WildHorse Resource Development: Leaders Vs. Laggards

Summary

• 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.

(Source: TC2000.com)

(Source: TC2000.com)

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).

(Source: TC2000.com)

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.

(Source: TC2000.com)

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.

(Source: TC2000.com)

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.

(Source: TC2000.com)

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.

(Source: TC2000.com)

(Source: TC2000.com)

(Source: TC2000.com)

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”

(Source: AZQuotes.com)

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.

Comments

[MyFairShare]

Taylor, the guidance you provide for selecting potential winners is full of wisdom, as usual. So pleased that I caught the right wave this time, with Wildhorse. By the way - The Harvey Weinstein comparison works well. Thanks for explaining your reasoning so logically. Your newsletter has helped me improve my stock picks.

[homeboogie]

Just announced that they beat income expectations by $0.13 for Q1. I hope you guys didn't take profits too early!

[Taylor Dart]

Just going through report now. I took another 1/8 of my position off at $28.20 for a 44% gain, holding the remainder with a stop 25% below market prices. Have 1/5 of my initial position left purchased at $19.58 four weeks ago. Will be interesting to see how it acts tomorrow. Quite a run-up into these earnings so I'll be curious to see if some of the exceptional results were being priced in to today's gap.

Would love to see a new base built at this higher level for a few weeks to add back to some of my position.

[AG2USN]

Taylor, Interesting article. Do you have a price you would considering adding more shares?

[Taylor Dart]

Hi AG2USN,

Thanks for the comment. Not at this time, I think it is a little extended and it would be constructive if it could build a new base. Over the next couple weeks it should show if it's going to provide an add point but I can't even speculate on what that would look like yet.

[Norman Bates at Disneyland]

Taylor,

Sometimes your theory is correct, but sometimes not. I remember you wrote an article not too long ago on the mining company TGB recommending a buy at about $2 - it is now about $1 (figures are approximate). I know you will reply about the need for the application of a stop-loss etc. etc. but that leader was clearly a very poor laggard heavily in disguise. Fundamentals do matter considerably.

[Taylor Dart]

Hi User477,

I think that applies to everything in the stock market. Nothing is certain or works 100% of the time in the market or it would make it very easy to operate in the market.

Right within the article on TGB I said my exact stop was at $2.08, I was out well before it dropped through $2.

Even if you are right on less than half your endeavors in the stock market, you can be extremely profitable if you have a safe-guard for limiting the losses on those that go awry like Taseko.

For every Taseko there are 2 Kirkland Lake, Viper Energy or Wildhorse Resource. It's impossible to know when a leader is a laggard in disguise as you've suggested, even the leaders with the best fundamentals may have topped in their earnings cycle. Stops are always required.

I'm not sure how it's relevant really and I've never said that fundamentals don't hold any weight, but TGB was strong fundamentally so it doesn't help the argument anyways. There will always be exceptions to the rule, the key is losing as little as possible on the exceptions.

It would be akin to saying "Ya but I played pocket Aces in poker last week but lost the hand, so I'm not playing that hand again". That would be very silly. Just because you have an edge it doesn't mean it's going to work every time, but it does mean that it will work more often than not. That is how you consistently make money whether it be poker or the market - you do something over and over that has a probability of 55% or greater of working.

[TopDoggie]

I play in tournaments with a guy. He usually makes it to the money table. He plays AA extremely weak. He is convinced that the hand is bad luck because of a couple bad beats. I don't get it. The brain has a tendency to forget all the time you win with them because you are supposed to. It will remember every time you get beat.

[gsgold]

Thoughtful commentary here - thank you. And as usual, wise counsel from Mr Dart. (Does contrary-contrarian ever apply to your thinking?! ... going against the contrary-media sentiment when momentum is the single-most powerful factor at that time.)

[Taylor Dart]

Hi Gsgold,

Thanks for the comment. Can you elaborate or give a specific example? Not sure I understand. If you're suggesting what I'm thinking I do simply sell into momentum when I feel that we've hit a "climax top". I sold Aphria on the way up in January right before the peak and cautioned that pot stocks were likely in a short-term bubble there. It's an art though and sometimes I can get it wrong.

