SandDance: Tracking Bankruptcy Risk Using Predictive Analytics (Video)

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Includes: CHK, EGC, HK, PVAC, ROAN, SD, SN, TALO, UPL, XCO
by: Dallas Salazar
Summary

Bankruptcy risk is becoming a national narrative; regardless of sector but especially in energy and even more so especially in oil and natural gas.

Bankruptcy has become this year’s financial McCarthyism.

But is bankruptcy really all that predictable? Is bankruptcy really that easy to spot?

We don’t think it is; But, in saying that, we also don’t think that bankruptcy risk and bankruptcy itself are completely unpredictable.

In an effort to help provide something of a structured, repeatable, scalable process for identifying bankruptcy risk that we present a “Part 2” to our 12-Month Default Probability series.

Bankruptcy risk is becoming a national narrative; regardless of sector but especially in energy and even more so especially in oil and natural gas. It seems that with each new day yet another major financial publication is updating us with speculative commentary on "who's next", which company is seeing its balance sheet weaken most, which company is the market showing a disdain for. Bankruptcy has become this year's financial McCarthyism.

But is bankruptcy really all that predictable? Is bankruptcy really that easy to spot? Sure, there are traditional identifiers of bankruptcy risk - such as high levels of leverage, precipitously falling revenues and/or EBITDA, an equity price plumbing the lows (for those that prefer to track technical metrics). But is the single most sophisticated area of finance - stressed equity - really this easy to silo into identification columns? We don't think it is.

But, in saying that, we also don't think that bankruptcy risk and bankruptcy itself - over time, when using a wide and diverse data-set, and when something of familiar with the mechanism of bankruptcy (both the technical and human aspect of it; much too complicated to explain within this short note) - are completely unpredictable. In fact, we would argue that tracking credit health is the single easiest, most accurate, and most actionable way to track overall default/failure/bankruptcy probability. And while this isn't a statement that hasn't been reiterated time and time again across the financial academia it is one that we'd like to underline.

It's in this effort to help provide something of a structured, repeatable, scalable process for identifying bankruptcy risk that we present a "Part 4" of sorts to our 12-Month Default Probability presentation. We believe that now more than ever having a defined process for risk managing bankruptcy risk is paramount to capital preservation. In that, we'll try to have increased frequency of updates and increased engagement.

While we refuse to engage in the above stated "financial McCarthyism" we will continue to "undress" stressed equities via investor presentations for those that choose to follow our continuing series. Ultimately, as it has already with (we believe) PennVirginia (PVA), (we believe) Halcon (NYSE:HK), Ultra Petroleum (NASDAQ:UPL), (we believe) Stone Energy (SGY), (we believe) SandRidge Energy (NYSE:SD), Energy XXI (EXXI), and (we believe eventually) Linn Energy (LINE), we believe our process will help investors identify candidates at high risk of bankruptcy. Capital preservation and loss management is arguably the single most important variable to control in portfolio management; at the very least we hope our data can assist in a small way with that strategic initiative.

We reiterate our suggestion to consistently and frequently assess bankruptcy risk of both total-portfolio as well as individual names within a portfolio. We would advise on doing this with each meaningful change to the oil or natural gas pricing deck. Having a process with which to define and assess bankruptcy risk is priority number one for those heavily weighted towards energy; especially those with positions initiated at earlier points in the current credit cycle.

Good luck and enjoy.

PART i: 0:00 - 10:00

  • Introduction to SandDance Breaking out 12-Month Default
  • Probability by E&P and Risk-Indication Curves
  • Noting Outliers by 12-Month Default Probability
  • Noting Equity Risk Indications Versus Credit Counterparts

PART ii: 0:00 - 15:17

  • Sanchez Energy (NYSE:SN): Potential Short Side Alpha
  • Indiscriminate "Bunching" Creates Risk Adjusted Gains
  • Chesapeake (NYSE:CHK) and EXCO (NYSE:XCO): Market Confusion
  • Valuation Multiples by Risk Indication: What's Cheap, What's Expensive?

PART iii: 0:00 - 10:44

  • Who is growing EBITDA, who isn't?
  • EBITDA + 12-Month Default Probability = Survival?
  • Who's going to have a rough 2H/2016 and/or FY2017 based on the EBITDA data?

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.

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