Corporate bond players, who have reveled in the good fortune--and spread tightening-- of the energy sector, are now worried that oil companies may use excess cash flows to boost lagging stock prices through stock repurchase programs and increased capital expenditures. Traditionally, bondholders would rather see the companies pay down debt to maximize cash flow. "Equity buybacks hurt bondholders because they just prop up the price of the stocks and do nothing for the value of the company," says Michelle Cunningham, portfolio manager at California State Teachers' Retirement System in Sacramento.
Bondholders have touted the oil sector as one of the most stable in the market. "Bondholders recognize today's strong cash flows and lack of risk associated with the energy sector. Because the rest of the market is so bad, it is an easy place to hide out," says Mark Pibl, oil analyst and II first-teamer at Merrill Lynch.
But "bondholders have to worry when things are going too well, we have to ask ourselves what could crash the party?" says Mike Dineen, portfolio manager at theMONY Group in New York. Dineen points to numerous issues of oil company bonds, credits such as Texaco (A1/A+), BP Amoco (AA+) and Conoco (A3/A-), that are trading at or above par.
However, some bondholders say companies are doing what they wantpaying down debt in conjunction with repurchasing stocks. John White, oil analyst at Nesbitt Burns in Houston, points to Vintage Petroleum and Ocean Energy as two companies that have focused on paying down bank debt in addition to boosting equity valuations. "Paying down debt is good for equity guys the same as it is for bondholders," says White. "Lower debt means higher net asset value, which means high stock valuations and lower interest expenses, giving companies more free cash flow."