Random Musings - The Gulf Contagion, Tree-Hugging Hippies & A Growing Watch List
June 02, 2010
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I honestly can't think of enough names to give this recent sell-off of all oil drillers and service companies. They might have as little as a drill bit lying somewhere on some rig within 100 miles of the Gulf of Mexico and they're getting clobbered with the entire sector. So here's what I have so far and I promise I'll get into something more meaningful after some name calling...
The Crude Awakening
The Gulf Contagion
The Gulf, Where Time Passes Like Molasses
Oil, Black Gold, Texas Trouble
Oil Rigs, We Meant Raise Not Raze
Oil, Lotion and Transocean - Sounds Like A Kinky Party
The Drill Run'th O'er
The Gulf, Fish Straight Out Of The Ocean Into Your Frying Pan - No Oil Needed!
Deepwater Is Gonna Collapse (Day 43, Vol 1.)
BP Is Gonna Put A Cap In Dat Wells A$$
How To Lose A Well In 10 Days
BP's CEO Sports New Suit, Looking Slick
The Crude Reality
All Glory To British Petroleum
Ok, enough of that. The real reason for this blog is to both draw the realization that yes this is indeed a very sad environmental problem and it is brutally unimaginable that they didn't have a contingency plan in place in case of such an occurance but the beating the sector has taken has far and away been overdone.
The ramifications here are relatively easy to figure out yet no one seems to be able to put a bead on where the scope of the liability could end. The main companies at fault here appear to directly be British Petroleum (BP), Transocean (RIG) who owned the rig, Halliburton (HAL) for supplying deep well parts, and Anadarko Petroleum (APC) for being a partial owner in the well.
I find it highly unlikely that Transocean will face any repurcussions in this disaster at all outside of criminal investigations into it's actions and the safety record of its rig. I would say the overall damages that RIG can expect to pay given litigation fees to defend itself will be in the neighborhood of 450 million dollars when all is said and done and spread out over the next four years.
Likewise, Halliburton may be found to have some fault in the legal preceedings, but outside of the general context of defending some of its members against lawsuits and legal proceedings from Washington it should have it's fees capped around 1.5 billion to 2 billion over the next three to four years.
British Petroleum however is going to get a spanking when it comes to the cleanup bill. They are going to be found without a doubt to be directly at fault for this disaster and their malfeasance is going to cost them a dramatic amount of their cash flow. They will have to pay for cleanup efforts both on land and in the water, environmental fees, oil per barrel leakage fees, fees to those displaced from work due to the disaster, and the continued relief effort to plug the leaking well. Estimates for this have greatly ranged anywhere from 13 billion dollars up to as high as 22 billion dollars. I think the ultimate cost here will be towards the high end of this estimate and come in closer to 23-24 billion dollars. The scary thing here is that hardly puts a dent into BP which brings in over 30 billion dollars in free cash flow a year and could save billions of dollars a year simply by not paying out a hefty dividend if it wanted to.
Anadarko Petroleum will simply be guilty by association and will face something in the realm of 1-2 billion dollars in punitive damages from the amount of oil that will have leaked into the ocean by the time the well is plugged. Anadarko may actually suffer worse than BP largely because they don't have that same ridiculous amount of cash flow that BP has but APC should survive no problem. I don't suspect much of the pending litigation will be pointed at Anadarko.
So what does this all mean? It means that the general investor has brutally overreacted to the downside and crucified the entire sector for basically no reason. What I expect however is a continuation of this move to the downside as traders, or as I have liked to call them recently, tree-hugging hippies, drive the sector down on fears that we have seen the end to deepwater drilling. Deepwater drilling is without a doubt here to stay but you can rest assured that the government is going to impose new safety measures to ensure that drilling is done properly and contingency plans are in place in case of future incidents. Oil is just far too useful a power source to not drill, especially in the United States - you've heard the term necessary evil, well this is a perfect example. Hippie activists can cheer all the way about the six month moratorium on new deepwater permits but this is a temporary lapse til the government itself can figure out what's going on.
