The following is an interview I conducted with Brian Harper, CFA, who was the winner of my March Madness stock competition. I looked for underfollowed authors here on Seeking Alpha to submit a selection from the S&P 500 (NYSEARCA:SPY) that they thought would perform the best over the month of March. For those who have not seen, the following paragraph is the thesis that Brian submitted with his entry of Marathon Oil (NYSE:MRO):
"The thesis behind MRO is based on the price of oil; MRO is highly levered to oil prices, which we expect to rebound as the year progresses. Shares trade at just 1x 2014 operating cash flow. World oil demand continues rising while supplies are on the decline due to curtailment of unprofitable projects. The potential for a surprise OPEC cut would cause a surge in oil and in shares of MRO."
Brian, thank you for taking the time for this interview and congratulations on winning my March Madness stock contest with your selection of Marathon Oil.
Over the month of March, oil increased 12.42% and your selection of MRO increased 35.69%, which plays into your thesis of MRO being highly levered to the price of oil. In addition to MRO being highly leveraged to oil, you noted that it was trading at an attractive valuation based on its operating cash flow.
Were those the two deciding factors that drew you to MRO over other oil companies?
Yes, the thesis was based on two parts. The first and biggest piece was the fact that oil supply has been coming in faster than had been expected. Offshore rigs have been idled as they come off contract; shale drillers are not drilling new wells. Most of the new oil that has come online in the past 5 years, particularly in the U.S., does not produce an economic profit with oil at $30-40. Oil demand is self-correcting in that more is consumed as prices go lower. I feel that oil will have to settle at $70 or higher within the next year, based on the economics of the industry.
The 2nd piece was the valuation of MRO. Shares were trading at 1x 2014 operating cash flow and had dropped 80% from mid 2014. Unlike many MLPs and other E&P companies, MRO carries a reasonable debt load and had actually reduced outstanding shares in the prior few years.
Overall, though, to win a contest like this, you need to pick an outlier. Exxon (NYSE:XOM) or Chevron (NYSE:CVX) would be unlikely to win; they simply are too big, too close to the mean. I picked a stock that had the potential for a huge move. I have actually never owned a single share of MRO.
For all the reasons you stated above, is there a point at which you would consider owning MRO?
I have exposure to energy mostly through credits, which I found through the downturn fell faster and harder than many of the associated equities despite being senior. I might consider owning MRO, but frankly have not done enough work on it yet to put actual $$ in it.
Moving on, I want to talk about your general investment process you use. On your Seeking Alpha profile page, you note that you use a bottom-up, fundamental approach to investing. What are some key fundamental factors you look for when searching through ideas?
I do source ideas by things like fundamental screens, looking for companies at cheap valuations with low financial risk. I occasionally buy franchise-type names when they are available at cheap prices as well. I presently own Blue Bird (NASDAQ:BLBD), which is valued like a car company but has returns on invested capital more like a software company.
I also like what are termed special situations or workouts. Once a month, I review all upcoming spin-offs and have invested in a number of those over time. I invest in liquidations, which selectively can have very attractive risk/rewards.
Over time, I have devoted more time and energy to what I call VSCs [VerySmallCompanies]. Most have no sell-side analyst coverage, and the area is much more likely to be inefficiently priced. I own a couple of names, which are at valuations, which are standard deviations lower than the cheapest stock on the S&P 500.
I will say generally, something not acknowledged much by the industry of fee-based fund managers, that markets have gotten much more efficient since 2000. There are value investors who used to consistently beat the market who have now underperformed for 1, 3, 5 and 10-year periods. That is not just "out of favor." That is the fact that computing power has eaten their lunch for them. Quant funds marry value strategies with momentum, and the internet is full of very smart bloggers/part-time investors who are competing. Free tools and resources available online today are better than some of the best pay stuff available 15 years ago. I personally love that investing has become so democratized. However, you have to work harder and look in darker corners of the market to have an edge.
I also try to use fundamental screens to search for ideas as a starting point and then incorporate other factors like looking at complete financial statements and technical charts. Some of the fundamental screeners I use are FinViz, Fidelity and Zacks.
What stock screener[s] do you prefer to use?
I have a subscription to YCharts, so I use their screening tools. I think FinViz's are solid, although last I checked they do not include OTC stocks, which I do a good amount of. Years ago, I would use the Yahoo screener, which was decent at the time. I still, every couple of months or so, run a screen via www.magicformulainvesting.com.
