the recent market downturns, the share price dropped enough to push the yield above 10%.

Eventually, the share price will recover, generating gains in your portfolio value, while you will have locked in a 10% yield on your committed capital. It’s a win-win.

To successfully employ a high-yield stock strategy, you need to be confident that the stocks you pick will be able to sustain their dividends. The pandemic-triggered crash gave us a good list of companies that continued to pay dividends and take care of their shareholders.

My Dividend Hunter service provides a diversified recommended portfolio of this type of high-yield investment.
Regulators recently seized Silicon Valley Bank due to concerns about its financial health and compliance practices, leading to investors losing confidence.As a result, funds and investments tied to the bank could be vulnerable to significant losses and market volatility.But this new AI investing tool can help you figure out if your investments are at risk, what to do about it, and find new opportunities for you to invest in.Click here to see how.

Well, that was unexpected.

The bank run we saw last week at Silvergate (SI) and Silicon Valley Bank (SIVB) was stunning and completely unforeseen.

Unless, of course, you were listening to what I’ve been saying for 18 months: the Fed’s rate hikes make unprofitable, risky companies much less valuable, and fast.

But the vast majority of banks will be completely unaffected by this.

Which gives you and me a great opportunity to snap up some stellar banks at dirt-cheap prices…

Earlier this year, I spent some time at the Acquire or Be Acquired conference in Phoenix, Arizona, with more than 1,000 bankers and dozens of Wall Street analysts, plus investment fund managers, industry journalists, and private bank investors.

I can promise you that the subject of a bank run never came up.

We did talk at length, however, about the securities issue banks were dealing with this year. Banks that had been buying securities at very low rates since the start of the pandemic saw the value of these securities plummet as the Federal Reserve raised interest rates at a rapid pace to fight inflation.

While the losses on fixed-income securities impacted earnings and accounting measures of book value, they did not impact regulatory capital levels. Furthermore, these losses would be fully recovered if the banks just held the securities to maturity.

So, no one was losing any sleep over the securities portfolio.

Then we saw the deposit run at Silvergate as its crypto industry customers needed to withdraw deposits to pay off their investors. The bank had to sell securities to meet the demand for cash and, by doing so, turned paper losses into actual losses.

Silvergate took losses of more than $1 billion in the fourth quarter of 2022, and the forced selling continued into this year. Last week, the bank threw in the towel and announced plans to liquidate.

On Monday, January 6, the management of Silicon Valley Bancorp was overseeing a bank that was turning 60 this year and had a market capitalization of over $20 billion.

On Friday, March 10, the bank was out of business, with a market cap of zero.

What a wake-up call for the venture capital industry, which has now realized that there was a severe funding shortfall, especially for early-stage companies. Funding for early-stage companies has all but disappeared.

It seems that the reality of what I have been saying for 18 months finally occurred to the residents of Silicon Valley: rising rates make unprofitable, risky companies worth a lot less money.

Warnings of the possibility of losing access to whatever cash they had left caused many early-stage venture capital firms to transfer funds out of Silicon Valley Bancorp to smaller, more traditional banks all across the United States.

Other companies followed suit, and the run was on. Silicon Valley Bancorp had to sell securities to meet demand, turning billions of dollars of paper losses into real losses. The bank tried to raise capital, but buyers were nowhere to be found. And so early Friday afternoon, the FDIC seized the bank.

Bank stocks sold off across the board. After all, most banks have securities losses this year. It was hard to avoid with rates rising as fast as they did. Still, unless the news media sparks a national bank run with breathless headlines foretelling a repeat of 1929, 99% of all banks will be just fine.

Banks are going to have to raise the rate they pay on deposits to keep cash from walking out the door.

That will pressure earnings for the rest of 2023 and into 2024. It will not, however, cause any more banks to close their doors.

The current situation in banking does set up an opportunity for investors looking for a steady income stream with the potential for an eventual significant capital gain of 20% or more: bank-preferred stocks have also been selling off in the past week. This includes preferred stocks issued by some of the safest banks in the country.

Bank of Hawaii Corp. (BOH) is an excellent example of what I am seeing right now. This bank has been around since 1897. When it opened its doors, it had only been four years since Stanford Dole overthrew Queen Liliuokalani to assume control of the islands. Hawaii did not become a U.S. territory until the following year.

The bank has survived countless geopolitical events and economic crises since it opened; it will survive this one as well.

Bank of Hawaii has a preferred stock (BOH-A/BOH-PA) trading with a coupon of 4.38%. Based on the $25 par value, every share receives dividends of $1.09 annually (payments are made quarterly.) Thanks to rising rates and bank-related fears, the stock traded hands last week as low as $17.22. At that price, the shares yield 6.33%.

