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Summary

  • The following four energy companies have under-performed over the last months despite the rise of the indexes and the analysts' bullish calls.
  • I do not expect them to outperform the market for the remainder of 2014.
  • I am not a buyer for any of them at the current levels because I have way better picks in my energy portfolio.

Introduction

Sometimes, you regret the things you did not do in life. This applies to my case, and I wish I had shorted four energy companies about five months ago. In early 2014, I wrote three articles about four intermediate oil and gas producers, explaining also why I was heavily bearish or neutral to bearish about them. I also discouraged the investors from initiating a long position on these four stocks for several reasons.

Given also that the key metrics and the fundamentals always serve as a reality check, I wrote back then that those investors who were in denial would most likely record significant losses or end up holding laggards.

I am talking for the following companies:

1) SandRidge Energy (NYSE:SD), and my article is here.

2) Quicksilver Resources (NYSE:KWK), and my article is here.

3) Magnum Hunter Resources (NYSE:MHR), and my article is linked above (SandRidge's article).

4) Penn Virginia Corporation (NYSE:PVA), and my article is here.

Their ugly performance over the last five months is shown at the table below:

Company

Publication

Date Of My

Article

Price On The

Publication

Date

Of My Article

Price Today

Return

(%)

Penn Virginia

Corporation

9 April 2014

$16.71

$13.3

-20

Quicksilver

Resources

14 April 2014

$2.83

$1.17

-60

SandRidge

Energy

17 April 2014

$6.75

$5.18

-24

Magnum Hunter

Resources

17 April 2014

$8.6

$6.31

-27

Based on these four bearish calls, the average return of this hypothetical portfolio is approximately (-33%) in about five months. I guess this return is not bad at all, given also that S&P has risen significantly since early April 2014, as shown below:

(click to enlarge)

The Updates

Let's check out now all the latest developments about these four energy companies and let's evaluate whether they are still good short candidates at the current levels:

1) SandRidge Energy: Tom Ward, the company's former CEO, was ousted in 2013 when he was accused of strategic missteps and self-dealing at the expense of shareholders. For instance, I disagreed with him in Q1 2013 when he sold the Permian assets. That was a hasty decision. SandRidge used the proceeds to pay debt and fund drilling at its Mississippian Lime fields in Oklahoma and Kansas, but that was a major strategic mistake in my opinion. SandRidge should exit the technically-complex with high water content Misssissipian Lime instead, following companies like Royal Dutch Shell (NYSE:RDS.A) (NYSE:RDS.B) and Encana (NYSE:ECA). If I was the CEO, I would sell the spotty and inconsistent Mississipian Lime acreage to divert the proceeds to the proven and oil-weighted Permian Basin.

In my article about SandRidge, I wrote that I was concerned about the funding gap, the key metrics, the debt and the subpoena from the US Department of Justice.

In addition, I noted back then that SandRidge Energy was fairly valued compared to its peers. As such, the upside potential did not seem to be significant and did not lure me to initiate a long position at $6.73.

In early August 2014, Global Hunter Securities downgraded SandRidge Energy. Once again, these analysts were too late, as shown at the chart below:

(click to enlarge)

A) The Latest Developments: In Q2 2014, the new management continued the efforts to refine the business model and improve the economics of the Mississippian wells (i.e. new drilling techniques, new well designs, lower expenses) in order to generate higher IRRs.

Furthermore, the company expanded its core acreage by adding Garfield County to its focus area.

B) The Key Metrics: The company's key metrics (Upstream segment) at the current price of $5.18 per share are shown below:

 

EV (**)

($ million)

EV (**)

---------

Current

Production

($/boepd)

EV (**)

---------

Proved

Reserves

($/boe)

EV (**)

---------

2014

EBITDA

(*)

Net Debt

(***)

---------

2014

EBITDA

(*)

SandRidge

Energy

5,350

76,648

(50% light oil/liquids)

14.19

(46% light oil/liquids)

6.37

3.1

(*): Estimate that excludes EBITDA from Oilfield Services and Midstream activities ($30 million).

