(Energy stock trading story updated for Nabors Industries' catalysts)
NEW YORK (
) -- There's a cynical stock market adage that explains recent trading in shares of
: Bad companies make for good trades.
It's a bit of trading knowledge that can help investors identify stocks where even if the long-term outlook is promising, short-term management mistakes offer trading opportunities.
A stock goes down because it messed up so much, and that presents an opportunity to ride it back up. Often, though -- and this is key -- it's riding that stock back up before it goes back down again because management messes up yet again. Positive headlines are magnified, but so are the negative ones.
Take Weatherford, which a year ago announced that it might have to restate years of financial statements because it messed up its tax status. Weatherford sank so low by the time the market bottomed out last October that it's up 25% since -- though its shares are down 30% in the past year.
It's a law of the markets: 'bad' companies often make the best trades.
This week, Weatherford announced that it couldn't announce its fourth-quarter results because it still doesn't have a handle on
its accounting mess a year later, and shares sold off. It takes time to untangle a mess of this magnitude with financial statements all the way back to 2008 impacted. However, it means that the best way to play the stock is by asking the question - Will the next short-term trigger be up or down?. Given that the Weatherford overhang remains one acutely tied to accounting risk, confidence requires a healthy dose of Tums and a strong stomach.
If it seems like a value play in comparison with oil service peers like
, keep in mind that it is difficult to compute the value of a company that can't tell you what it earned in the most recent quarter, or for the past four years.
So let's focus on the other three "bad" companies.
Chesapeake, which is the poster child for the exploration and production-levered balance sheet, continues to be a very murky story long-term.
Yet it's steady stream of self-promoting press releases intended to combat both investor and
sell-side criticism have made this "bad" company a great trade at any given time. Chesapeake shares are up close to 10% this year, while being down 28% in the past year.
Chesapeake's 200-day moving average is $26, and it is currently trading at the $25 mark. It is the only of these three "bad" company energy stocks that is not currently trading above its 200-day moving average.
Does that mean it is the best "bad" company positioned for a move up from current levels? Here's the cautiously bullish view...
There's always decent case to be made that Chesapeake remains a good short-term trade without making a bet on the company's longer-term strategy. The worst-case scenario for the company is 1) the inability to monetize assets, which it has shown an ability to do historically and at valuation levels that it has outlined; or 2) sustained low natural gas prices, even going as low as $1.
Even with its move to liquids, this is a company which will be 70% natural gas production in 2013. Indeed, Chesapeake noted in its earnings that a $1 improvement in the price of natural gas would lead to an increase of 60% in cash flow in 2013. A $1 increase in the price of natural gas could be "heroic," in the opinion of some analysts. However, Chesapeake's point in making the comparison was likely to show that they are planning for the worst case and in a best case the company would have great cash flow, said Sterne Agee analyst Tim Rezvan.
Rezvan said the stock has traded in a fairly decent range, and two things stand out in the pattern: 1) even though JPMorgan recently told investors to sell shares and that Chesapeake was headed for $14.50, the stock has found support in the low $20s. It's unlikely that Chesapeake can take any action in the near-term that sends it shares above $40, but getting shares to $30 would not be heroic for 2012 if a few things go right.
Even though the last time Chesapeake reached as high as $35 it was due to Carl Icahn taking a stake in the company and hopes that Icahn would force management's hand, now Chesapeake has potential catalysts in 1) Utica well results; 2) any uptick in natural gas prices; 3) a joint venture in the Mississippian Lime that fetches an even better per acre value than
recent deal with
; and 4) a stabilization of the pressure pumping market, which could allow the company to monetize its oil service assets at more attractive pricing than currently anticipated.
Rezvan noted that the acreage held by Chesapeake in the Mississippian is considered even better than some of the acreage JV'd by SandRidge. The pressure pumping rebound seems the least likely to turn back to Chesapeake's favor in the near-term.
