Caterpillar's (CAT) big bottom-line miss and resulting share reaction was driven to a large degree by weakness in energy and transportation and tariff headwinds. But commentary from energy companies and analysts suggests that trend could turn around with a few key shifts.
Schlumberger (SLB) might hold one of the best indicators, as outgoing CEO Paal Kibsgaard -- who is often cited as one of the most honest executives in the industry -- places much weight on oil.
"What we're saying is that the balance between demand and supply, as we see it today, we don't see it changing dramatically as we go into 2020," Kibsgaard told analysts bluntly on Friday morning. "The main issue I think around the oil price today is the negative overhang around trade and what the implications of that is going to be for the medium- to long-term."
Interestingly, however, he said that he expects a resolution soon enough, which could take oil prices higher in the near term.
"We see a gradual fall off of the supply additions from the projects that were sanctioned and largely funded prior to 2015 and this will further expose the accelerating decline that we see in the more mature production base," he added. "You can look at Norway, U.K., Nigeria, Indonesia, Mexico and so forth and you will see there that even the non-presalt in Brazil, you will see that there is significant declines taking place there."
It stands to reason then, that a trade deal coupled with a supply reduction could be a tailwind to oil prices, even if they remain "rangebound" as Kibsgaard suggests. At the very least, the factors would be expected to lift oil prices out of their recent rut.
"A tighter global supply/demand balance that induces higher breakeven production activity and greater recovery in exploration would play to SLB's portfolio strengths and potentially lead to outperformance," J.P. Morgan analyst Sean C. Meakim noted in a potential upside to shares of the oilfield services company.
Caterpillar Carry Through
So why does all of this matter for Caterpillar?
For one, management says it does.
"Energy and transportation sales and revenues declined by 4%, primarily due to continued softness in oil and gas," CFO Andrew Bonfield said on Wednesday morning. "Sales into oil and gas applications decreased by $162 million, or 11%, due to the timing of turbine project deliveries in North America in last year's quarter (and) lower demand from new equipment in the Permian Basin."
A change in fortunes in the oil markets would necessarily reverse much of this erosion and make the segment less of a headwind and possibly return it to the acceleration seen in the first quarter, for example.
Added to interest-rate changes and the potential for trade tensions rolling off make energy a speculative catalyst for Caterpillar.
"We continue to like the longer-term framework of management's strategy and believe CAT can produce better results in the second half of the year into 2020 as more favorable economic conditions develop due to lower rates, eased trade tensions, and perhaps even a recovery in the oil cycle as told by Halliburton (HAL) and Schlumberger," Jim Cramer's Action Alerts PLUS team said.
Additionally, tightening supply plays directly to the strengths of some of their top customers internationally. For example, FactSet lists Malaysian oil drilling services company Deleum Services as the company's second most important customer. With much the same dynamics as Haliburton and Schlumberger at play, the dynamics to piggyback on strength with this prominent customer could be beneficial in a big way for the segment.
More pointedly, it makes the Permian Basin a more viable play for Caterpillar as producers would be more open to spending on oil equipment for fracking if prices made margins for the activity more attractive.
With the West Texas Intermediate crude currently trending in the low $50 area, there is not much extra profit to be generated, especially for oil services companies. With higher prices, many services companies will be compelled to spend more, which of course could involve many Caterpillar products.
Proceed With Caution
Still, investors should not look at a rebound in oil, trade tension resolutions, or even a dovish Fed as certainties. Fool me once, as they say.
Also, no one factor is necessarily enough to get oil and oil field services companies over their prolonged lower levels.
"The macro outlook, from our perspective, is considerably more Darwinian. We believe that the demand anemia is being driven in large part by a global economic deceleration that, admittedly, has been compounded by trade policy errors and intransigence, but is fundamentally being propelled by considerably larger forces than U.S./China trade friction," Simmons Energy analyst Bill Herbert noted. He said he believes that non-OPEC production growth will be not only driven by the U.S., but by other areas, including Canada and, most prominently, Brazil.
That dynamic could curb the supply reductions expected by many analysts and temper the potential resurgence of attractive oil prices.
Additionally, as companies like Schlumberger have touted price recovery as a key catalyst to buoying its own stock price higher through increased capital expenditure on oil exploration, the dynamic has been shaky at best.
For more speculative players, there is certainly a good deal of hope.
At just 11 times earnings and diversification benefits away from oil as well, Caterpillar could be an interesting ancillary play to pure oil or oil services companies.
Still, with plenty of uncertainty remaining, less risk tolerant investors still do have reason to tread lightly and might be better to hold off on filling up the whole tank.
CAT and SLB are holdings in Jim Cramer's Action Alerts PLUS member club.