(**): Including the preferred stock of approximately $765 million, but excluding the estimated enterprise value of the midstream assets. Given that SandRidge recently raised the guidance and the company's 2014 EBITDA from its midstream business are estimated at $30 million, the enterprise value for SandRidge's midstream business is estimated at $600 million (30 X 20 times).

(***): Not including the interest-bearing preferred stock of approximately $765 million (as of June 2014).

2) Quicksilver Resources: In my latest article about Quicksilver, I emphasized on the fact that the company had to deleverage in order to strengthen its extremely weak balance sheet. I also noted that Quicksilver had growing negative stockholder equity and the operating CF was not enough to serve the staggering debt. Quicksilver was at the mercy of its creditors, and I warned the investors to not bet on this highly risky turnaround play at $2.83.

Just a few days ago, Global Hunter Securities downgraded Quicksilver. The analysts were obviously too late once again, given that the stock chart over the last six months is shown below:

(click to enlarge)

A) The Latest Developments: In June 2014, Quicksilver entered into a joint participation agreement involving its assets in the Midland Basin in Crockett and Upton counties. As part of the agreement, Quicksilver retained a 12.5% interest in the applicable acreage and would be carried on both the cost to extend a majority of the leases in the basin and the drilling and completion cost of five wells.

In terms of the company's JV with Eni (NYSE:E) in Pecos County that was announced in late 2013, the first well targeting the Wolfcamp and Bone Springs formations was commenced in Q2 2014. Completion activities are currently underway, and this phase of the drilling program includes five wells.

Quicksilver owns approximately 90,000 gross acres in West Texas (Pecos, Crockett and Upton counties).

B) The Key Metrics: The company's key metrics at the current price of $1.17 per share are shown below:

 

EV

($ million)

EV

---------

Current

Production

($/boepd)

EV

---------

Proved

Reserves

($/boe)

EV

---------

2014

EBITDA (*)

Net Debt

---------

2014

EBITDA (*)

Quicksilver

Resources

1,970

47,854

(~15% light oil/liquids)

8.89

(~18% light oil/liquids)

16.42

14.67

(*): Estimate.

3) Magnum Hunter Resources: In my latest article about Magnum Hunter Resources, I noted that the company was grossly overvalued, and I would not touch it with a ten foot pole at $8.60. I also noted that aside its sky high key metrics, Magnum Hunter Resources had a staggering Net Debt to CF ratio that exceeded 6 times.

However, Credit Suisse had a different opinion from me, setting a price target of $9 for the stock. In addition, Stifel upgraded Magnum from Hold to Buy when the stock was at approximately $8.

And this is the stock chart over the last six months:

(click to enlarge)

A) The Latest Developments: To pay down outstanding borrowings under its Senior Revolving Credit Facility, the company sold in April 2014 its Canadian assets consist primarily of oil and gas properties located in the Tableland Field in Saskatchewan, Canada, for approximately $67.5 million.

In May 2014, Magnum sold 21,428,580 shares of the company's common stock at $7.00 per share, for net proceeds of $150 million. The company would use part of the proceeds to repay a portion of the outstanding indebtedness under its Senior Revolving Credit Facility.

In June 2014, Magnum announced the formation of a JV with EM Energy Ohio LLC, a privately-held company headquartered in Canonsburg, Pennsylvania. The contract area covers an existing mineral leasehold position currently owned by both companies which includes collectively approximately 1,080 net acres in the Marcellus Shale and Utica Shale Formations located in Washington County, Ohio. Terms of the new Agreement include Magnum Hunter's wholly-owned subsidiary, Triad Hunter LLC and EM Energy, collectively working together within the contract area on two units in Washington County, Ohio, the Merlin Pad and the Haynes Pad.

In July 2014, Magnum announced the purchase of approximately 1,700 net mineral acres located in Monroe County, Ohio and Wetzel County, West Virginia for approximately $22.7 million.

