I’ve mentioned a few times (most recently here) that I’m a little confused by the price of commodity and cyclical companies. The basics of this confusion are simple: commodity prices have absolutely ripped higher, and while many of the commodity stocks have seen their stocks go up, their stocks have not gone up even close to as much as the underlying input’s increase would imply.
been wondering this for a while too... frankly I thought last year we would see a ton of this as energy started moving but the stocks hadn't and the FCF gen by then was already clear... some people tell me ESG keeps them away (I don't think so, but maybe keeps them away for a while). Buffett finally made his move.... again, not sure what took so long.... thanks for the blog
Its a good article and I lean more to 2 than 1. Mgmt teams nowadays are hyper sensitive to the external environment. However it is impractical to hedge out the curve. Many products are illiquid after a few months. Hedging the benchmark means taking on basis risk. Physical hedges maybe but that too is complicated in size longer dated.
In theory: Energy producers owned first and foremost a physical call option on futures. So it's logical that as this option moves deeper into the money, that the extrinsic value premium in the p/pv 10 ratio should go down.
Now I agree with your argument in practice in terms of magnitude of the delta :)
Look at something like Baytex. Very cheap. When you adjust for the hedges even more so.
Nice post! Very interesting sectors.
I think the hedging results in a tad more risk than one might realize? If you would hedge your best estimate of production volumes per (whatever) period there is some risk from operations, ie a catastrophe with much lower production volumes.
Further, as we have seen recently, there can be big margin calls.
And, politics might limit future profits, as might cost inflation?