In all, Chesapeake has plans to monetize as much as $12 billion in assets this year. Even if the
long-term impact of asset sales like in the Permian could be negative, investors often exhibit a short-sighted view.
"We see lots of fast money plays on these deals. Shares tend to pop and then sell off. It happened with the Eagle Ford and the Utica. The risk reward is favorable at the current price to the extent Chesapeake unlocks value in positions," Rezvan argued.
There has always been a disconnect between the retail investor and media attraction to Chesapeake's steady stream of monetization news, and the skepticism with which Wall Street views the maneuvers. "Whenever they have a release it gets lots of media attention and investors perk up. Retail people love the stock even though some of the stuff can be a bit of a non-event," said Rezvan.
Consider that Chesapeake
rallied early in 2012 on the announcement of a joint venture in the Utica shale region that it had already announced last November.
While its shares slipped on earnings Wednesday, Chesapeake has not traded on top- or bottom-line numbers in recent history, and shares rebounded by 4% on Thursday.
Transocean fits this bad company/good trade bill to a T. The company reported woeful results in the third quarter that missed consensus by 72 cents. That's about as big as a miss gets. Transocean ratcheted up debt in acquiring
, diluted shareholders by issuing equity at a time when its shares were at a multi-year low, and was put on negative credit watch with the risk of being moved down to junk by the rating agencies, all in one quarter. So far in 2012, the shares are up 30% but the stock is actually down nearly 40% from year-ago levels.
On Wednesday, the judge overseeing the
oil spill case ruled that Transocean was not subject to liabilities as an "owner" of the Macondo well, a legal victory for Transocean. Though how much of a victory was it compared to the larger issues that the company is facing? On Thursday, shares opened up 4%, and analysts like Robert Mackenzie of FBR Capital Markets issued notes highlighting the "mostly positive" judge's ruling.
It was a positive in light of everything else that has been so bad in terms of headlines for Transocean. However, consider that
Transocean eliminated its $1 billion dividend earlier this week, a move widely expected given its balance sheet issues, but shares went down 2% on the headline. The 3% gain in Transocean shares on Thursday, then, was little more than making up for the 2% decline on Tuesday when it announced the dividend elimination.
The oil spill court decision is a positive for Transocean, but to say it's a strong positive and a reason to buy shares is only giving the smart money investors who have been in this stock for the volatility trade a convenient day to book some profits.
The right way to look at the ruling is like an Agatha Christie novel, "And then there were ..." process of elimination.
Phil Weiss, analyst at Argus Research, remarked of the court ruling, "It's an incremental positive. Could it still be found liable as an operator? Yes. But, it seems even less likely now. It's not liable as rig owner. It's not liable as well owner. Operator is the only avenue left."
Yet the company still faces the Macondo overhang, the Justice Department may still try to make an example of the company -- 11 of its workers were killed on the Deepwater Horizon rig -- which could lead to criminal charges. Transocean still faces court uncertainty as the judge ruled that the question of whether Transocean was an operator of the Macondo well along with BP and Anadarko should be decided at trial, since the definition of such was vague in the Clean Water Act.
As an investor, do you want to be a legal scholar playing the political football of the oil spill while also attempting to make a long-term call on a company that has neared junk bond status -- though at least is now working overtime to avoid that?
"The last six months have been extremely volatile for this stock, not just the oil spill but operationally, and investors are going to pick up on good and bad news and magnify it all in this environment," said Edward Jones energy analyst Brian Youngberg. He said the judge's decision reduces the chance of a "extraordinary adverse" oil spill outcome for Transocean, but there still could be an adverse outcome and there are plenty of companies to "invest" in -- not trade in -- without taking any risk at all on Transocean for the long-term.
Youngberg rates Transocean a hold on the belief that it makes sense to ride out the current volatility and bet on the company's lead position in the deepwater market in the years to come. However, for new money going into the energy space, Youngberg said there are just too many companies without the oil spill or operations baggage of Transocean that are attractively valued.