Are there values in the sector? Oh absolutely and I'm going to do some simple copying and pasting of a few oil drillers and service names that I currently have on my CAPS limit order buy list complete with today's closing price and the target limit buy price. Am I confident that all of these companies are going to hit my limit orders? No, not at all, in fact I think nearly every company I'm mentioning below is brutally undervalued, but that's what happens when tree-hugging activists trade on emotion and not on the common notion that drillers and oil service sector companies are literally the best cash cows in the market place. There are no toxic assets to hide, there is a limited supply, and an increasing demand for the product.
Below are a few names I would consider buying on this absurd dip from the Gulf contagion...
Foster Wheeler (NASD: FWLT)
• Closing Price $22.92 / Limit Buy @ $19.82
It's so incredibly retarded how we bid the crappy companies up and let good companies fall in tandem with the crappy ones when they finally deflate and come back to earth. Foster Wheeler provides construction and engineering services to the oil industry and they are looking dirt cheap based on my estimates. They maintain just shy of $6 in cash per share and are currently trading at 9 times 2011's figures. If we back out their cash pile that figure drops to just over 6 times earnings. Cash flow is strong, business demand is good with a long-term growth of 9%-10%... I mean really, what more could you ask for? I'm taking a stab that traders will be dumb enough to fill that gap around $19.82 and I'd love an entry there.
British Petroleum ADR (NYSE: BP)
• Closing Price $36.52 / Limit Buy @ $33.42
Classic overreaction by the tree hugging hippie investors who would love to see British Petroleum wiped off the map! I'm not saying this isn't a macro catastrophe, but it is going to effect BP's day to day operations in such a small way that I'd call it rather negligible. Let's say that the worst case scenario plays out and the well leaks until it's plugged in August, by this case scenario analysts have thrown out cost figures for BP of anywhere from 14 billion to 22 billion dollars. I'm going to go ahead and blow those figures out of the water and assume punitive litigation fees on top of that and claim they'll net 27 billion dollars from this spill. Now get ready for this folks... BP brings in about 30 billion dollars in free cash flow a year, so even AFTER the spill, taking into account even the most dire estimates and making them more dire, BP should be cash flow positive. They still do have over 6B in cash (along with 32B in debts which is fine since they bring in nearly that much a year in free cash flow) and are trading below 1.2 times book value now. Forward earnings even with a lowered outlook are at near historic lows, about 5 to 5.5 times profit potential. I am going to go ahead and place a limit to buy order just above their book value and above their multi-year low, at $33.42. If that level hits I get BP basically at book value ($33.25), under 5 times 2011's profit potential and about 3.5 times cash flow which is incredibly reasonable. So feel free to keep taking it down hippies..
Diamond Offshore Inc. (NYSE: DO)
• Closing Price $58.51 / Limit Buy @ $39.50
Attempting to do more falling knife catching here with Diamond Offshore as panic in the Gulf sets in. Diamond Offshore is already trading at a nice discount to competitors and if panic selling really sets in it could get even cheaper. I'm setting my limit buy order at $39.50. Let's keep in mind that Diamond Offshore is still cranking out 1.3-1.5 billion in free cash flow in a moderate growth year. They are well capitalized and even with a downturn in drilling, they should be able to produce $5 in yearly EPS placing this at 8 times 2011 figures if my target hits. So let the tree-hugging hippies keep taking down DO and I'll keep placing buy orders on these drillers.
Pride International (NYSE: PDE)
• Closing Price $22.21 / Limit Buy @ $17.17
Pride International can join my merry list of drillers and drilling equipment service companies that have been beaten up due to Washington's six month drilling ban as the Gulf contagion spreads. If it's not one thing it's another for these cash cows in the drilling sector. PDE can produce somewhere in the neighborhood of 500M in free cash flow in a moderate growth year. They also are now trading below their book value and something like 6.7 times 2011's profit figures. Given a slowdown in revenue I'm going to place my limit buy at $17.17 which will get me Pride International at 0.7 times book and roughly 5-6 times 2011's figures. Let these tree-hugging hippies keep freaking out about big oil and let's get these wonderful names back down to some very inexpensive levels.
