 Industry Analysis

Types of Industry Analysis  Two main methods used  Porter’s 5 Forces  SWOT – Will not go over but another qualitative way to analyze industries

Porter’s 5 Forces  Method of analyzing industry and competitors  5 Competitive forces that shape every industry

5 Forces

Threat of New Entrants  How easy it is to enter the industry?  Barriers to entry for new producers/suppliers  Economic moat

Barriers to Entry  Most prominent barrier to entry is legislative limitations  Others Include:  Patents  Tax benefits to developed companies

Pharmaceuticals (Growing Expenses)

Power of Suppliers  Pressure that suppliers can place on a business  Can supplier impact company’s margins and volumes?  Examples:  Loyalty to major brands  High Fixed Costs  Scarcity of resources

Power of Buyers  Pressure that consumers can place on a business  Can customer influence margins and volume?  Examples:  Few suppliers  No substitutes  Extremely important product

Availability of Substitutes  Probability of switching to other competitor  Factors that influence threat of substitutes:  Small number of buyers  Purchases large volumes  Low switching costs  Customers are price sensitive

Competitive Rivalry  Intensity of competition between existing firms in an industry  Higher competition = Lower Margins  Highly competitive market may occur:  Similarity of substitutes

Quantitative Factors  Size of Industry  Growth Rate  Breakdown of consumer (By Sector and Geographical Location)  Contract based revenue or constant revenue  Debt profile of industry

Let’s Dive into an Example  We will begin with the oil industry  Quantitative factors  5 Forces

Size  Fossil fuels account for more than 85% of energy consumed in the US  Oil supplies 40% of US energy needs

Oil Consumption Growth

CAGR  Compound annual growth rate  Mean annual growth rate over a specified period  Works in all growth rates not just $$

Consumer Breakdown (Geographically)

Consumer Breakdown (Sector)

Supply Chain  Before petrol can be used it is sent to a refinery  Separated and converted into finished products  About 90% is made into fuel  10% is used as petrochemicals

Who’s competing and for what?  Two major components:  Oil Drilling and Services  Refining

Drilling  Physically drill and pump oil out of the ground  Highly skilled labor force  Very expensive  Usually hired on contract basis  Very sensitive to oil prices

Oilfield Services  Seismic Testing  Mapping geological structure beneath the surface  Transport Services  Both land and water rigs need to be moved at some point  Directional Services  Angled or horizontal holes

Oil Refining  Small handful of large players  Huge barriers to entry  Slow and stable business  Not very sensitive to oil prices

BTU  British Thermal Units  Amount of heat required to increase the temperature of one pound of water by one degree Fahrenheit  Quote different energy at price/BTU  Simply measures the energy content of fuels

DayRates vs. Meterage  DayRates – Contract based rates charged by oil and gas drillers  Meterage – Contract based rates charged by oil and gas drillers which is dependent on the number of feet drilled  Which is more or less desirable?

Debt Levels  Total Debt reach 2.4 Trillion in 2014

Top Down Approach  Economics  Politics  Supply and Demand  Rig Utilization Rates  Contracts  Financial Statements

Economics  Easily influenced by economic and political factors  Cyclical investment periods  High correlation with energy prices

Supply and Demand  Price is determined by supply and demand  Demand rather stagnant  Frequent supply shocks  OPEC

Supply vs. Demand Shocks

Rig Utilization Rates  Higher utilization means more revenue and profits  Rates per individual company  Higher quality rigs will have higher utilization rates especially during slower periods  At capacity cannot increase revenues

Regional Rig Utilization Rates

Financial Statements  Looking at individual companies  Certain ratios are more critical in different industries

Broad Financial Indicators  Revenue and profits  PE Ratio  Debt  Credit rating  Debt/Equity  Working Capital

Oil and Gas (CVX)  Want increasing revenues and profits  Inorganic profit growth/improvement of margins

Profit and Revenue  Profit margin is not decreasing in fashion with revenue suggesting in organic margin improvement

P/E Ratio  P/E should be comparable

Credit Ratings  Is the company paying back debt?  What is the risk of default?  CVX rated as AA- (Above IG rating)

Debt to Equity  Measure of companies financial leverage

Working Capital and the Ratio  Current Assets / Current Liabilities  Short-term measure of financial health  Whether a company can cover its short term liabilities  Very important in younger companies

Entry and Exit Points  You’ve determined you want to invest in oil… now what?  Everything trades at premium/discount to intrinsic value  Timed entry to maximize profit

SMA and Volume Indicators