The Edward Jones analyst likes
on the E&P side of the business, and Schlumberger closer to Transocean's oil service market.
The point, though, isn't one analyst's buy recommendations, but the idea that investors shouldn't go chasing shares like Transocean on one positive headline, unless they are chasing it for a short-term gain.
"The picture may improve a year or two out, but there is still uncertainty and the company has to execute. The huge third quarter miss was followed by a bounce back to where shares had been before the fall. We've seen this a few times with Transocean. It goes back down. I still think it's well positioned in the longer term, but it's a better trade in the near term than investment," Youngberg said.
The oil spill trial begins in New Orleans next week. Transocean is due to report its fourth-quarter results on Feb. 29. Wall Street's consensus view has come down to 21 cents a share from 55 cents a share while the full-year 2012 earnings estimate for Transocean has been reduced by $1 to $2.93 a share.
Whether the earnings trade is up because expectations have been lowered enough or down because Transocean follows in the stumbling footsteps of Weatherford is the type of $64,000 question that, if could be answered, would make trading non-existent.
The important point, though, is that it's a trade either way, not an investment. Energy stock investors should try to remember that, or look for stocks with a less volatile trading pattern.
There's one extension of the bad company/good trade phenomenon worth exploring: Bad companies that have already been good trades, but that may be transitioning into good companies.
is a test case for this trading pattern.
The criticism of Nabors as a bad company -- more or less a fiefdom run by former CEO Gene Isenberg for his own personal enrichment -- is well known, and culminated in the
furor over Isenberg's retirement "bonus" of $100 million.
When Isenberg named his right hand man Anthony Petrollo as his replacement, some analysts heralded it as a new age for the company; others made a comparison to Vladimir Putin and Dmitri Medvedev.
Whatever the truth may be -- it is still evolving-- 'bad' company Nabors has worked as a trade, up 30% this year after declining by almost exactly the same amount in 2011.
Phil Weiss, analyst at Argus Research -- and a long-time critic of Nabors under Isenberg -- is sort of kicking himself for not getting in on the early 2012 trade, which he thinks was a combination of Nabors shares being so cheap and the management transition perking up investor interest. Yet Weiss says the bad company/good trade opportunity has already been played out -- he is betting on the good company transition for Nabors. Weiss changed his rating to a buy on Friday and with a $30 price target.
"When Petrollo was named CEO I did think of him as Isenberg's right hand man and thought 'he was here through all the garbage.' But as I listened to him on the earnings conference call, what I heard was different."
Weiss sees four catalysts for Nabors shares to move higher, although he still retains some apprehension about the speedy ascent that's already taken place.
"This stock was $11 in October and now is near $23. It's a little much," Weiss said. In fact, Nabors shares have rallied back without the new management having executed on anything yet. So the "shares are cheap" rally may be exhausted and that means it is time for Petrollo to prove it's a new era.
The four catalysts are: (1) the cancellation of plans to build some rigs on spec; (2) greater selectivity about opportunities in Canada because of the shorter work season; (3) an increased commitment to selling noncore businesses; and (4) new efforts to align core businesses to improve operational efficiency.
Weiss says all of these catalysts fall under the general theme of a company that is moving from being a poor allocator of capital to a good allocator. "I heard more mention of cash flow on the (most recent) earnings call than in the entire time I've covered the company," the analyst noted.
The Nabors turnaround is not without its risks. The pressure pumping market is going through a major shift from the uneconomic dry gas basins to the liquids-rich shale plays, for one. More generally, Petrollo has to be held on a short leash with his rhetoric. When it comes to scaling back in Canada, which he talked about, selling off non-core businesses and restructuring the company to be more efficient, the Argus Research analyst said in six months there will have to be proof of execution.
"I'm giving him the benefit of the doubt even though he hasn't proven anything, a few quarters to see if they follow through," Weiss said.
-- Written by Eric Rosenbaum from New York.
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