Motley Fool Money - Europe's Energy Challenge

Episode Date: September 6, 2022

The energy situation in Europe is getting more challenging. Finland's economic affairs minister (0:12) Bill Mann discusses: - CVS Health buying Signify Health for $8 billion in cash - Finland's minister of economic affairs comparing Europe's energy situation to the collapse of Lehman Brothers - How his investing outlook has been affected  (14:54) Nick Sciple joins Alison Southwick for an overview of the energy industry. (We opened the show with the tragic news of Bed Bath & Beyond CFO Gustavo Arnal taking his own life. If you are having suicidal thoughts, contact the Suicide & Crisis Lifeline at 988 for support and assistance from a trained counselor.) Stocks mentioned: CVS, SGFY Host: Chris Hill Guests: Bill Mann, Alison Southwick, Nick Sciple Engineers: Dan Boyd, Rick Engdahl Learn more about your ad choices. Visit megaphone.fm/adchoices

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Another day, another acquisition. Motley Full Money starts now. I'm Chris Hill joining me today, Motley Fool, Analyst Bill Mann. Thanks for being here. Hey, Chris, how you doing? I am doing all right. I'm doing all right. We are going to get to CVS and their deal, and we are going to get to Europe in a second.

But I did want to start by just saying a quick word about the tragic event over the weekend, those who had not heard, Gustavo Arnaul, the chief financial officer at Bed Bath and Beyond, took his own life on Friday. News of this tragedy broke on Saturday, and this is one of those stories that makes talking about business seem trivial. So instead of talking about what this means for the company or the stock, I will simply say two things. First, our condolences to Mr. Arnaudal's family and friends.

colleagues. And second, for anyone listening, please take care of your mental health. And if you are in any way struggling or in distress or thinking about any level of self-harm, please call 9-88, which is the Suicide and Crisis Lifeline, 24 hours a day, seven days a week. Someone is there to talk and to listen. Just call 9-88. So with that, my friend, let us move on to the business of business. CVS Health is going even further into the pharmacy world. CVS Health is buying Signify Health, which is a home health care company. They're paying $8 billion for this deal. All cash. We can talk about, I was just going to say all cash, which is something you and I talked about recently at Fulfest when we were talking about.

acquisitions, your expectation, Maria Gallagher's expectation, that more acquisitions are coming, and you specifically called out the all-cash type of acquisition. It's safe to assume you like this deal, or at least the fact that CVS is doing it in cash, not stock? Sure. I mean, what we talked about last week, and I think that this definitely applies, is when you see a company buying another company or making a transaction with all cash, it shows a certain level of confidence in the business, then also the business combination. Now, Signify Health. It's an $8 billion transaction, which may be a lot of money to most people.

It's not a huge amount of money to CVS. CVS is actually already, and this blows my mind, Chris, the largest healthcare company in the United States by revenues. So not a huge transaction for them, but it does mean that they are still reforming and taking their place in how health care is provided in this country. This, when I was looking at Signify Health, I was struck by the fact that this is a stock that is in positive territory in 2022. We've seen acquisitions of businesses where their stock has been cut in half or more.

Is it reading too much into that to think that CVS Health wasn't just looking for a bargain? They like what Signify had to offer? So, Karen Lynch is the CEO of CVS. Boy, that's a lot of letters in a row. She last year spelled out a plan from CVS. to really reinvent itself. They're closing a lots of stores. A couple of years ago, they bought Aetna. They are trying to push themselves into the center of how health care is provided in this country. And so what you're seeing here, and it's a good point about the share price,

I don't actually think that this is a bargain for them. They didn't, they're not out there. They're not out there looking in the Phileans basement bin for companies. They are looking at a best-of-breed home care service that has an estimated 10,000 physicians that are currently out in the field providing primarily house calls. It's in-home care. And so the price of the shares, I don't think, were as important as where Signify sits within the healthcare space. So this was about fit, because you're right about CBS Health as a business.