B) The Key Metrics: The company's key metrics (Upstream asset) at the current price of $6.31 per share are shown below:

 

EV (**)

($ million)

EV (**)

---------

Current

Production

($/boepd)

EV (**)

---------

Proved

Reserves

($/boe)

EV (**)

---------

2014

EBITDA

(*)

Net Debt

(***)

---------

2014

EBITDA

(*)

Magnum

Hunter

Resources

1,770

110,625

(44% light oil/liquids)

22.18

(38% light oil/liquids)

11.06

5.88

(*): Estimate that excludes EBITDA from the Midstream asset (~$30 million).

(**): Including the interest-bearing preferred stock of approximately $416 million, but excluding the enterprise value of the company's midstream assets and Alpha Hunter Drilling which is estimated at approximately $530 million.

(***): Not including the interest-bearing preferred stock of approximately $416 million.

4) Penn Virginia Corporation: In late March 2014, George Soros and Soros Fund Management revealed a 9.18% ownership stake in Penn Virginia, with 6,003,509 shares. I guess Soros' arrival and the quarterly report made RBC Capital raise its price target to $22 from $19 in early May 2014. In early May 2014, Canaccord was also bullish on the stock and raised the price target to $20. Back then, I was a contrarian instead.

And I presented the reasons why George Soros arrived too late to the party, and why it would be very difficult for him to unlock additional value from those levels of $17 per share.

I also noted that Penn Virginia was not a compelling opportunity at those levels, and those investors who bought the stock at approximately $17 because George Soros did so, should be prepared for a very bumpy ride.

And this is the stock chart over the last six months:

(click to enlarge)

A) The Latest Developments: In June 2014, Penn Virginia sold its Mississippi assets to an undisclosed buyer for cash proceeds of $73 million.

In July 2014, the company expanded its Eagle Ford position and also announced the sale of its right to construct and operate a crude oil gathering and intermediate transportation system to Republic Midstream for $150 million. This transaction, along with the aforementioned sale of the Mississippi assets and the gas gathering sale in January 2014, brought the total proceeds from 2014 asset sales to $319 million, exceeding the company's original goal of up to $300 million.

B) The Key Metrics: Pro forma the private offering of $325 million (preferred stock) and the transactions mentioned above, the company's key metrics are shown below:

 

EV (*)

($ million)

EV (*)

---------

Current

Production

($/boepd)

EV (*)

---------

Proved

Reserves

($/boe)

EV (*)

---------

2014

EBITDA

(***)

Net Debt

(**)

---------

2014

EBITDA

(***)

Penn Virginia

Corporation

2,250

~102,740

(~73% light oil/liquids)

18.44

(~66% light oil/liquids)

5

2.04

(*): Including the interest-bearing preferred stock depositary shares with a face value of approximately $414 million (as of June 2014).

(**): Not including the interest-bearing preferred stock depositary shares with a face value of approximately $414 million (as of June 2014), as linked above.

(***): Estimate.

My Takeaway

First, I will follow closely how these four stocks will play out during the remainder of the year. But I must also point out that all these energy companies have moved so far in the opposite direction to several analysts' upgrades and bullish opinions. And besides making bad calls, what I do not like about analysts is that they have no accountability. If a hedge fund manager makes a bad call, or repeated bad calls, his performance looks terrible, his investors pull out their remaining money from him, and he likely loses his livelihood. If an SA contributor makes a bad call, or repeated bad calls, his reputation takes a hit while the followers start complaining and sometimes attack him personally.

Analysts can make repeated bad calls for years with no consequences. They just keep covering a company and get big paychecks but nobody calls them on their bad track record. Why do these guys deserve to keep their jobs in this situation? And some of them even get to go on TV continuing to espouse their lousy point of view.

Remember all the talk of moral hazard back in 2009 when people complained that the government shouldn't reward Wall Street with a bail-out when they caused all the problems of the financial crisis? People said Wall Street would never learn to change if their bad actions didn't have consequences. Well, stock analysts had moral hazard in spades.

Second, what is next for these four energy companies?

1) To maximize EUR, SandRidge's management has become picky and focus on the proven sweet spots while they avoid the "dud" areas. As a result, out of the nearly 1.85 million acres that Sandridge has in the Mississippian Lime, the company has narrowed its focus to seven focus areas. Those areas include the counties of Comanche, Barber, Harper, Woods, Alfalfa, Grant and Garfield.

