One trite but true rule about analyzing insider activity is that it's more significant when a cluster of insiders at a firm buys into their stock instead of just one. But it is also particularly notable when clusters of stocks in the same industry show such a consensus of insider opinion. That is certainly the case with energy stocks right now.
It is absolutely understandable to see oil and natural gas related stocks down big time along with the price of the commodities they profit from. Concerns about global growth given the potential blow up in Europe and slowdown in China represent real risk to the revenues of energy firms, but is arguably old news at this point. The real question now: is the risk of a global slowdown already priced into energy stocks?
At this point, we're supposed to relay that the slew of significant insider signals in various energy stocks argues that they are all obviously raving buys as soon as insiders buy into them. But at InsiderInsights.com, we've been following insider data and the stock market too long to use the fact of heavy insider buying in the energy sector as an immediate buy signal. If we did, we would have gotten into energy big time in the first half of May, when Basic Energy Services (BAS) was trading for over $14, Devon Energy (DVN) was over $60, QR Energy (QRE) was at $18, GulfMark Offshore (GLF) was $40, Nabors Industries (NBR) was over $16, Swift Energy (SFY) was over $24, and Hess (HES) was over $50. All these stocks are lower (some substantially so) today, even after trading better recently.
Usually right. Often early.
Specific to energy insiders, we've seen this generally knowledgeable population get their timing very right, and we've seen them be right but very early with their optimism. Back in both 1998 and 2008 energy insiders were so early with their bullish calls as to appear dead wrong for months. When energy insiders did turn out to be way early, it was usually due to macro events overwhelming executives' ability to see just how gruesomely economic events outside both their control and ken were set to push their stocks down further.
We are by no means perfect, but the risk of macro events again making their purchases too early was easy to see in May, and was the caveat that kept our hands off the buy, buy, buy button for weak and cheap energy stocks then. That risk remains real today as well. For even if the known risks to global growth are priced into energy stocks now, it is unknowable if there will be new bad information that will need to be priced into these shares tomorrow.
So despite energy stocks finally having the look of picking themselves of their various floors, we're still not prepared to say the sector is suddenly "all good", and that it's safe to pile wholesale into all the energy stocks that have met our insider and fundamental criteria, and now look woefully oversold both technically and valuation wise. But we can justify starting to trickle some new money into energy stocks, and have chosen to do so with Basic Energy Services.
Basic Energy Services operates in four sectors of the oil and gas industry. The company offers well completion and remediation services, fluid services, well servicing and contract drilling. The company's drilling and fracking services are used in most of the major unconventional oil and gas fields in the United States. The company has managed to avoid some of the gas related weakness in the industry as 70% of its servicing and drilling capacity is exposed to oil and liquid production. Of course, that same exposure to oil understandably sunk BAS in Q2 as the price of that commodity finally lost its bid.
Basic Energy's largest operations are in the Permian Basin of West Texas and New Mexico. Permian is the most economically attractive of the unconventional oil and gas fields in the US. The field has the lowest breakeven price for drillers and more rigs are expected to be brought online this year and into 2012. Basic already has 181 well servicing rigs, 12 drilling rigs, 364 trucks and 1064 frack tanks in the basin to take advantage of the opportunities in the basin. Roughly 40% of revenue for the company comes from these servicing and drilling operations in the Permian.
Basic has grown consistently since it was founded in 1992. In 2000 the company was purchased by DLJ Merchant Banking and came public via a 2005 IPO. In the past 10 years the company has spent $900 million on 59 acquisitions that added to its servicing and drilling capability. Revenues have grown from just under $200 million in 2003, to more than $1.2 billion last year. Basic continues to look for strategic acquisitions that will allow it to continue to expand revenues and profits.
Recent operations have experienced the same problems as other companies in the oil patch. Higher revenues have been offset by lower margins, and the company fell short of Wall Street expectations in Q1. Revenues for the first quarter were up more than 50% year over year and exceed analyst expectations. However, the Street was looking for the company to earn $0.56 a share, and Basic only managed $0.50.
Following the release of the results CEO Ken Huseman told investors: "Activity levels in our oil and liquids-rich operating areas combined with equipment additions drove our revenue to a new quarterly record during the first quarter of 2012. Despite sequential revenue increases achieved in each of our segments, first quarter profit margins declined due to deteriorating conditions in our gas markets, rising labor costs and several non-recurring expenses."
Shares of Basic Energy have plunged from over $30 a year ago, to around $10 today-and that's after bouncing from a recent low of $8.50. As a result of the decline, the stock is now valued very cheaply at 6 times earnings and less than two times book value. The Enterprise value to EBITDA ratio is just three right now, and shares trade for less than four times free cash flow.
That historically low valuation has not gone unnoticed by the people running the company. Insiders have been substantial buyers of BAS as it has fallen. Since the end of April, four insiders acquired $4.9 million more of BAS at prices ranging from $8.70 to $13.50. All four of the buyers increased their holdings substantially with their recent purchases, and two of the buyers were recent smart sellers of BAS at much higher prices.
CEO Huseman was one of those recent sellers. He instituted a 10b5-1 (automatic selling) program only back in March 2011, and the plan trickled yet more shares out as recently as April 16, when BAS still fetched $15.24. The decline in his stock appears too have been too much for him to keep selling, though, and the program seems to have been halted or paused. Instead, Mr. Huseman chose to exercise incentive options and hold them all-increasing his holdings by a decent 5.2%. Given short-swing restrictions, exercising options (a non-open-market transaction) was the only way he could act on his bullishness. The exercise price for his options of $6.98 is also instructive info. That is obviously the price that he does not think BAS will fall through during this turmoil.
Extra intelligence can also be gleaned from the recent purchases of oil industry stalwart, Steven Webster. He is a director at both Basic Energy Services and Hercules Offshore (HERO), and he has been buying both shares since April. Mr. Webster's $4.2 million worth of buys of BAS have been far greater than the mere $323k he's put into HERO recently, however. His stake in BAS is also worth more than double his exposure to HERO at this point. This definitely relays Mr. Webster's opinion of the relative undervaluation of both those energy plays.
Even with Basic's particularly bullish insider signal, however, anyone following us into BAS now (or any of the other perfectly good energy stocks we mention above) should still have a longer-term mindset. Our addition of Basic is part of our opportunistic rotation into longer-term value plays that we think will surge again when larger macro travails get calmer.
But there could yet be another storm (or several of them) before real calm can settle in, and BAS' recent nadir of $8.50 could quickly be hit again on the next disappointment regarding European debt, Chinese growth prospects, and/or the dangerously polarized U.S. legislature. Second-quarter financials could also prove to be a short-term drag given the relatively low price of oil in Q2. All the energy plays we've investigated should prove more sensitive to larger issues, however, and we're of the belief that forgettable Q2's are baked into all the beaten-down prices of energy stocks at this point.
Additional disclosure: Clients of Insider Asset Management llc also own BAS.