You look at its size and it's not unreasonable to look at the business and say, well, wait a minute. Isn't this a business that kind of does everything now? But clearly would signify they found a niche that this business filled, if not just improved upon. Yeah. that this is, although CVS is the largest of them, this is one in a line of transactions of this type that have taken place. Walgreens, which may be the best proxy for CVS, just finalized a deal

to buy CARCentrics, which is a home health care platform in the spring United Health, which is a massive insurer, bought LHC group, which is in-home health. So this is part of a process. And I think that what you're seeing is for better or for worse, and I happen to think as a consumer of health care services, unfortunately, for us, it'll turn out to be for the worse. But for CVS shareholders, maybe for the better, this is another step in the consolidation of health care in this country. Let's move on to Europe, because for anyone who is looking for more evidence of challenges for the European economy. Congratulations. You got them over the weekend, as it seems like, and this is another thing that we talked about on stage at Fool Fest, just sort

of the challenges, the growing challenges that Europe is having with power and energy. Where do you want to start with this story? Because there are, there are, a couple different angles of the 50,000 foot view that you can pick from here. I think you might want to start with the energy minister in Finland describing this as a potential Lehman Brothers situation. I don't know if you remember Lehman Brothers, but the end of the story was not great. It was a firm that literally blew up during the financial crisis. and there are people in Europe in very, very prominent positions who are terrified where they find

themselves from a demand and a supply imbalance on the continent. And just to add a slightly more color. Did that sound great to start out? I mean, it certainly gets my attention. And just to add a little bit more color, the further we get away from the great recession, 2008, 2009. I think the easier it is to look at certain events within the Great Recession and think, well, that was inevitable. But you and I were there at the time. And I think, I don't want to speak for you, but I believe for you and I and a lot of other people, right before

it happened, it seemed completely improbable. At the time, it was like, what do you mean Lehman brothers might just disappear? Have you seen the building that they're in? Have you seen? Yes. Yes. I think that's right. I mean, I happen to think, I love the word inevitable because the opposite of that, I guess, is inevitable. And I felt like, you know, in the late two, 2000s that a lot of the mortgage industry in this country was a bug in search of a windshield. And it has seemed to me for a while. And I want to be careful here, Chris, because I don't like being frankly political. And I don't think we are not a political show and we are not a political company.

But sometimes you have to take a look at politics that are driving certain things. what has happened in Europe, and this is overly simplistic, but there has been a drive towards replacing fossil fuels with renewable energy, and it seems, it has seemed for me to me for years that they have missed a step, which is to say that the way to replace the current energy slate with a new greener slate is not to go about trying to figure out how to make it harder and harder and harder to produce and to make money from the current slate. You have to have the next slate in place beforehand. So what has happened in Europe? You've had countries that have shut down nuclear power plants. They've they've canceled permits. They've they've

canceled pipelines. All in the while, they have made the choice. to simply replace that by buying as much fuel as they could from countries that weren't very nice to them, that were not that did not have the same principles and interests in Germany. They call it, you know, Vandon do Handel, which is, you know, change through trade. It has not happened. And it was always naive. And here we are. So, you and I talked earlier this year, when U.S. companies were pulling their operations out

of Ukraine, out of Russia, and in the case of businesses like McDonald's, Domino's Pizza, Starbucks, it was pretty straightforward in terms of the math that shareholders could look at the businesses and say, well, in terms of their international sales, here's the percentage that come from these companies, okay, we're going to have to back this out. And there was some discounting that went on. When you look at what's happening in Europe, it is not as clear cut. It is not as straightforward. But what kind of discounting should U.S. shareholders be doing when they're looking at Europe grappling with energy challenges? I think the clearing price for energy at some point is going to stun people.

Already this weekend, we have seen one of the larger German toilet paper companies declare that it was insolvent. That may seem funny, but it is an energy-intensive, low-margin business, and they don't have the funds to operate under the current power regime. And I think it may get a lot worse. And basically, what we're coming down to, Chris, is that the solutions really involve governments stepping in and stimulating again. But those solutions, they don't do a bit of good at all when you've got a supply issue for energy. If anything, they make it worse.

So I don't know what the solution is. All I know is that two plus two doesn't equal five even for really, really large instances of two. And so for us to be in a situation and for them to be in a situation where they have somewhat naively not taken pains to harden their fuel supply issues. And they've had a decade when they could do this. I mean, it is going to be bad, and I hate to say it that way, but I really do believe that that is the case, that the solutions are in some ways going to exacerbate the problems. Has anything that we've just talked about affected your investing in terms of you moving

industries or companies higher or lower on either your watch list or just your confidence list? Yeah. In January of this year, we had a full online conference. And at the time, I mentioned that I was really interested for the first time in a while the mainline energy companies, the oil and gas producers. And, you know, I think that's where you have to go. I think you absolutely positively have to go because if you think about it, Chris, energy prices are the offset for every other kind of economic growth. Everything requires energy. So spiking energy prices are something that are impactful to almost everything else. So to me, I go back to what I said

