Energy: Seven A-Grades Built on Declining Margins

The Headline Numbers Tell Two Stories

Energy delivered eight A and B-grades out of 16 companies analyzed. That's 50% of the sector scoring in the top two tiers. The median FCF margin sits at 10.1%, right at the sector's A-grade threshold. On paper, this looks like health.

Then you see the trend breakdown: seven companies improving, seven declining, two stable. The sector is split down the middle. The companies generating strong cash today are mostly weakening. The companies climbing out of holes are mostly starting from terrible positions. Only Coterra and ONEOK are holding steady, and ONEOK carries enough balance sheet problems to drop it to a D despite a 13.2% margin.

The Top Performers Are All Sliding

EOG Resources leads the sector at 24.7% FCF margin and an A-grade. It's also declining. So is Williams Companies at 21.9%, Cheniere at 20.1%, and Occidental at 16.5%. Four of the top five cash generators are trending the wrong direction. Williams in particular stands out: a 21.9% margin should be an easy A-grade in this sector, but balance sheet problems knock it down to a D.

The only stable performer in the top five is Coterra at 18.8%. That's it. One company in the upper tier that isn't either falling or clawing back from disaster.

This pattern matters because energy margins are cyclical. When the best performers in the sector are already declining, it suggests the current cycle peaked sometime in the last few quarters. The companies posting strong margins today built them during better pricing windows. The question is whether those windows are closing.

The Bottom Is Improving From Catastrophic

Diamondback Energy sits at negative 48.8% FCF margin with an F-grade. It's improving. Devon is at negative 5.4% with a D-grade. Also improving. Targa Resources at 4.2% and an F-grade: improving. APA at 7.3%: improving.

Four of the bottom five companies are trending upward. That sounds encouraging until you realize what they're improving from. Diamondback burning cash at a 48% rate of revenue is not a turnaround story. It's a company that was in freefall and might have stopped accelerating downward. Devon at negative 5% is still burning more cash than it generates.

The sector average debt-to-FCF ratio of 7.7x explains part of this. Energy companies spent the last cycle leveraging up for growth. When margins compress, that debt load turns into a problem fast. Several of these "improving" trends are really just companies that haven't collapsed yet.

The A-Grades Don't Match the Margins

Four companies earned A-grades: EOG, Coterra, Schlumberger, and Baker Hughes. EOG and Coterra make sense based purely on margins. Schlumberger at 12.7% and Baker Hughes at 9.1% are more interesting.

Schlumberger barely crosses into A-territory at 12.7%, but it's improving and carries a clean enough balance sheet to earn the grade. Baker Hughes at 9.1% is below the sector's B-grade threshold of 10%, but modifiers push it up. Both companies are service providers rather than pure producers, which gives them different margin structures and different balance sheet profiles. Their improving trends suggest the service side of energy is moving differently than the production side.

That creates a sector where the A-grades are split: two producers with great margins that are declining, and two service companies with modest margins that are improving. There's no unified story here.

Williams Companies Is the Cautionary Tale

A 21.9% FCF margin in the energy sector should be an automatic A-grade, possibly even after a modifier or two. Williams earned a D. The company is generating strong cash relative to revenue, but something on the balance sheet or in the cash conversion metrics is killing the grade.

Without seeing the full breakdown, the most likely culprit is debt load. A company can post a 20%+ margin and still grade poorly if it's carrying debt at 15x FCF or higher. Williams is also declining, which adds another modifier hit. The combination creates a situation where the headline margin looks great but the underlying financial health is shaky.

This is exactly the scenario the Aureus grading system is designed to catch: companies that look strong on one metric but are hiding structural problems in the details. A D-grade on a 21.9% margin is a red flag worth investigating.

Only One Company Is Stable

Coterra's 18.8% margin has been consistent across recent quarters. That's the only company in the top tier that isn't sliding. ONEOK at 13.2% is also stable, but its D-grade suggests balance sheet issues that offset the margin.

Two stable companies out of 16 analyzed. The rest are either improving from terrible positions or declining from strong ones. That's not sector health. That's a sector in transition, and the direction of that transition isn't clear yet.

Energy's problem isn't that it lacks strong performers. EOG, Coterra, Cheniere, and Occidental are all generating double-digit margins or better. The problem is that most of those performers are weakening, and the companies strengthening are doing so from positions so bad that "improving" just means "less catastrophic."

What This Means

The energy sector earned 50% A and B-grades, which sounds healthy. The 10.1% median margin is right at the A-grade threshold. But seven of 16 companies are declining, including most of the top performers. Seven are improving from deeply negative or low single-digit margins. The sector isn't healthy. It's split between companies that had a strong run and are now fading, and companies that got crushed and are attempting recovery.

If you're looking at energy, the question isn't whether the sector grades well overall. It's whether you're buying into the tail end of a strong cycle or catching the early stages of recovery. Right now, the trend data suggests the former is more likely than the latter.