I thought I'd revisit a popular short target, Whiting USA Trust I (NYSE:WHX), which still remains significantly overvalued. With royalty trusts falling out of favor, it would seem that some of these have maybe fallen too far. WHX, specifically has been the subject of a few negative articles on Seeking Alpha and is down sharply over the last 9 months or so. It would be logical to think that there may be some value here since the stock was trading $18 in July, and now is around $8. Not the case, as it turns out.
WHX still remains massively overvalued and has a fair value closer to $3.50.
A quick recap of how WHX works:
WHX is an oil and gas trust. It receives 90% of the profits received from producing 9.11 MMBOE. So far it has produced 6.78 MMBOE. Roughly 63% of the production is oil, 37% is gas. After hitting 9.11 MMBOE the trust will terminate. Production is expected to decline 9-11% a year, so termination is expected to occur during the second quarter of 2015, with the last distribution being paid out in 8/15. At that point the trust has no residual assets and is worth zero. That last part bears repeating: the trust doesn't own the wells, the only assets in the trust are the net profits interest (NPI) in the wells. So the only payouts that a shareholder will receive are from the sale of the oil and gas until 9.11 MMBOE are produced.
Due to the short life remaining in the trust, valuation should be relatively simple. All of the variables are given in the quarterly announcement for the distribution. Here's the one from the Feb 2013 dividend:
Natural gas (NYSEMKT:MCF)
Average sales prices:
Oil (per Bbl)
Natural gas (per Mcf)
Natural gas sales
Total gross proceeds
Lease operating expenses(1)
Realized gains on hedging settlements
Percentage allocable to Trust's Net Profits Interest
Total cash available for the Trust
Provision for estimated Trust expenses
Montana state income taxes withheld
Net cash proceeds available for distribution
Trust units outstanding
Cash distribution per Trust unit
For my model, I used that breakdown as a template and made some assumptions going forward. Sales volumes I used a decline of 2.5% a quarter for both oil and gas until the termination of the trust.
It's important to note that when the trust provides this information on the distribution, they include the sale of NGLs in their oil numbers. Roughly 10% of the oil sales volumes are actually NGL sales volumes. Between the discount resulting from including NGL sales and the costs of transportation and storage, the realized price for their oil number winds up being about a 14% discount to the NYMEX price. The realized gas price is historically a 3.5% discount to the NYMEX price. Readers can confirm these numbers at Whiting's website. I used the three month average NYMEX prices for the applicable period (which I've included at the end) and discounted them by the historical discounts.
For lease costs I used 7.4m for next quarter and took it down 2.5% a quarter going forward. I have no reason to think that these costs will decline at the same rate as production. Since some costs are fixed costs, this number will almost certainly be too low (meaning my fair value will be too high), but this seemed like a conservative way to do it. Production taxes I used 7.3% for oil and 7.1% for gas, numbers provided by the company.
The realized gain on hedging settlements line is an important one, and one that requires no assumptions. They have had collars on which have been winners, and therefore resulted in a decrease in the expenses of the trust. These hedges expired at the end of 2012 and so were still a significant factor in the Feb distribution. They can't put any more hedges on though for the duration of the trust; so starting with this next distribution, there will be some value lost (see the 10-K for more on this). Last quarter the trust made 1.38m on the hedges which accounted for .10 of the dividend. Going forward the hedges line will be zero every quarter.
For the " provision for estimated expenses" I used 175k and for "Montana tax" I used 50k, which are in line with the historical numbers.
So, you plug those numbers in and you get total remaining distributions of (drum roll):
That's it. You're only getting $3.80, it'll take you two years to get that and then you're left with a stock that's worth zero. For those who like to talk about it in present value terms: PV-5 is $3.61; PV-7.5 is $3.53; PV-10 is $3.42.
Obviously, you can increase FV by increasing oil or gas prices, and/or decreasing expenses, but the oil and gas prices are things you can hedge out. If you need oil and gas to go up 50% just for you to break even, you've picked a really bad way to get long oil and gas. Bottom line is that there's really no set of assumptions that will give you anything close to where the stock is trading. Note that if the trust winds up terminating later than expected, you won't receive more money even though you received more distributions - the trust doesn't get anything more after 9.11 MMBOE have been produced and sold - it'll just take longer to get the payouts.
According to Bloomberg only three analysts are still covering this stock, two have it as an underperform and one has it as a sell (in all cases their lowest rating).
So why's it trading this high?
One reason is that this stock is tough to borrow right now, with borrow rates in the 20-30% range (although it does have options out to December). There're also probably a decent number of investors that are attracted to the high dividend "yield," don't realize the trust is terminating and have no idea that by buying this they're going to lose half of their investment. Then you have the people that know exactly what they're buying, but think that it'll trade at inflated values for a few more quarters so they can get a few more distributions before the world wakes up. A quick perusal of the message boards shows you that these unaware and greater-fool investors are still prevalent in this stock.
One significant catalyst is the hedges coming off. The next dividend will be announced around 5/7/13 and this will be the first one that doesn't include the hedges, which accounted for .10 of last quarter's .577 div.
Time is also a major factor here - with such a small number of distributions remaining, it's almost impossible for WHX to trade at inflated levels for too much longer. If there were two distributions left there's no way it would be trading above fair. If there were four distributions left it probably wouldn't be above fair either.
Well, there's 8 or 9 distributions left…. How much longer can people hold onto this hoping to get one more distribution before the stock crashes?
I suspect that the stock may run up some more going into the dividend, but any decrease in the dividend should be the event that wakes everybody up again in this one.
The endgame is approaching, and I expect a significant correction is imminent.
Oil numbers: 88,87.22,87.23,86.73,85.93,85.35,84.81,84.42,84,83.58
Gas numbers: 3.50, 4.13,4.45,4.49,4.71,4.32,4.21,4.28,4.55,4.29