[homeboogie]

FWIW the analysts at Raymond James, who have been covering WRD since its IPO, bumped up its price target from $26 to $38 on 4/24. So they're still seeing 50% upside, and that's just their base case. The bull case is closer to $60.

They've been right on WRD so far. I've been a buyer since the $11 to $12 range and will not be looking to reduce my position for a while.

[22023171]

While WRD has clearly performed better over the time period in question. Today's losers can often be tomorrows winners in the market. I would not be surprised to see SN start outperforming WRD over the next couple months. SN is beaten down and leveraged but they also leveraged to a recovering oil and gas market and should rebound and deliver out performance as oil continues to go up.

[Taylor Dart]

I would challenge the "often" claim. Losers tend to stay as losers and continue to underperform and winners tend to stay as winners and outperform the peer group. It does happen that losers can be tomorrow's winners, but I don't believe it's often. The 52-week low list generally and more often than not heads to more lows and the 52-week high list generally and more often than not moves to more highs.

It's possible that SN outperforms WRD as WRD is likely going to need a rest after its near parabolic run but the point is that they've significantly underperformed during the "sweet spot" of this oil rally where the "easy" money has been made in E&P's. The first round of leaders have emerged and many other mediocre names have already broken out, SN is still treading water. Not a name that I'd be putting in my portfolio. If a stock can't budge while oil moves from $58 - $70 and the sector runs up 20%, it's not something I'd want in my portfolio.

[22023171]

I picked up SN recently after they had their run up to $4 a few weeks ago. After that it did tank after they released their production guidance which was below prior guidance. I break even at about $3.69 with them but they were up nicely today and report earnings after the close. If they are good I would expect another big move tomorrow although some of that will be dictated by Trumps Iran announcement tomorrow which if good for oil could help if not it could mute some of the upside.

SN is leveraged to the upside in oil and gas prices though. There is a lot of leverage on their balance sheet and any improvements in oil and gas prices has a more pronounced effect on them. Another factor in this is roughly 40% of the float is sold short so when the stock starts moving up and you get all those shorts starting to cover SN is going to fly. I would not be surprised to see it over $5 in 5 weeks from now.

[Taylor Dart]

Short interest in meaningless if a stock is in a bear market, the shorts have profits to play with and cushion and aren't worried about small trades higher against their thesis.

I would be extremely surprised to see SN at $5 five weeks from on, especially given the fact that it's down over 15% today.

[blackberryman]

I fundamentally agree, Taylor. I like to buy stocks on weakness and will frequently trade them when they pop. I am increasingly learning to avoid the laggards (which often tie up my monies for a long time) and trade around leading stocks- much more fun and profitable. I still like a good deal and hunt for them, but am hopefully growing more aware of laggards.

Wish I had held onto WRD. I've traded it a number of times but underestimated its strength. I'm looking for another pullback opportunity to trade- it is definitely a race horse.

[Taylor Dart]

Hey Bbman,

Thanks for taking the time to comment. I couldn't agree more on the leader vs laggard sentiment.

I've found the best opportunities if searching for "deals" come when value meets momentum. Several papers have been written on the success many funds have enjoyed by employing momentum strategies with value names. I've found them to be slower moves than momentum strategies with growth names, but slow and steady can still finish a race and do well in a portfolio as an addition.

Kicking myself for not holding onto more also but thankful to still have a piece of it. Admittedly I did too and the price of oil over the past month. Only wishing I had taken a few more listens to the conference call earlier, I'd likely have peeled off a little less on my initial sell. Clearly, a company that's executing on their plan.