National Oilwell Varco Inc. (NYSE: NOV)
• Closing Price $33.90 / Limit Buy @ $26.78
National Oilwell Varco is one of my favorite companies in the oil sector and the poor company has been beaten up as the gulf contagion spreads. NOV has an absurd amount of net cash, about $4.10 per share and is now trading below their book value. They bring in a boatload in cash each year and are currently trading at only 10 times 2011's profit figures. I'm not thrilled with their revenue downtick which could enter a 2nd and 3rd year, but they produce solid profits and should be trading higher than this. I'm placing a limit buy order at $26.78 to take advantage of these extremely inexpensive prices.
Plains Exploration & Production Inc. (NYSE: PXP)
• Closing Price $19.34 / Limit Buy @ $15.87
Plains Exploration & Production, another company that has been brutally beaten down by the Gulf crisis. PXP has had trouble with one of its deepwater projects and investors have shaved off almost half its value despite all of its other revenue streams. PXP is capable of producing well in excess of 600M in free cash flow and is trading at only 0.8 times its book value. Future profit forecasts have been timid and even so PXP is only at 9 times those forecasts. I am going to go ahead and try to snipe the falling knife at $15.87 which would place this at 2/3rd's of book value and roughly 7.5-8 times future earnings. Plenty of growth to be had here with the new Gulf drilling laws in place or not.
Hornbeck Offshore Services (NYSE: HOS)
• Closing Price $13.64 / Limit Buy @ $9.66
Hornbeck Offshore Services is not a traditional recommendation of mine because it's probably one of the weaker buys currently sitting in my long limit buy queue, but the valuation here is getting very close to making sense. HOS supplies services to deepwater drillers, mainly supply vessels and obviously with some of those services up in the air right now HOS is taking a hit. Still, we need to remember Hornbeck has services near Puerto Rico and in the NorthEast as well so it's not like they have zero revenues coming in. They are trading well below half of book value and around 14 times it's profit guidance on the low end. I'm not a huge fan of the debt levels, but they are bringing in over 100M in free cash flow a year so I'm not too concerned. Looking for a limit buy order at $9.66 if panic selling continues.
Noble Corp. (NYSE: NE)
• Closing Price $27.04 / Limit Buy @ $19.89
Crazy has hit the stock market and it has manifested itself in the form of a precipitous drop from Noble Corp. I just don't see Noble Corp. being completely incapacitated by this Gulf spill or new laws from Washington. Noble is one of those very few drillers who is actually net cash positive, with over 100M in net cash. They are growing a bit slower than most drillers, but I'd take 4-5% any day of the week. They are now trading below book value and just 5 times forward profits which is already inexpensive. Given some old school point and figure trendlines I'm placing my limit buy order at $19.89, but I think there would need to be some serious panic selling for that to hit. All in all Noble is about as stable as they come.
Anadarko Petroleum Inc. (NYSE: APC)
• Closing Price $42.10 / Limit Buy @ $33.25
And now the great plague has caught up with Anadarko Petroleum as well! Anadarko may have partial ownership in that now sunk well but give me a break, have we completely forgotten about their other assets or should we just throw a blind eye at those! Anadarko is trading right at book value and could be poised to head lower as panic selling really sets in. APC default swaps are rising and really for no good reason as there is likely no litigation impact pending for them. Even with tempered profit expectations APC is trading at only 13 times forward earnings. I am placing a limit buy order right at their 20 year trendline around $33.25 hoping to snipe this falling knife. Very strongly cash flow positive company caught in a whirlwind of tree-hugging hippies.