in January, I don't care if you like it or not. I don't care if you believe that our future is green. I agree and I can't wait for us to get there. But the process is going to go through additional generation through hydrocarbons. And that's just reality. And I think investing is a reality-based pursuit. And so that's the best advice I can give. Bill, man, always great talking to you. Thanks for being here. Thanks, Chris. Sticking with energy. Nick Seipel joined Allison Southwick for an overview of the industry. A break is behind us. And perhaps you, like the kiddos, are heading back to your desk and are ready to focus again on the serious stuff of life. In the next few weeks, we're going to help get you up to speed on what you may have missed in the energy,

tech, and consumer goods sectors when you were poolside at the bottom of Pinia Colada. Motleyful analysts will cover the big headlines, where the sectors are headed, and share some stocks to watch so you can hit the ground running. This week, we're joined by Motleyful analyst Nick Seiple to talk about the energy sector. Nick, thanks for joining us. Great to be here with you, Alison. Lots of exciting stuff going on in energy today. Yeah, we have a lot to cover. Okay, so between the impact of COVID, climate change, and the war in Ukraine, this sector has gone for a wild ride in the last few years. And before we get to the, so where are we now? Let's talk about the basics of the sector, because the answer is different if you're asking the SMP or the average person on the street.

Sure. So I think a lot of times folks maybe get mixed up about what is actually in the energy sector. You think about solar energy, your local utility, those sorts of things. Those do sell electrons to your house and provide electrons into the market. When you think about the S&P 500 energy sector, we're really talking about traditional fossil fuels, oil and gas. And when you think about that, really three buckets to put that in, they describe it as upstream, midstream and downstream. The upstream is the folks that are really pulling the oil and gas out of the ground, exploration and production companies, and then also the servicing companies that help them do their work, you know, drill the holes in the ground,

those sorts of things. You've got midstream companies, which are the pipelines that actually take the oil that comes out of the ground and bring it to market. And then you have the downstream companies, which these are the refiners, the folks that turn oil into finished products like diesel and gasoline. When you go to the gas station, these are the folks that you're interacting with. And then lastly, you have the integrates, the axons, your chevrons that do all those things I just talked to you about. That's really what the energy sector is in a nutshell. All right, let's talk about trends in the sector. I think the obvious place to start is

the invasion of Ukraine and the repercussions there. But actually, we need to cover what came before February of this year. Absolutely. So the way you can maybe put a bow around what's going on right now is we're in a global energy crisis. That's not something I've made up. You've got the executive director of the executive director of the International Energy Agency, Dr. Fatea Beryl, actually said that on the 18th of July. And certainly this has been exacerbated by what's going on in Ukraine when you have some a country in Russia that provides almost 40 percent of Europe's natural gas, really a big deal. But we're already heading into an energy crunch in 2020, in 2020, in 2020, experience.

excuse me, before Russia invaded Ukraine in February. And that's because we had been looking at many, many years of underinvestment, a new exploration of oil and gas, and also a big surge in demand coming out of the pandemic. So just give you some stats. Global operators are spending about 60% less on global oil and gas production projects today than they were in 2014. And global energy demand continues to rise as quality of life improves, those sorts of things. So you had coming out of the pandemic crashing into lack of investment, this is a lot of investment. you throw on top Russia invading Ukraine. Even in 2021, you had Russia curtailing some natural gas flows to Germany and other Western countries, but that's really accelerated here in

2022. That's created energy crunch in Europe, which is also expanding globally. Europe has rushed out to buy supplies of liquefied natural gas to solve their energy problem. But to the extent Europe is winning these bidding wars, places like Pakistan, Asian buyers are losing. So it's not just a European problem. It's a global problem. We've got a big supply and demand problem here, everywhere. Absolutely. I think another thing to think about as well, if you go anywhere in the market, there's a labor shortage, and the oil and gas industry is not an exception. After years of lack of investment in the space, lots of skilled labor has left the industry.

There's certainly some of the same supply chain shortages hitting the oil and gas industry. Lots of folks don't want to invest in oil and gas for ESG concerns, those sorts of things. So, you know, we have this supply and demand imbalance, but there's really some barriers. to increasing supply in the near term. And that's really exacerbating some of the problems as well. All right. So amidst all this chaos and uncertainty, what's your advice for investors in the energy sector? I mean, generally or even just specifically for right now? So the first thing investors should always keep in mind when you're looking at the energy market is that this is a commodity industry. It's set by global supply and demand. So today,

we've seen a really down swing in supply because of some of those issues about underinvestment. and demand keeps rising up. However, keep in mind that this cycle will turn again and don't over extrapolate what's going on all the way into the future. Another thing to keep in mind as well, this is true in oil and gas, but also in some of these other sectors you hear talk about, folks talk about it's kind of adjacent to energy, so batteries and things like that. Watch out for companies that haven't done it yet. You hear lots of these kind of junior miners or junior acceleration companies that haven't really pulled oil and gas out of the ground or haven't built a facility yet. Those companies tend to be much.

