If you read my year end review and outlook for oil that was published a few weeks ago, before I went on my somewhat extended holiday break, you will know that I started this year bullish for oil, but with a few provisos. Mainly, they are to do with economic conditions in the US and to a lesser extent China. Higher for longer interest rates should inflation remain elevated (as Thursday's US CPI suggested it might) could affect the demand side of the pricing equation, but as long as crude stays above $65 simple economic theory dictates that, at some point supply will increase too. That could be absorbed if demand stays strong, but there is always the chance that increased supply will hit just as there is a wobble in the economy, pushing prices significantly lower.
So, I have been looking at stocks that might benefit from increased production but won't necessarily get hit hard should oil drop later in the year. That search led me to Liberty Energy Inc. (LBRT), and the more I looked, the better the play seemed. My analysis is usually top down, starting with a big picture look, then looking for value and financial stability, and then finally looking at a chart to see if there is a logical support close by and the potential for an upside significantly larger than the downside created by setting a stop off that level. LBRT fits on all fronts.
They are a Colorado-based company that provides fracking services in North America, which some may think is a risk in itself. After…
If you read my year end review and outlook for oil that was published a few weeks ago, before I went on my somewhat extended holiday break, you will know that I started this year bullish for oil, but with a few provisos. Mainly, they are to do with economic conditions in the US and to a lesser extent China. Higher for longer interest rates should inflation remain elevated (as Thursday's US CPI suggested it might) could affect the demand side of the pricing equation, but as long as crude stays above $65 simple economic theory dictates that, at some point supply will increase too. That could be absorbed if demand stays strong, but there is always the chance that increased supply will hit just as there is a wobble in the economy, pushing prices significantly lower.
So, I have been looking at stocks that might benefit from increased production but won't necessarily get hit hard should oil drop later in the year. That search led me to Liberty Energy Inc. (LBRT), and the more I looked, the better the play seemed. My analysis is usually top down, starting with a big picture look, then looking for value and financial stability, and then finally looking at a chart to see if there is a logical support close by and the potential for an upside significantly larger than the downside created by setting a stop off that level. LBRT fits on all fronts.
They are a Colorado-based company that provides fracking services in North America, which some may think is a risk in itself. After all, it is a presidential election year in the US, and should the Democrats regain the White House, Biden will no doubt have been elected on a platform laden with anti-fossil fuel, pro green energy rhetoric. Right now, though, that looks far from certain, with polls showing Trump a slight leader in key states. And even if the opposition to Trump is so strong when push comes to shove that the unpopular Biden does win, his actions in office suggest that while the green talk will continue, the fear of high gasoline prices will ensure a practical approach to exploiting America's natural resources by any means necessary, including fracking.
If we discount the political risk that has presumably been holding the stock back and look just at the business, it is hard to escape the value. LBRT currently trades at around five times both trailing and forward earnings, a big discount to larger, less specialized oilfield services. Schlumberger (SLB), for example, has trailing and forward P/Es of 16.8 and 13.3 respectively and Haliburton (HAL) 11.7 and 9.7. Nor is Liberty a struggling entity where any downturn would represent an existential risk. They have a very solid balance sheet, with just $446 million of debt and free cash flow of well over $300 million on a trailing twelve month basis.
Even the chart supports the thesis. The stock has been falling recently, losing 19% from its high of 21.25, achieved in October. That brings it close to the $16.50 level that is significant in two ways. It was the bottom of a gap in early September, then held as a logical support after a sudden drop just over a month later. There is another support at around $16, the low that held multiple times in August, that can be used for a stop. With an entry point just over $17 and a stop at, say $15.70, the downside to the trade would be just under 9%, while just a return to challenge the high represents a potential upside of over 20%.
With a longer-term play like this, I typically stick to my initial stop level, but the target level is flexible. That would definitely be the case here, with a move up to around $20 prompting a partial profit take and a reset of the stop for the balance of the position to around $17. The new target would then be a break to a new high above $21.50.
Often, when a trade or investment theme is suggested by broad economic conditions, picking an individual security to benefit from that theme is a matter of making a concession or two. It is very rare to come across something that fits the theme, represents value, has a solid balance sheet, and where the chart indicates a good entry point and the right kind of risk/reward ratio. LBRT does all of that, so it is something I will be buying over the next few days.
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