Halliburton Inc. (NYSE: HAL)
• Closing Price $21.15 / Limit Buy @ $14.88
Man, it's like one retarded concept after another! Now default swaps on Halliburton debt is rising with the possibility that Halliburton may default on one of their loans. I have a fancy word for this phenomenon - bullpucky! Halliburton is sound as a pound to quote my British bretheren! Halliburton is cranking out over 2B in cash flow each year and can maintain 1.2-1.5B even in a severely depressed gulf oil market. They're trading at roughly 2.2 times book and growing around 10% per year. Even with pending litigation, I'd cap Halliburton's exposure at 2-2.2 billion or roughly one years cash flow. Do they not think Halliburton has a line of credit. As I said, a conglomeration of tree-hugging hippies are trading these oil companies down to obscenely cheap levels. If my limit buy order at $14.88 hits I will get HAL at only 1.5 times book, and roughly 9 times 2011's profit potential with a 10% growth rate...a very reasonable expectation.
Atwood Oceanics (NYSE: ATW)
• Closing Price $25.76 / Limit Buy @ $21.65
Oh my goodness, now we're beating down the good companies with the crappy ones. So Transocean made a whoopsie out in the Gulf of Mexico, it's not like this wasn't expected to happen at some point between now and let's say 2015. Accidents happen and they really shouldn't affect a company like Atwood Oceanics which is far and away the best company in the sector. A steady growth rate of 12%, trading at less than 6 times future earnings and generating over 300M dollars a year in cash flow. Their earnings momentum has then moving higher every quarter and the only thing working against them is pending litigation against other companies in their sector and a poor technical pattern. I'm going to bet that pattern could yield some panic selling in this sector and with that I'm putting in a limit order to buy for $21.65. If this level were to hit I'd nab Atwood Oceanics at less than 5 times forward earnings and hardly 1.1 times book with a PEG of something like 0.45....just sick!
ATP Oil & Gas Inc. (NASD: ATPG)
• Closing Price $8.72 / Limit Buy @ $7.86
ATP Oil & Gas is finally coming back down to a reasonable valuation and although it is nowhere near my favorite company in the sector I'm angling this as a limit order which might catch ATPG as a falling knife. ATP Oil & Gas has seen solid profits in the past but has been experiencing higher than normal disappointments in production and expensing. I think they could be trading at approximately 6-7 times 2011 figures at the moment which is just slightly undervalued. Revenues are scheduled to rise like a rocket again but I think it'll be a while before they re-visit those 2007-2008 figures. I'm not a huge fan of the 1.15B in net debt but on the all it makes for an intriguing play if it drops below book and can maintain a 25% growth rate. I'm placing my limit buy order at $7.86.
Transocean Inc. (NYSE: RIG)
• Closing Price $50.04 / Limit Buy @ $42.10
You know that game you used to play as a kid with a knife in one hand and your hand on the table as you try to stab the table in between your fingers without stabbing your fingers, well that pretty much sums up this limit order. I'm attempting to do more knife catching here with Transocean and am putting in a limit buy at $42.10. RIG is already trading below book value and with reason at the moment. They are facing considerable litigation and revenues have been dropping for three consecutive years. Despite this cash flow remains incredibly strong and their oil rig presence is basically unsurpassed. If I can get my limit order hit they will be trading at roughly 5 times 2010 figures and perhaps less than 4.5 times 2011 and they should see a return to revenue growth in 2011 as well. Although largely indebted, cash flow remains very strong regardless of the price of oil. It remains one of my favorite long-term holds and I'm eager to see if it will trade as low as $42.10! I have updated my limit buy in price from $48.55.
Oil Service Holders Index (AMEX: OIH)
• Closing Price $89.48 / Limit Buy @ $72.18
I'm trying to do a little knife catching as I expect more panic selling in the oil service sector as the Gulf contagion spreads. This is merely a sector-wide play on numerous companies which I've already selected to the long side. I'm placing a limit buy order at $72.18 which is approximately 20% below where it currently trades at and is not surprisingly around a level that would correlate with plenty of my current buy limits on other companies in the sector.
This is a partial list of some of my favorites in the oil drilling and service sector... this list could continue to grow!
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