In light of the recent Energy XXI (EXXI) bankruptcy filing and what I view are imminent bankruptcy filings by Ultra Petroleum (UPL), Halcon Resources (NYSE:HK), Stone Energy (NYSE:SGY), Penn Virginia (PVA), SandRidge Energy (NYSE:SD), et al., I think now is an appropriate time to review a key risk-management process that might have been able to help investors avoid undesirable investment outcomes (if invested in a name that ultimately declares bankruptcy). To be specific, this note will review the process of closely inspecting stressed-enterprise debt within a more comprehensive viability analysis. I very much so believe in the truism that "credit leads equities" - in fact I've presented this thesis in an investor presentation which can be found here - and in that I scrutinize all debt vehicles within a cap-structure for each investment within my coverage universe. Obviously, I would recommend all investors do this as well.
Typically, the debt/credit architecture within the broader cap-structure can give a good idea of "on the clock" viability at any given time - essentially answering the question of "how long can this enterprise survive under the current operating assumptions"; this is on a per enterprise basis in my experience(E&Ps in the cases I've chosen to break out in the screencast below). This, to me, is an invaluable tool in deciding the risk-weighting of any particular equity trade. It's an even more invaluable tool in determining ultimate recovery value should a trade/investment move against its holder. Knowing the parameters of "time until death" (viability, if said in more sophistication) and the total potential recovery value in a worst case scenario are, in my opinion, the two basic fundamental pillars of stressed-enterprise investing. Basically, what is my risk and what is my reward.
Debt structures assessed within this screencast walkthrough are: Ultra Petroleum, Halcon Resources, Stone Energy, Vanguard Resources (NYSE:VNR), and Rex Energy (NASDAQ:REXX). To be clear, I keep things very "high level" within this screencast and nothing within this screencast is entirely inclusive of all relevant information; out of respect for those viewing this screencast both are being done to keep this note at a readable length. As a bonus, I assess the bankruptcy return probabilities for each tranche of the cap-structure at Halcon Resources.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
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.
Editor's Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.