NEW YORK (Real Money) -- The recent decline in the price of crude oil has given journalists and analysts alike something to talk about. All that attention has also given investors something to consider: Is investing in oil an opportunistic bet?
The answer is yes and no. In the short term, oil is probably going to be a slippery investment. In the long run, the decline in black gold has sent stock prices of oil-related businesses crashing.
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Anyone investing in oil today simply needs to answer one very simple question: If you invest today and the price of oil drops below $50 per barrel next month, what will you do next? Will you hold on or invest more, or will you exit and take your loss?
For what it's worth, there appears to be some intriguing pricing going on in the oil industry. Oil-drilling company Ensco (ESV) has fallen down to $33 per share and currently yields 8.9%. Unlike peers, however, Ensco has a very solid balance sheet. And cash flows support the dividend. In 2013, Ensco pulled nearly $2 billion in operating cash flow against $500 million in dividend payments. Interest expense in 2013 was $158 million.
But let's recall back in 2010 and 2011 when oil prices were at or below today's prices. In 2011 Ensco pulled in $700 million in operating cash flow and paid out $300 million in dividends. So if Ensco's operating cash flow fell by more than half, the company would still generate sufficient cash to pay today's dividend. To be sure, I am talking about operating and not free cash flow, and it is from free cash flow that dividend payments come. But I assume that in a tight oil market, Ensco, as it has done in the past, will restrict capital expenditures until forward pricing dictates otherwise.
But what good is a 9% yield if the stock falls another 30%? This is when you decide if you are going to invest in oil today or tomorrow. At $33 a share, Ensco shares may find $20 before moving back up to $50, which is why you have to have a long-term playbook for oil. A barrel could drop below $50 before climbing back above $80.
In the meantime, names like Ensco and giants BP (BP) and Chevron (CVX) are continuing to get hammered as the price of crude heads lower. An opportunity is surfacing in oil; you just have to be patient and pick your spots.
Editor’s note: This article was originally published on Real Money Dec. 2 at 1 p.m. EST.