- WildHorse Resource Development is up 40% over the past 4 weeks and has soared to new all-time highs.
- The company has built up the second largest land position in the industry in the Eagle Ford shale, with over 400,000 acres of prestigious drilling area.
- This articles discusses the value of buying leaders vs. laggards in an industry with exact examples.
In a market that's been rather tricky to navigate the past few months for most investors, the oil stocks have provided a bit of a safe haven as many of them have seen strong performance. While the S&P 500 (SPY) is up 1.5% since the week of February 9th, 2018, the SPDR S&P Oil & Gas Exploration & Production ETF (XOP) is up nearly 20%. This has been helped by the price of oil (USO) which has soared from $59.00/barrel to $69.00/barrel over the same period. The issue is that while XOP has seen a strong move off the February lows, not all oil/gas stocks are created equal. Many analysts and investors favor the stocks that are down in price the most as they believe they have the largest potential to increase in price. This is extremely flawed thinking. Rather than looking for the stocks down the most from their highs, one should be looking for the stocks that are the closest to their highs and have come down the least. The "buy low, sell high" crowd is sure to come after me with pitchforks for this statement, but the article below details specific examples of why "buy low, sell high" is not as effective as "buy high, sell higher". One has to look no further than Sanchez Energy (SN) and WildHorse Resource Development (NYSE:WRD) and the massive difference in their performance over the past month for proof of this. Based on WildHorse Resource Development asserting itself as a leader, I have gone long the stock at $19.58.
One of the most common mistakes I see investors and traders making is buying the laggards in a group vs. the leaders. I believe the reason for this is because it is much easier to buy things that are cheap than it is to buy things that are expensive. This has been proven in several studies that have shown that less than 5% of retail investors are willing to buy stocks at a new 52-week high. The biggest flaw in buying something that is near its 52-week lows or "cheap" is that most of the time it is down there for a reason. It also goes against human nature to buy things that are expensive as outside of the stock market we are taught from a young age that it's best to buy things when they're on sale. For this reason, it's more comfortable for investors to buy things when they are cheap as they have been doing it their whole lives. This is precisely why Boxing Day, Black Friday and Cyber Monday attract such massive interest - people love to buy things on sale. Unfortunately, the opposite is true in the market and this is why the majority of individual investors/traders lose money. This is because doing what's comfortable in the stock market is rarely right. Whether investors and traders are willing to admit it, it is the majority that prefers to buy low and the minority that are willing to buy high. Based purely on these statistics, it is more uncomfortable for individuals to buy high than it is to buy low.
If we know that the majority of people lose money in the market and the majority of people buy low, it would be wiser to do what the minority are doing, not the majority. It would be unreasonable to expect to perform like the minority if one uses the same strategy and principles as the majority. The same is true of the character traits of billionaires. They have a relentless work ethic, they take risks, they are extremely passionate, and they thrive on criticism and pressure. Just as it would be unrealistic to be in the minority that makes money if you trade like the majority, it would be equally unrealistic to want to become a billionaire but not be willing to operate with the same traits that separate billionaires from the average person. The point of this is quite simple. You cannot expect to be part of the minority if you operate in line with that of the majority.
(Source: Author's Photo)
Moving on to how this actually applies to the stock market, let's take a look at two stocks below: WildHorse Resource Development and Sanchez Energy Corporation. Going into Q2, WildHorse Resource Development had a 6-month return of (+) 44% vs. a (-) 35% return for Sanchez Energy. Using a very simple scan of the top performing stocks, one could take a look and see which names were the leaders and which were the laggards. This is one of the easiest ways to see if you are potentially investing in a leader or a laggard. Based on these stats alone and comparing them to the XOP's (+) 3.50% return over the same period, we can see that WildHorse Resource Development had outperformed the index by 12x (44% vs. 3.50%), while Sanchez Energy had underperformed the index by 10x ( (-) 35% vs. (+) 3.50%).
