oil is down. so what?

Unless you’ve been living under a rock or on a commune somewhere, you know the big news in the markets over the past few weeks has been the plummeting price of oil. With domestic production at record levels thanks to the fracking revolution and OPEC stubbornly refusing to cut production, oil is getting cheaper and cheaper. Investors have predictably responded by selling off energy company stocks in a big way. That makes sense. Lower prices mean lower profits and, especially for smaller producers, possible bankruptcy.

But there are two related stories to the drop in oil that don’t make sense, in my opinion–and they could signal potential opportunities on the long and short side.

One: the oil contagion has spilled over into ancillary companies that are oil-patch related yet not wholly dependent on oil, with investors dumping the stocks of Texas homebuilders like LGI and Forestar and industrial and engineering companies like Primoris.

I understand why folks might be nervous about the prospects for these businesses, but as I write about in my book (available for pre-order now!), I lived through the oil bust of the 1980s and the present situation does not resemble that event in scope or scale. More importantly, the economy of Texas isn’t nearly as dependent on energy as it once was. Lower oil prices won’t help growth, but with dozens of major corporations in every sector from tech to healthcare relocating to the state in recent years–and many more sure to follow in the future–the region will almost certainly continue to prosper and companies located there will almost certainly continue to grow their earnings along with it. And yet, after weeks of downward pressure, many of their stocks are approaching once-in-a-lifetime fire sale prices now, which brings me to the second nonsensical thing about the recent sell-off:

Where it’s not happening.

It’s been nearly eight months since I wrote about the mania in fast-casual restaurant stocks, and while some companies in the sector have cooled off, most are trending above their 50 and 200-day averages, despite being just as earnings-challenged as ever. Take Zoe’s Kitchen, for example. As energy stocks have been getting reamed over the past few weeks, Zoe’s has appreciated nicely. Despite a meager projected EPS of a couple cents, it hit a new high of almost $40 a share in October.  That’s crazy enough, but when you consider that Zoe’s is headquartered in Texas and a large portion of its restaurants are located in energy-centric states like Texas, Oklahoma, and Louisiana, its recent rally seems downright bizarre.

If investors really believe that falling oil prices put the wider economy of Texas in grave peril, why are they buying stock in an overvalued Texas-dependent company like Zoe’s while punishing more established and profitable Texas-dependent companies with much better stock valuations? That seems, well, maniacal to me. Then again, this is the same market where dubious social media stocks like Yelp, LinkedIn and Twitter sell at 10-14x revenues while a well-managed company like Primoris only fetches around 11x earnings and an even lower multiple of cash flow, so I guess I shouldn’t be too surprised.

5 thoughts on “oil is down. so what?

  1. J. Bucknell

    Great post, Scott. I’ve been baffled by Zoe’s Kitchen’s valuation as well. At its current price, when I back out the implied long-term growth rate of ZOES using a simple three-stage DCF, I get upwards of 70% annual earnings growth expected over the next five years. To put that in perspective, Chipotle grew earnings at around 35% annually between 2005 and 2009… To expect Zoe’s to grow twice as fast as Chipotle did in its early years is slightly absurd, in my opinion.

  2. Mjb

    so what would you buy in TX based on this selloff? Are you long the home builder that you mentioned? Do you have any positions that reflect this perspective?

  3. Fellow Texan with a different memory

    Scott, you are starting to sound like a value investor. What happened momentum and growth? This distresses me. Are you aging? While I totally agree with you on Zoe’s, I could not disagree more on the Texas economy and its dependence on oil. Last time, we had large finance companies (banks, insurance companies, mutual funds). Now, none of size. Last time, we were a player in technology (Texas Instruments maybe the largest semiconductor company), Compaq, and Dell to name a few (all with manufacturing locations in the state). Last time, we had a couple large software companies. Now? Health Care, not a single meaningful company location in the state, except Tenant. Despite the great hospitals at Texas Medical Center and UT-Southwestern, not a single legit biotech company. Auto companies (TEN gone). Any retailers located here? Oh, yeah Radio Shack, Pier One, and Stage Stores. Not exactly, Columbus, Ohio. On the bright side, we do have Southwest and American.

  4. Christoph Michelle

    What about the news about the crown capital management all over the web, You don’t write anything regarding that?


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