The company's debt hurdle must not be ignored. On top of that, SandRidge disclosed a few months ago that it had received a subpoena from the US Department of Justice back in December of 2013. This subpoena is part of a probe into potential antitrust violations during the purchase or lease of land, oil or natural gas rights.

In case SandRidge is found to have engaged in such practices that violate the US antitrust laws, it will incur fines that will impact negatively its financial health and cash position. Since the magnitude of these penalties is currently unknown and cannot be estimated accurately, the effects on the company's balance sheet must not be ignored by any prudent shareholder and any potential buyer.

From a valuation perspective, SandRidge is fairly valued compared to its competitors, while its stock has not gone anywhere over the last two years. This stock has been stuck in a trading range between $5 and $7, and I believe it is not going to break $7 anytime soon. Given that I only look at stocks that have the possibility to double over a twelve month period, I will pass SandRidge.

2) Regarding Quicksilver, the storm was coming in early 2014, but unfortunately many investors did not see it in a timely manner. Quicksilver is not out of the woods yet. Frankly speaking, it will not surprise me if Quicksilver Resources follows the fortunes of GMX Resources (OTCPK:GMXRQ), ATP Oil & Gas (OTC:ATPAQ) and Lone Pine Resources (OTCQB:LPRIQ) and files for bankruptcy by 2016.

Those investors who have been following me for long, know very well that I forecast twice in late 2012 and early 2013 that GMX Resources was on the verge of bankruptcy, although the stock was flying at $7 and $3.4 back then. GMX Resources filed for bankruptcy in April 2013.

Quicksilver has been kicking the can down the road for many months now, but the company must take drastic steps to improve its balance sheet substantially. The productivity of its acreage in the Delaware Basin is not enough to turn things around. Selling a significant part of its producing properties (i.e. Barnett, Horseshoe Canyon) while also making a JV for its Horn River gas assets should be two of these initiatives. In addition, the company will have to restructure its debt, by converting part of it into shares and refinancing the outstanding balance.

3) Penn Virginia is increasing its rig count in the Eagle Ford to eight in the second half of 2014, while expanding its ongoing pad drilling program in the Eagle Ford. Furthermore, their results in the Upper Eagle Ford are encouraging.

The ongoing benefit from the pad completions and rig expansions along with an increased focus on the Eagle Ford will most likely help them hit their production guidance in H2 2014.

Nevertheless, the company has been losing a bunch of money for many quarters now. And I am not convinced yet that this losing streak is going to end anytime soon and the company will be consistently profitable over the next quarters. Personally I'm in the "wait and see" camp. All in all, this stock is not my cup of tea, and I believe that this stock cannot beat the market over the next months.

4) Magnum Hunter Resources is an indebted company that spends more than it makes. And I have explained several times why I steer clear of the heavily indebted companies. They are excellent short candidates instead. For instance, I wrote a bearish article in June 2014 about two other indebted companies, Halcon Resources (NYSE:HK) and Goodrich Petroleum (NYSE:GDP), when their stocks were hovering at $6.7 and $29 respectively. I also recommended all to steer clear of these two companies. Halcon and Goodrich have dropped 25% and 40% respectively since my call. In contrast, I am very bullish on grossly undervalued energy companies with stellar balance sheets like Epsilon Energy (OTCPK:EPSEF), which is presented in my latest "Top Idea" article given that the stock is a steal at the current price.

Aside the weight of debt, Magnum Hunter is also richly valued given the low oil and liquids portion of its total production. And this is not going to change anytime soon, given that the company's Marcellus and Utica properties are natural gas weighted plays.

After all, I am not buying Magnum Hunter at $6.31 because I have way better bullish picks in my energy portfolio.

Disclaimer: The opinions expressed here are solely my opinion and should not be construed in any way, shape, or form as a formal investment recommendation. Investors are reminded that before making any securities and/or derivatives transaction, you should perform your own due diligence. Investors should also consider consulting with their broker and/or a financial adviser before making any investment decisions.

Disclosure: The author is long EPSEF. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

Source: Do These 4 Energy Companies Remain Excellent Short Candidates?