[camrob123]

I challenge the author to look at more qualities than price momentum as there are many more fundamentals that make up the whole. Also, when referring to cheap or expensive stocks you have to discount price to earnings and growth and weigh it versus the industry competitors as well as book value when you talk about price. Just because a stock price goes up or down does not mean it is cheap or expensive. That's one small technical analysis in a large works of analysis. There are many other factors that go into affect. How many assets do they have that they have not tapped into yet, how old is their equipment, how is their equipment valued, what's their expected price to earnings to growth, did they over pay for their average, are their drilling techniques giving them better returns, etc. Is the stock price being ran up because they've been adding on debt and the price of oil has been increasing? These are the questions you need to answer and much more.

[Taylor Dart]

I haven't found any of these things mentioned to be helpful when selecting stocks, especially leading stocks. Leaders always look expensive and trade well above book in most cases. I've been listening to the fundamental guys complain about valuation on Amazon, Netflix and Abiomed for years.

They have industry-leading margins, they have industry-leading production growth, they have the largest land package in the Eagle Ford next to EOG. They have industry-leading earnings growth next to Viper, Callon and Diamondback and industry-leading revenue growth. The list goes on. They're a leader in nearly every metric. I'm not as worried about how old their equipment is or what their book value is as I am with the fact they are working on building out a new sand mine to further efficiencies, they're drilling from larger pads to also further efficiencies and they've been over-delivering and executing on their strategy the past two years.

The stock price is running up because they're a growth company trading at a valuation reserved for a non-growth stock in an industry that's being rotated into. If I tried to buy at 1.5x book or less I wouldn't own any leading stocks, I'd own all the laggards that are in down-trends in most cases. VNOM hasn't traded at under 2x book value in 12 months, it has doubled though while most of the sector laid dormant until recently.

[camrob123]

Yeah, WRD does have some good fundamentals, but it has approached a very lofty valuation now. I would reduce holdings. I bought VNOM very early on and have now reduced at 50%+ gains as it is approaching higher valuation. You could make the argument of holding or buying as the management is the strongest in the business, though.

I'm currently liking SRCI, REI, CPE, and CDEV. While CDEV and REI currently have high valuations, their management and growth makes up for it in the years to come.

[Taylor Dart]

Hi Camrob,

As mentioned in the article I have reduced my position to 1/3 of its initial size and have zero risk on the trade. I'm now riding the position in WRD with a wide stop and no risk. Possibly yes on valuation for WRD, but I think that all changes if oil decides to continue it's ascent. Money managers are going to want a bigger piece of this space and already are fighting for a chunk and they'll be looking for the best names to do so.

I also traded VNOM and like it a lot, unfortunately only got a 20% gain out of it and was shaken out late last year near $23.00. I would agree it's the best. Nicely done still being in.

Thanks for the tips on the below names, I'm familiar with most and will check them out.

Taylor

[nrdani1]

Enjoying the ~40% stock gain since you sent out the buy signal. Great work and let’s keep shopping for more out performers!

[TopDoggie]

Keep it up and might make me rethink strategy

[billmasi]

Hi Taylor,

Followers of William O'Neil will recognize the 'Buy the Best' strategy, I'm sure.

Thanks much,

Bill M

[Buyandhold 2012]

Taylor Dart,

I like Wildhorse Resource Development.

I checked it out on Yahoo Finance and mostly liked what I saw.

Trailing P/E is 85.69. BAD
Forward P/E is 12.52. GOOD.
5 year expected PEG ratio is 0.37. GOOD.
Market cap is 2.73 billion. GOOD.
Up 131.88% in the past 52 weeks. GOOD.
Founded in 2013 in Houston. GOOD.
An oil and natural gas company. GOOD.

[yeti786]

Thanks for another interesting read, Taylor!
By the way, how would you compare WRD - going forward - with WLL and DK?

[Taylor Dart]

Hi Yeti,

No problem, glad it was of value. All 3 have great fundamentals and technicals, I believe they are all holds but would have taken at least some profit at this time if was in either. I don't believe any are buys as they are quite extended, but I would consider all holds. If I was long any of these names I'd likely have trimmed 1/2 of my position by now and be holding the rest for a free ride with a very wide stop to allow the position room to work.

Taylor