That is not the whole story.

When the current bank-related fear leaves the market, the shares will trade higher, possibly climbing back above the $21 level where it sold last month—a gain of more than 20%. And, the shares should move higher when the Fed stops raising rates.

If we have a recession later this year or early next and the Fed has to lower rates, Bank of Hawaii preferred shares could easily trade back toward the par value of $25, which would be a gain of more than 40%!

As long as the bank stays in business, you collect more than 6% on your capital.

The risk-reward for bank-preferred stocks is being skewed in a very positive manner, and the Bank of Hawaii preferred is a very attractive issue right now.
Regulators recently seized Silicon Valley Bank due to concerns about its financial health and compliance practices, leading to investors losing confidence.As a result, funds and investments tied to the bank could be vulnerable to significant losses and market volatility.But this new AI investing tool can help you figure out if your investments are at risk, what to do about it, and find new opportunities for you to invest in.Click here to see how.

Recently, I dug into recent financial results of several downstream crude oil refiners. I am a fan of the energy subsector, but I was surprised at how well these companies can and will perform in the current energy price environment.

So surprised that I was happy to add a new refiner stock to my dividend growth-focused investment service recently.

Here’s why – and three refiners to consider for your own portfolio…

Successful fuel refining companies are some of the best-managed businesses in the U.S. They operate in an industry where the prices of both the raw materials (crude oil) and finished products (gasoline and other fuels) are set by outside market forces. Refiners have to live with whatever the commodity markets give them.

Refining profitability relates to the crack spread. The spread is the calculation of the price difference between refined products and the cost of a crude oil barrel. The benchmark 3-2-1 crack spread is the difference between three barrels of oil, two barrels of gasoline, and one barrel of distillates (diesel, jet fuel, heating oil). Put another way, the crack spread is the gross profit margin per barrel of oil when refined into fuels.

A modern, efficient refinery has an operating cost of $5.00 to $8.00 per barrel. Factor in other corporate expenses, and you get a breakeven at around a $10.00 crack spread. On this chart, the blue line is the U.S. crack spread with the corresponding value on the left side of the chart:

Over the decade, the crack spread ranged from a low of $7.50 in early 2020 to more than $58.00 last Spring. Historically, you can see the spread tended to be in a range of $15.00 to the low-$20s. The Russia-Ukraine war caused the prices of crude oil and fuels to spike higher, pushing the crack spread to record levels.

Next, let’s look at the same chart for the last six months:

If you watch the financial news, you may have observed that crude oil trading has been relatively stable, in a $70 to $80 range. You may also have noted that gasoline at the pump has been stable for several months. In my area, every station shows regular unleaded at $3.29 a gallon.

The recent price stability, from the end of November to the present, kept the crack spread locked in at $30 to $35 per barrel. At these levels, the refining companies are hugely profitable. Let’s look at the fourth quarter results from the three large independent refining companies:

Marathon Petroleum Corporation (MPC) reported earnings of $6.65 per share, compared to $1.30 a year earlier

Phillips 66 (PSX) reported earnings of $4.00, up from $2.94 in the last quarter of 2021

Valero Energy Corp (VLO) reported $8.45 per share, up from $2.47 per share

If you annualize the Q4 earnings, these companies trade at a P/E ratio ranging from 4 for VLO to 6 for PSX. On a fundamental evaluation, these stocks are very cheap.

I expect the price of oil and the crack spread to stay current. We are already most of the way through the 2023 first quarter, and you can see that profits this quarter will be excellent.

I have one of the three listed refining companies in the portfolio for my Monthly Dividend Multiplier service, which employs a dividend growth strategy. This month I am adding a smaller regional refining company. Now is a great time to get overweight in the downstream energy space.

The Invesco QQQ ETF (QQQ) is a wildly popular ETF that tracks the Nasdaq-100. It’s a tech-heavy index that has been in a sideways pattern for much of the last year. When a stock is moving sideways, a covered call can be a good way to optimize returns while holding the shares. In this case,

Despite the volatility caused by two banks collapsing over the weekend, the broader market is still overvalued, so I have been avoiding that for the most part.

Instead, I’ve been looking at special situations. And for this week’s Hidden Profit Report, I’ve uncovered two situations that have the potential to deliver strong returns no matter what the market does.

And, best of all, both companies involved in these trades are ones you will be okay with owning for the long term if the short-term scenario does not play out as hoped…

The first special situation for this week is First Horizon Corp. (FHN).

About a year ago, Toronto-Dominion Bank (TD), also known as TD Bank Group, made a $25-per-share offer to buy First Horizon.