I have also devoted time looking at VSCs and spin-offs as well. For VSCs, I look for companies that are profitable or close to profitable and have the potential to grow long term [5-10 years]. The two VSCs I own are Strategic Environmental & Energy Resources, Inc. (OTCQB:SENR) and Chembio Diagnostics (NASDAQ:CEMI). SENR has a number of different businesses under its umbrella, which include environmental services, rail car cleaning, gas capturing and medical waste disposal. CEMI manufactures & licenses rapid point of care diagnostic tests that detect infectious diseases. CEMI could be important this summer and fall because of the Zika virus, which the company received a grant from the Paul G Allen foundation to develop a point-of-care test for Zika.
For spin-offs, I look at the growth prospects of the spin-off or the remaining company and look for long-term value. The most recent spin-off I purchased was PayPal (NASDAQ:PYPL). I purchased shares of eBay (NASDAQ:EBAY) prior to the split and once the split occurred, I sold my shares in eBay, held, and plan to hold my shares of PYPL for the long term.
An upcoming spin-off I am looking into is the Alcoa (NYSE:AA) split that will happen later this year. I am really interested in the value-added company [Arconic] because of its long-term growth prospects and knowing that half of the business will not be weighed down by the aluminum focused half of Alcoa.
What is an upcoming spin-off you are looking at that you find intriguing?
I recently took a hard look at Manitowoc (NYSE:MTW), which is now a crane operator, as it is presently in a weak cyclical environment and looked interesting in a classic value sort of way. The company ended up being capitalized more aggressively than I would have liked, so I passed. The stock is up over 50% since the time of the spin. There is more potential with that one, as housing starts remain below the historical average and new construction is increasingly urban and requiring of cranes. A couple of years ago, they were generating EBITA of over $1 a share, and at an 8x EV/EBITA multiple, the stock would be worth more than $6. Still, we are risk averse so passed due to the leverage.
Other than that, we do not have any spins on our radar. I will mention a company we own and like is Conrad Industries (OTCPK:CNRD). The shipbuilding industry is cyclically depressed right now, which explains Conrad's current valuation. The company has managed to stay busy; however, it has a near record backlog. This required sacrificing margin, but they remain profitable, and carry around $10 per share in cash, plus a claim against BP, which should be worth a couple bucks a share. Management are owner/operators (they own over 40% of the stock), and have been aggressively repurchasing shares lately. They recently cut the dividend, a shrewd move to us given the opportunity presented by share repurchases. Conrad is a low cost operator, building on very low cost, modern facilities in Louisiana and Texas. We think they are worth north of $30, but with more upside, the more shares they repurchase.
I looked through your list of articles you have written on Seeking Alpha and found that the company you have covered the most is StoneMor Partners L.P. (NYSE:STON). You have been bearish on STON for over four years. However, you recently published an article on STON, which was the first article you had published on the company in a couple of years. What new development[s] made STON an attractive short target?
I wrote the first bearish piece on STON on SA, and that was in late 2011. I will say first that STON is one that could persist for a while longer. It is a battleground stock between retail investors who love the fat distribution and point to management's non-GAAP numbers, and more skeptical analysts who dig through the numbers and believe the distribution is totally unsupported. The debate about their accounting gets a little complicated and arcane, and for brevity, I will stick to the broad strokes here.
For years, STON has paid out far more than they have generated in cash. They have an incentive structure where they are right at the point that management gets fat incentive payments for any increase in the distribution per share. So they are incentivized to keep those dividend payments going and even increase them. STON has filled the cash shortfall by running up their credit facility, and then every year or so doing a big equity issuance. To give you an idea of the size of these issuances, in the last 3 years, they have issued $287 million in new equity. Their market cap was only about $531 million prior to these three issuances. In addition, they closed 2015 with record debt levels and are due to go back to the well again.
Bulls claim the new issuances are for acquisitions. Indeed the company is a frequent acquirer. However, I would like to note that their revenue on a per share basis was over $15 in 2008 and was about $9.50 per share last year. The merchandise trust has been severely diluted in the last 5 years on a per share basis. The company is not building value. They are selling new stock to pay distributions to the old stockholders. They are rapidly destroying value, and my opinion is the equity is worth somewhere between zero and high-single digits.
I will admit I have no idea how long this thing can go on. However, STON has a nearly $900 mil market cap and their distribution consumes $84 mil a year in cash at present. How long will the market continue absorbing new stock issuances?
Thank you for the information on STON, I read your articles and other articles & stories from other sources and I determined that I would avoid [not necessarily short] shares of STON because of the complicated nature of their accounting and structure.
Brian, thank you for taking the time for the interview and once again, congratulations on winning my March Madness stock contest.
Thank you Brad, it was my pleasure.
I encourage readers to check out Brian's profile and articles he has written here on Seeking Alpha as well as follow him going forward. I also encourage readers to check out the stock selections that 23 underfollowed authors on Seeking Alpha made for my Spring Showdown contest.
Disclosure: I am/we are long CEMI, SENR.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.