Interview with Suhas Nayak by Ben Hagemann
As commodity prices have declined it is understandable that investors have been wary of resources stocks, but there may be opportunities to invest in undervalued shares that will increase the value of portfolios over the long term.
Oil has suffered a beating that has left the major investment houses reeling, with prices plummeting to $US27 per barrel at the start of the year. However the commodity has recovered quickly, and is now worth over $US40 per barrel.
This follows a similar trajectory to that of gold, which only 18 months ago dropped from a high of US$1900 per ounce to as low as US$1,050 only to bounce back above US$1,200. Observing this trend, contrarian investors like Allan Gray have begun investing in oil companies in the expectation that industry profitability will recover.
Allan Gray investment analyst Suhas Nayak, explains the basics of how to go against the flow and develop a portfolio that will lead to long-term wealth generation.
“We try to invest in companies which are generally out of favour amongst other investors,” Nayak says.
“The idea behind this is that you want to buy shares when they’re cheap, and that occurs when other people are looking to get out.”
Nayak explains that now is the time for the Allan Gray funds to seek oil producers with reliable assets and good balance sheets. As was the case with gold 18 months ago, oil companies are struggling to break even while the commodity remains relatively cheap. Currently these companies may be undervalued, but they have the capacity to weather current markets and go the distance.
“The companies we look for are low-cost producers, which control assets with long reserve lives.
“Although it’s hard for anyone to know what will happen in the short term, we can seek out companies that we know can withstand low commodity prices for a longer period.
“Companies that can produce oil at low cost may have a better chance of being able to withstand low oil prices, because they can tread water while their operations are still able to break even or make a small profit.”
Applying this approach to global gold producers, Allan Gray’s analysts chose to invest in Newcrest some time ago due to its long reserve life, while in the oil sector they have invested in Woodside Petroleum and Origin Energy.
Nayak says both of these energy companies have assets that can produce for 15-20 years at very low cost, enabling them to withstand low commodity prices while continuing to produce cash flow.
“With so much of the sector losing money, oil prices appear to be too low. When the price of oil rises, so too will the market value of these companies,” Nayak says, emphasising that the key to a long reserve life is ensuring that the company doesn’t destroy value by producing too great a percentage of their reserves while prices are low.
“If you have a short reserve life and you produce at those prices for one or two years, and your reserve life is six or seven years, you’ve destroyed a lot of value just by producing at that price,” he says.
“But if your reserve life is 15-20 years then sure, the short term hasn’t been good for you, but it won’t have been as bad as for the other producers with shorter life reserves and you will be well placed to deliver strong returns when prices come back.”
Suhas Nayak holds a Bachelor of Science (California Institute of Technology) and a Doctor of Philosophy in Mathematics (Stanford University).