The offer makes much sense. First Horizon has a very attractive franchise with operations in 12 southern states, including Florida and Texas, two of the most attractive markets in the United States. The bank has 444 branches across the region with close to $80 billion in assets, plus plenty of capital. And the loan portfolio is in fantastic shape.

At $25 per share, TD Bank is paying 2.4 times the book value and 16 times the earnings for the First Horizon franchise.

Under the decidedly bank-unfriendly Biden Administration, regulators are still dragging their heels long after the deal should have closed. In the first week of March, TD announced that it was unlikely to receive approval to close the deal before the May 27 merger deadline.

There are two possible outcomes. First, TD Bank says it is committed to closing the deal. The deal could still close, and we can get paid $25 a share.

Given the massive volatility we have seen as a result of Silicon Valley Bancshares (SIVB), Silvergate (SI), and Signature Bank (SBNY) collapses, the deal closing looks unlikely at this point.

First Horizon has a strong balance sheet and can easily expand into some of the most attractive banking markets in the United States. It is also possible that the very attractive Southern franchise of the bank would attract another buyer.

Although the stock has sold off in the past few days, First Horizon has almost nothing in common with the failed banks:

It has no exposure to venture capital or cryptocurrency

Only 13% of its assets are invested in securities

And it has an enormous geographic edge over the bank the regulators closed

Every bank in the country has noticed the strong population and business relocation trend towards the South, and they would all love to be here. The risk-reward of buying First Horizon at current prices is attractive.

Heads, the deal closes, and we lock up a solid risk-arbitrage profit of over 60%.

Tails, and thanks to the market’s sudden distaste for bank stocks, we own one of the best Southeastern bank franchises at bargain prices that should trade at several times the current battered price in a few years.

The other special situation worth a look this week is Atlantica Sustainable Infrastructure plc (AY). The UK-based company has seen its stock price fall by over 20% over the past years. While it has recovered slightly in 2023, the board has still decided to review its strategic alternatives – usually code for: “We might just sell the company and move on with our lives.”

Atlantica owns a global portfolio of power generation companies, most of which produce renewable energy. 73% of its global production capacity is solar.

Atlantica is also investing in battery storage projects that will benefit from the global green energy trend.

The company has a strong balance sheet and plenty of cash on hand.

If Atlantica’s board sells the company entirely, it will be at a price much higher than the current level. If they sell off their natural gas or water assets and reinvest the proceeds in more renewable energy projects, that should also boost the stock price.

Using the proceeds to buy back stock would also turbo-charge the stock price.

But, if the board decides to do nothing, you would still own a world-class collection of energy and water assets that are producing a yield of over 6%.

The stock is trading at just 6.5 times free cash flow right now, so the assets are undervalued and should eventually trade much higher than the current price, even without a strategic transaction.

It has been hard to find interesting special situations of late. Both of these have the potential for short-term gains, with the most significant risk being that you end up owning high-quality businesses at bargain prices that should give you outsized long-term gains.

As earnings season winds down, a review of the stocks recommended through my newsletters that my subscribers received a lot of excellent dividend news. Dividend growth generates annual total returns that work through the market cycles—no timing required.

A couple of recent examples illustrate my point – and show how you can get in on this great strategy, too…

A dividend growth strategy involves buying shares of stocks where the company regularly—usually annually—increases the dividends it pays to shareholders. If you calculate the average annual total returns of dividend growth stocks, you will find that over the long term, you get a compound annual growth rate that comes very close to the average dividend yield plus the average dividend growth.

Dividend increases can also help a stock price in the shorter term. Last week we saw a dramatic example.

On Tuesday, March 7, the Dow Jones Industrial Average closed down 575 points, and the S&P 500 dropped by 1.5% for the day. That day, Dick’s Sporting Goods (DKS) gained over 11%. Dick’s released fourth-quarter earnings showing excellent results. A significant factor for the share performance was the fact that the company more than doubled the quarterly dividend going from $0.4875 per share to $1.00. The boost also doubled the yield to 3.0%.

Before the big increase this year, the DKS dividend had been growing by more than 20% per year. Investors have seen a 380% total return over the last five years. I suspect the growing dividends had something to do with those great returns.

In February, the Federal Agricultural Mortgage Corp (AGM) increased its dividend by 16%, going from $0.95 to $1.10 per share. Through most of the first quarter, when the broader market was up about 4%, AGM appreciated by 26%. The AGM dividend average growth for the last decade was 20% per year, meaning investors in the stock enjoyed a 400% total return for the ten years.

I hope boards of directors realize that few things help a share price more than meaningful dividend increases. Share buybacks are a hot topic these days, but I think returning cash to shareholders as growing dividends produces better returns for those investors.

