Risk-averse retail investors drive shift in money markets
Small-cap oil and gas stocks feel the brunt of investor anxiety
The fallout from the financial meltdown of 2008-09 is still being felt by institutional investors and oil company executives. The mental trauma experienced by most retail investors (and for that matter portfolio managers and energy executives) has changed how both institutional money managers and oil companies must do business, and yet many companies have been too slow to adapt. Let me explain why.
The vivid memories of 2008 still haunt retail investors, and their habits and investment preferences have changed accordingly. Their attitude towards risk, both real and perceived, has changed how most institutional money managers invest, and this shift directly and indirectly affects oil and gas companies.
First, risk aversion has largely remained intact since 2008 (with the odd greed-induced deviation along the way). This has led to the continued shunning of micro- and small-cap oil and gas stocks, despite having had two great years (2009, 2010) and one mildly negative year (2011) of performance. I can personally recall (somewhat painfully) several smaller cap investments falling by over 75 per cent in 2008.
Those dramatic losses shifted retail investors’ focus from “make me as much as you can” to “make me 10- to 20-per-cent a year if you can but don’t lose me any money.” This shift is profound. It has led to a significant-multiple contraction in the small-cap space (~300 basis points difference now against intermediates).
The direct impact on oil and gas companies is significant. A lower share price means a substantially reduced currency in which to transact, be it for land or accretive corporate acquisitions. The apathy towards micro- and small-cap stocks, combined with increasing well costs and shrinking cash flow has meant that in order to survive, companies need to get bigger. Some have caught onto this already, while many others are still behind the curve. Low natural gas prices only make consolidation more of a necessity.
Second, due to increased risk aversion, demographics, and low interest rates, the demand for yield is nearly insatiable. The increase in retail investor demand for yield has led to the emergence of a “new post-income trust with a twist” business model.
What I’m referring to is the low- or no-growth, high-dividend paying model. For example, Twin Butte Energy’s strategy of low growth and high yield transformed the stock into a retail darling. Other companies should pay attention to Twin Butte’s market success with this strategy – the stock appreciated by roughly 25 per cent.
There are many mid-cap companies, for instance, that could likely support a modest to healthy dividend payment in addition to a more modest growth rate, assuming they have already spent the capital to capture enough resource inventory. So long as the dividend is sustainable, companies would likely trade off a yield metric as opposed to a cash-flow metric.
The addition of a small dividend can also increase the overall investment audience. Income-oriented mutual funds have been by far the largest recipient of investor capital over the past few years and yet they have certain qualifications for fund holdings. In short, even a two- to three-per-cent “carrot” can make a huge difference to one’s share price.
The third impact of a risk averse investor climate has been the change in view towards producer hedging. The demand for lower risk and lower volatility has translated into the desire on the part of institutional investors for oil and gas companies of all sizes to hedge a portion of their production (minimum 25 per cent).
It is my belief that companies will trade at a premium, and not a discount, if their business model is protected via a hedging program against a sudden decrease in the price of oil. Sadly natural gas hedging is off the table for some time to come.
There has also been a small but noticeable shift in the attitudes of some producers towards hedging, especially considering the unbelievably egregious margins that can be crystallized at US$100 West Texas intermediate oil. I have a hard time believing that investors will punish companies that decide to lock in 25- to 50-per-cent of their production if they can secure over $60 netbacks in many oil plays.
That would ensure strong production per share growth, which happens to be the metric with the highest correlation to share price performance.