As mentioned earlier in the article and proven by financial articles on the stock, analysts have been lined up to try and catch a bottom in Sanchez Energy and have not had much positive to say about WildHorse Resource Development. Low-priced stocks that are down significantly from their highs look more attractive as the assumption is that they should easily be able to recoup lost ground if the sector swings back in favor. My rebuttal to this assumption would be that an investor should first consider what caused a company to drop 80-90% in value and significantly more than its peers, and why it deserves to trade at previous highs? The argument that a stock was at $30.00 previously and is now at $3.00 so it should go back to $30.00 makes about as much sense as the argument that Harvey Weinstein was once a highly acclaimed producer and so he should return to his level of stardom at some point in the future. Harvey Weinstein "stock" is down for a reason while the industry has not been affected anywhere near this degree and this is for a reason. Trying to make the case that Weinstein will return to his previous level of stardom would be a silly assumption and not grounded in much logic at all.
As we can see from the below chart of names in the oil/gas industry, WildHorse Resource Development currently holds the number 12 rank out of 140 (top 10%) in terms of 6-month performance and Sanchez Energy holds the 132 rank out of 140 (bottom 10%). This stat immediately shows that one is a clear leader among the space and another is a clear laggard. This is reason alone to avoid Sanchez Energy.
Digging a little deeper past a purely return standpoint, we can take a look at some daily and weekly charts for confirmation of the above assessment. As can be seen in the below chart of Sanchez Energy, the stock has been making lower highs and lower lows for the past two years as it's plummeted from $14.00 to $3.00. The stock has not once closed above its 50-week moving average since losing it in early 2017, and the 50-week moving average is trending lower at a good pace (indicating the stock is in a bear market).
Moving on to WildHorse Resource Development, we see a completely different chart. The stock spent nearly a year in a base after its IPO and then formed a double bottom before starting a clear new uptrend. The stock has been making higher highs and higher lows since Q3 2017, is above its 50-week moving average, and the 50-week moving average is rising (indicating a bull market). Based on this simple exercise that takes less than 2 minutes for each stock, we can come to the conclusion that WildHorse Resource Development is trading in a bull market vs. XOP's consolidation (as of early April), and Sanchez Energy is trading in a bear market vs. XOP's consolidation (as of early April). It speaks volumes that the Oil & Gas Exploration/Production ETF is trading in a consolidation (sideways pattern) and Sanchez Energy is in a full-blown bear market and cannot stop bleeding. In the most simple form, it's saying that despite the XOP having likely put in a new intermediate bottom at $30.00, Sanchez Energy cannot find its bottom.
Moving on to the daily chart of Sanchez Energy, we can find more evidence of a clear bear market in the company's shares. The stock has spent less than 5 trading days in the past year above its 200-day moving average and has been trading below declining 50-day and 200-day moving averages for the past year. The stock continues to make lower highs and lower lows and is clearly moving down from left to right on the chart. My barometer for a stock being in a bear market is if it's below a declining 200-day moving average and making lower highs and lower lows. Sanchez Energy clears fits this bill.
Taking a look at WildHorse Resource Development below, we can see the exact opposite. The stock spent several months consolidating but has been making higher highs and higher lows since Q4 2017. The stock was trading above a rising 200-day moving average and rising 50-day moving average going into 2018 and is in a clear bull market. This chart is saying that despite XOP consolidating, the stock was front-running the move and clearly was seeing more demand for the stock than supply coming to market.
There are several other examples of this within the oil sector that I could go over, but the point is that the stocks that had the better returns and were above their 200-day moving averages going into Q2 2018 make up the best performers - Valero Energy (VLO), California Resources (CRC), Delek US Holdings (DK), HollyFrontier (HFC) and many others. The ones that were performing the worst like Cimarex Energy (XEC), Range Resources (RRC), Cabot Oil & Gas (COG), Newfield Exploration (NFX) and Antero Resources (AR) continue to perform the worst.
