Joe Ponzio is the Managing Partner of the Ponzio Investors Funds, the owner of Ponzio Capital, a registered investment advisory firm based outside of Chicago, and the author of F Wall Street: Joe Ponzio’s No‐Nonsense Approach to Value Investing For the Rest of Us. Managing portfolios for clients and investors across the United States, Joe takes a deep‐value, concentrated approach to investing for long‐term growth.
We had the opportunity to ask Joe what his highest conviction holding is in his portfolios, and he selected midcap natural gas and oil producer BreitBurn Energy Partners (NASDAQ: BBEP).
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Joe Ponzio (JP): A few months back, we started moving heavily into natural gas companies as the commodity began rebounding from its panic levels in the $3 range. In December, we began taking positions in refiners as the crack spread has continued to widen. Oil and its refined products (gasoline, jet fuel, etc) can only diverge so far for so long before something gives – either oil falls or the refined products rise, both of which improve the future profits of the refiners.
I feel good about every position we hold, however our highest conviction position would probably be BreitBurn Energy Partners (NASDAQ: BBEP) at the prices we paid for it.
BreitBurn is an oil and gas partnership that focuses on the acquisition, exploitation and development of oil and natural gas properties in the United States. Their primary objective is to manage their oil and gas producing properties so that they can generate and distribute their excess cash flow. About 75% of the company’s proved reserves are in natural gas (with the balance in oil), making it more of a natural gas company than an oil company.
Seeking Alpha (SA): Can you talk a bit about the industry/sector? How much is this an “industry pick” as opposed to a pure bottom-up pick?
JP: Our long‐term holdings are both “industry picks” and bottom‐up picks. BreitBurn was an industry pick in the sense that the price of natural gas had fallen some 75% from its peak, which was certain to cause some headaches in the industry. And where there’s pain, there’s often value. That’s the “industry pick” portion of the analysis.
Once I feel comfortable that I understand the industry enough to look at companies, I then analyze each one from a bottom‐up perspective. What I liked about BreitBurn above most others was that it was suffering from a number of problems that, in my mind, seem very temporary.
Natural gas had crashed and was not providing anyone with profits at $3. Eventually, that situation had to change and natural gas would have to rise to a more “normal” level. BreitBurn suspended its dividend/distributions, primarily to reduce its long‐term debt and shore up its finances. Again, a temporary situation (in my mind) as the debt load was not enormous and the company would certainly be able to pay down debt and begin distributions again when natural gas turned.
Finally, the company was taking a bath on its natural gas hedges, causing massive losses. These were accounting losses that required no additional cash outlay and did little but make the company’s numbers look ugly. In time, that too shall pass.
SA: Can you describe the company's competitive environment? How is this company positioned vis a vis its competitors?
JP: Because their pricing and profits are set by the markets, it doesn’t really matter (in this case) except to the extent that, when analyzing the company and competitors as alternatives, you need to determine if the company has strong enough management, economics, and liquidity to survive a deep, prolonged downturn in the underlying commodities.
They don’t control their revenues, so you focus on the companies that can survive because they minimize expenses and can run lean for a long time.
SA: Can you talk about valuation? How does valuation compare to the competitors?
JP: A few months ago, most natural gas‐linked companies were cheap. I liked BreitBurn because it provided a nice margin of safety in its assets. If the company didn’t survive, the need for oil and natural gas in the United States would not dwindle one iota. With 102MMBoe of proved reserves (75% natural gas/25% oil), the company was sitting on a considerable asset base that, in an orderly liquidation, would command much more than the then‐current stock price.
On future earnings and cash flow, many of these companies looked cheap – particularly if you believed that $3 natural gas was not sustainable. And if it was sustainable and we began bleeding companies like BreitBurn, we had safety in the assets. That’s a very comfortable position to be in, regardless of which way the commodities or the stock price heads in the near‐term.
SA: What is the current sentiment on the stock? How does your view differ from the consensus?
JP: At a $600 million market cap, it’s too small and boring to generate any real following on Wall Street. There are about four analysts on the stock, each with a hold rating – a rating that hasn’t seemed to change in at least a number of months.
The consensus is generally ugly. If you bought this for clients back in 2007 because $34 seemed cheap and the $2.00 dividend looked solid, you’re not too happy right now.
SA: Does the company's management play a role in your position? If so, how?
JP: Management is always a consideration. A value analysis means very little if management bleeds the company of its value and potential. At the very least, you need to ask if these are the guys and gals you want as business partners. Are they honest? Do they seem to have the best interest of the long‐term holders at heart, even if that means they have to make tough decisions that upset the Street.
BreitBurn’s decisions haven’t been popular over the past year or two (as is evident in the stock price), but I think that management is not looking to the next quarter, but to the company’s long‐term future. I like that.
SA: What catalysts do you see that could move the stock?
JP: Natural gas and oil have come up from their panic levels, which will only serve to help BreitBurn’s profits and cash flows. They’ll use those cash flows to continue to pay down debt, which will ultimately lead to a reinstatement of the distributions (though I don’t know if they will be at $2.00 a year). And their hedges will continue to firm up as the commodities rebound and level off.
Any one of these could be a catalyst. A combination of two or three should help even more.
SA: What could go wrong with this stock pick?
JP: If commodities plunge again, BreitBurn will again fall on tougher times. There is always a risk that the banks will reduce BreitBurn’s borrowing base below its current debt level; however, they reaffirmed a $732 million base a few months ago and the company’s outstanding borrowing is $585 million (down 17%, as of 9/30/09). If that was a major risk, it would have likely happened six months ago as natural gas was bottoming and the future (at those prices) looked bleak.
Finally, you always run the risk that the markets never realize the company’s value ‐‐ that you lose opportunity because you wasted two or three years in a stock whose value was never realized.
SA: Thanks so much, Joe.
JP: My pleasure.
Disclosure: Joe Ponzio is long BBEP
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