Want a peek at this summer’s headlines? Then just watch the action in the oil market. The price of oil has been rising steadily for nearly two years, and it’s coming close to the point of inflicting real pain on many businesses. If current trends continue, we may be talking about $4 for a gallon of gasoline by spring, and surging home heating oil costs later in the year.
In many respects, the United States can tolerate $70 oil, or even $90 oil. But at $100 or even $110, so many companies will start speaking of profit-margin pressures. And profit margins are the key factor behind many strategists’ forecasts for continued stock market gains in 2011. This is why you should be worried, even if you don’t own oil stocks in your portfolio.
Up until now, stocks have been rallying in tandem with oil prices. That’s quite unusual. We’ve been in a rare period where rising economic activity has been good for both assets.
Yet if history is any guide, further oil price spikes will tend to deflate stock prices. Here are three stocks in particular that simply cannot withstand oil prices above the $100 mark.
AMR (NYSE: AMR)
All of the major airlines are in far better shape than a few years ago. Surging oil prices really hammered them in 2007, and a sharp drop in air travel kept shares down in 2008. Yet during the past two years, lower oil costs and rising demand have helped the Amex Airline Index (AMEX: XAL) to triple in value. Further gains will be hard to come by as the cost of jet fuel will likely be well higher in 2011, and no carrier is more vulnerable than AMR, the parent of American Airlines.
While other carriers have slowly migrated to more fuel-efficient fleets of planes, AMR’s cash crisis forced it to stick with older inefficient planes. The typical plane is 15 years old, nearly twice the average age of planes being flown by carriers such as JetBlue (Nasdaq: JBLU) or Southwest (NYSE: LUV). Just how bad would it get for AMR if oil prices surged? Analysts currently think the carrier will lose a modest amount of money in 2011 if oil prices stay at $90. But at $100 oil, AMR might lose upwards of $1.50 a share. And $110 oil would translate into an earnings per share (EPS) loss of around $3. Make no mistake, any further spikes on oil prices will start to push AMR’s shares down below the 52-week low of $5.86.
[More from David Sterman: “Forget Exxon: Buy This Stock Instead“]
Darden Restaurants (NYSE: DRI)
This operator of restaurant franchises such as Red Lobster, Olive Garden and Longhorn Steakhouse has staged an impressive rebound, with shares doubling in less than two years. But rising energy costs would inflict pain in several ways.
For starters, its client base would be paying a lot more to fill up gas tanks. The difference between filling a tank at $2.50 a gallon versus $4 a gallon is about $30. That’s money that has otherwise been spent dining out. In addition, Darden incurs energy costs throughout its supply chain, from the fuel used by agricultural suppliers, to the diesel burned by delivery trucks that may look to once again look to add fuel surcharges as they had done the last time oil spiked in price.
Right now, analysts think Darden will boost sales around 6% in fiscal (May) 2012, with profits growing at twice that clip. But downward revisions to those forecasts appear inevitable. Right now, it’s the surging cost of food — most notably beef and seafood — that will pressure margins in coming quarters. At a recent analyst day, Darden expressed plans to trim costs to offset some of the cost pressures and expressed plans to raise menu costs. Passing on those cost increases to customers at a time when gasoline prices are rising will be difficult to master.
Shares may start to feel the heat before those trends play out. A very difficult winter, highlighted by above-average snow and below-average temperatures in the eastern half of the United States (a trend which is expected to continue through February), looks increasingly set to crimp reported sales for Darden and its peers such as Brinker International (NYSE: EAT). Rising energy costs, rising food costs and traffic-sapping weather make you wonder why shares are within a point of their all-time high.
GM (NYSE: GM) and Ford (NYSE: F)
I’m very curious to hear what GM has to say about its 2010 fourth-quarter results (the date for the announcement has not yet been released). As I noted a few weeks ago, analysts at Morgan Stanley are predicting a very strong quarter. [They think it can jump 150%]
And they stand by that view, even after Ford’s disappointing quarterly results.
But regardless of how recent results are trending, rising oil prices would be a real disaster for both of these companies. Even as investors focus on all of the new fuel-efficient cars coming out of Detroit, industry profits are still rising on the backs of high-margin pick-up trucks. Sales have rebounded nicely for these trucks, and 6% sales growth in 2011 for each firm is predicated on truck sales rising even higher. In GM’s case, it’s a big factor behind forecasts for EPS to surge more than 40% this year.
In December, GM noted that truck sales rose 28% from a year earlier. That surely helps the bottom line, as trucks can deliver $4,000 to $8,000 in profits, depending on how they are configured. On the plus side, if home construction ever gets going, demand for trucks by contractors could really pump up GM’s numbers. But a spike in oil prices would work against that factor as well as put a brake on broader economic growth.
Action to Take –> On a purely fundamental basis, oil prices need not rise any higher. Supplies are ample and demand remains below levels seen a few years ago. But the International Energy Agency (IEA) recently noted that it expects global oil demand to expand by 1.4 million barrels a day or 1.6% year-over-year in 2011. The projected increase will be driven entirely by emerging markets, which underscores the greatest risk to the U.S. economy: that oil prices could rise even before the U.S. economy builds a true head of steam if emerging economies stay hot.
Now is an important time to assess the potential impact of rising oil prices on your portfolio. The stocks mentioned above would likely feel the heat of rising oil prices even more deeply than most other companies, but it’s important to keep this in mind for all the stocks you own.