While buying low may seem like the right thing to do as it's less risky, it's actually riskier. This is because laggards tend to remain laggards just as leaders tend to remain leaders. Would you pick Tom Brady for your fantasy football team or would you pick Trevor Siemian of the Denver Broncos (who went 206/349 with 1.5 interceptions for every touchdown scored)? You might get Siemian for a better price, but why pay anything for an asset that has not performed in the past. I would rather pay up and use my top pick for someone that has a history of excellence and is very likely to continue performing for me.
Based on the reasons outlined above and the fact that WildHorse Resource Development was a clear leader, I went long the stock at $19.58 four weeks ago. I sold 1/2 the position at over a 7% gain and another 1/5 of the position for a 16.5% gain within a week of the entry, and am now riding the rest of the position for free up about 35% in the past month.
The stock is acting exceptionally since it triggered its buy-point and has the potential to be a large winner given its strong fundamentals and powerful technical picture. The stock has broken out of a primary IPO base (shown above) and has one of the largest land packages in the Eagle Ford shale, yet one of the smallest market capitalizations among the companies operating there. To put this in perspective, EOG Resources (EOG), which holds the largest piece of land in the Eagle Ford (520,000 net acres), has a market capitalization that is 25x that of WildHorse Resource Development (404,000 net acres). While there's no guarantee that acreage equates to prolific drilling locations, it bodes very well for the company that this jurisdiction is one of the most highly sought after in the world (from a pro-regulatory, infrastructure, high netback standpoint).
The company has seen a reserve replacement ratio of 2,000% and has seen incredible F&D costs (finding & development) of $3.36 per boe. The company's current PV10 (current approximated value of oil/gas revenues in future) stands at $3.5 billion, above the company's $3.2 billion approximate enterprise value. The company will also enjoy savings as their income tax rate will drop from 36.6% down to 23% going forward as a benefit of the Tax And Jobs Act.
(Source: WildHorse Resource Development Company Presentation)
In addition, the company's production growth in the Eagle Ford is unrivaled thus far with a 130% compound annual growth rate from 2015 to present. The company has gone from producing less than 5 million barrels of oil equivalent per day to over 40 million barrels of oil equivalent per day in a span of only 4 years.
(Source: WildHorse Resource Development Company Presentation)
Finally, looking at cash margin, we can see that WildHorse Resource Development is well ahead of its peers. The company's cash margin is nearly $43.00 compared to $31.35 for operators in the Permian, $30.42 for operators in the Bakken, and $27.70 for other Eagle Ford operating peers. This has translated to a 75%+ margin at a WTI price of $55.40. Thanks to these high margins, the company is seeing very strong annual EPS growth. Below are how annual EPS looks for 2016 through 2019:
2016: (-) $0.49
2017: (+) $0.45
2018: (+) $1.64 (Estimates)
2019: (+) $2.19 (Estimates)
(Source: WildHorse Resource Development Company Presentation)
Based on the strong technical and fundamental picture and the tight share structure of 101 million shares outstanding (17% held by funds and 3% held by management), I believe the company to be well positioned for further upside going forward. I currently see the stock as a hold and would consider adding to my position if the stock were to give me another technical buy-point.
The point of this article is that rather than scraping the bottom of the barrel for stocks down the most, investors and traders should be looking at stocks that are up the most. The market is always right and companies with exceptional fundamentals that are in demand by the market are where real opportunities lie in my opinion. One should ask themselves that if a company is down 90% from its peak while its peers are not, what does the market know that the individual investor does not?
Ed Seykota summed this up with one of his more famous quotes:
“If you want to know everything about the market, go to the beach. Push and pull your hands with the waves. Some are bigger waves, some are smaller. But if you try to push the wave out when it’s coming in, it’ll never happen. The market is always right”
This article was written by
Analyst’s Disclosure: I am/we are long WRD. 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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