I employ a dividend growth-focused strategy with my Monthly Dividend Multiplier service. I provide a model portfolio and track the returns. The portfolio consistently outperforms the S&P 500.
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Everyone pretty much agrees that we will—eventually, at least—transition from a fossil fuel-powered economy to one powered by less polluting energy sources.

However, as this energy transition gains speed, the risk of chaos emanating from it is rising. Here’s why…

Today, investment in new oil and gas supply is well below what it was a decade ago. And investment in clean energy, though accelerating, is not increasing as quickly as it needs to.

Fast forward to a few years in the future and that could translate to a very large mismatch between ever-rising energy demand and energy supplies. The end result would be a replay of what we saw in the aftermath of Russia’s invasion of Ukraine, with energy prices rising rapidly, forcing governments to help their citizens heat their homes and fuel their vehicles—but magnified by several times.

As investors, here’s how we position ourselves for this possibility…

Oil Companies Are Not Investing Enough

A great article from the Financial Times’ Energy Source newsletter explained that one main reason for this is simply that oil and gas companies are just not investing as much as needed into increasing future production.

Despite record profits last year, oil and gas companies globally invested about $310 billion into capital spending. This was far lower than the $477 billion they invested in 2014. The rest of their profits went toward share buybacks, dividends, and paying down debt. If oil and gas companies had invested the same percentage of profits into finding more oil and gas as they did 10 years ago, the oil and gas firms could have invested an estimated nearly $600 billion.

There are a couple of reasons they did not. First, after many years of poor returns—especially in the shale sector—investors want to see their money coming back. But more importantly, the energy market is responding to policy efforts to cut down on future demand for fossil fuels.

Luisa Palacios is the co-author of a new research paper, entitled Investing in Oil and Gas Transition Assets en Route to Net Zero, from Columbia University’s Center on Global Energy Policy. She told the Financial Times: “What we’re looking at is an energy transition not where demand adjusts first—but an energy transition where supply adjusts first.”

So, while fossil fuel energy supplies are being adjusted downward—even as demand rises—we will need a bigger contribution from clean energy sources. However, investments there have not risen fast enough. They currently sit at a ratio of 1.5:1 compared to fossil fuels. Estimates are that this needs to increase to 9:1 by 2030 if net zero goals are to be achieved.

This all adds to a real mess on our hands in the near future with regard to energy as the transition happens…and it also leads to the companies that produce fossil fuels making a lot of money.

Energy Transition Winner

My favorite companies in this area continue to be the European oil companies, which are trading at much lower valuations than their American counterparts.

For example, Exxon and Chevron are valued at about six times their cash flow. That compares with about three times for Shell. And U.S. oil firms have a price-to-earnings ratio of around 8, while European oil stocks have a P/E of around 4! The reason for the lower valuations is ironic. Investors are rating these companies lower because they are slowly transitioning away from fossil fuels to clean energy.

Among the European majors, an interesting company is Norway’s Equinor ASA (EQNR), which produces more than two million barrels a day of oil and its equivalent, split evenly between oil and gas. Two-thirds of its output comes from its prolific Norwegian offshore fields.

European natural gas accounts for about a third of its total output, and most of it is sold on the spot market, benefiting from any spike higher in prices. But, unlike some of its European peers, Equinor plans to grow oil and gas production through 2026, at about a 2% compound annual growth rate.

The company made a record-adjusted pre-tax profit of $75 billion last year, thanks to all-time high natural gas prices. This helped it emerge as one of the biggest winners of the energy crisis, as Norway replaced Russia as Europe’s largest supplier of natural gas.

The $75 billion annual pre-tax earnings smashed the group’s previous record of $36.2 billion in 2008 when oil prices reached record highs of more than $140 a barrel. Adjusted earnings for the year after tax were $22.7 billion, up from just $10 billion in 2021.

Another company characteristic that I love is that Equinor has no net debt, giving it one of the best

balance sheets among the major energy companies and leaving lots of room for dividend growth (current yield 8.26%).

Speaking of payouts to shareholders…the company said it would increase returns to shareholders to an expected $17 billion this year, citing its strong earnings, outlook, and balance sheet.

Equinor increased its cash dividend to $0.30 a share for the last three months of the year, from $0.20 a share in the third quarter, a 50% increase! It will also introduce an “extraordinary cash dividend” of $0.60 in 2023, and plans to buy back $6 billion of shares in 2023.

The proposed $17 billion of payouts this year is equivalent to around 18% of the company’s total market capitalization.

Like other oil stocks, Equinor’s stock has been under pressure and is down 4.25% this year to date. That gives us a nice entry point, at anywhere in the $29 to $33 range.
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