more speculative relative to companies with track records of investing through the cycle, producing cash flows and spending them wisely for shareholders. There's lots of bad apples in the energy space, so you really need to be choosy when it comes to picking the companies you invest with. So where are you looking to invest? Where do you see opportunity or maybe even some stocks to watch? Sure. So I think there's kind of two buckets to look into. There's the short term. There's an energy supply and demand problem right now. How do we solve that with fossil fuels, things like that today? Then long-term, how are we going to solve this energy problem over the longer term? I think near-term, lots of needs for fossil fuels.

So I think some energy exploration and production companies look particularly interesting today. One that I've talked about quite a bit is Canadian Natural Resources, the largest producer of oil in Canada. It has some of the lowest break-evens in the industry in the low 30s, has a track record of wise capital allocation over 20 years of dividend increases, which is. difficult to see in the oil and gas space. And also, there's tailwinds behind Canadian energy as a whole. So to the extent Russian supplies are coming off the market, you have Western countries looking for new sources of energy. You actually had the German Chancellor Olaf Schultz visit Canada in recent weeks

and say we're looking to Canada as one of our key sources of energy security in the future. So I think near term, these producers are going to benefit from high prices. but I think longer term, we're seeing more political support for building things like liquefied natural gas export infrastructure in Canada, which could support demand for these countries, for these companies, excuse me, Canadian production companies, over the longer term. So I think these companies benefit today. And also, there's some tailwinds looking out longer term. Another area that I think is interesting as well is nuclear power. So I mentioned natural gas as a growth area. It's natural gas and nuclear actually were declared by the European Commission

as, quote, green energy investments in July. So really signifying that this change in policy. So you've seen a big shift towards supporting more nuclear power. Korea has been one example. In the UK, they're talking about expanding nuclear power. And part of that is, is you get that stable baseload power generation, but without the emissions problem. So one of the difficulties with renewable power is that it is intermittent. And so it's difficult to substitute renewable energy, wind and solar one for one for things like coal, oil. natural gas. And so you're seeing some of this renewed support for nuclear power, particularly as some of the countries that have more nuclear inventory in Europe are facing the energy crunch

relatively less, less than the ones who aren't. And so I think if you look at the nuclear power industry, it will take a number of years to build out new facilities. So the next wave of nuclear power designs is called these small modular reactors. The first of these designs is not going to come onto the market until 2028 in Canada, and one of the companies that's helping deploy that, and I think is worth folks paying attention to, is a company called BWX Technologies. They've been an early leader in the nuclear power industry for years. They actually helped develop the very first commercial nuclear power facility in the United States. They've been doing small modular reactors for a very, very long time as well, if you think about it, because

they are the only, the sole source provider of nuclear reactors for the U.S. nuclear fleet. So if you think about things like submarines, aircraft carriers, those sorts of things, what are those, if not small, modular reactors? So that's the core of the business. They also support nuclear reactors in Canada, and they have an exciting new business on the medical side where you take used nuclear reactor fuel, you spin it up and you turn it into cancer-treating isotopes. I think BWX technology is an interesting company looking out longer term to benefit from growth

in nuclear technologies. And again, some of these other exciting verticals as well. All right, Nick, before you go, what's your parting advice for investment? in the energy sector. The last thing I would say is just keep in mind, this is a commodity industry and know where the commodity risk that you're taking. If you're buying an exploration and production company, these folks explore for and produce oil. They're really exposed to the price of oil and gas.

If you're talking about a servicing company, these are the folks who help those companies drill holes in the ground. Those companies don't, I mean, it matters what the price of oil and gas is, but really what's important to them is how much activity of their exploration and production companies taking out in the market. if you're buying a refining business, what really matters to you is what is the spread between oil, which is their kind of key feedstock or natural gas and those finished products like jet fuel, diesel, things like that. So know your commodity risk that you're taking within that individual

company and know where they sit in that vertical. So that would be my advice. Well, Nick, thank you for getting us back up to speed with the energy sector. It's really interesting. It's an exciting place right now. Great to be here. There's new headlines every day. So, stay tuned. Things may change. Next week, we'll be back with Tim Byers to give you an update on the tech sector. As always, people on the program may have interest in the stocks they talk about, and the Motley Fool may have formal recommendations for or against.

So don't buy ourselves stocks based solely on what you hear. I'm Chris Hill. Thanks for listening. We'll see you tomorrow.