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.
In the energy sector, there are plenty of examples of this "bad" company trading phenomenon. Take
, 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?
, 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.
With plans to monetize as much as $12 billion in assets this year, investors can expect that Chesapeake will be setting up its shares for some more short-term spikes -- last year shares rose as high as $35, while the shares are currently trading below $25. 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.
Chesapeake's 200-day moving average is $26. It is the only of these three "bad" company energy stocks that is not currently trading above its 200-day moving average.
Transocean fits this bad company/good trade bill to a tee. 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 Aker Drilling, 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 BP 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 -- and 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. Youngberg 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 says 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
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.
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.
-- Written by Eric Rosenbaum from New York.
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