Looking at the crude energy price dynamics, I can only say one thing: stay away from Oil & Gas. Sure, there are some good plays among the large internationals and some speculative buys like Linn Energy (LINE). But there are also a lot of other opportunities in the market that offer a similar level of return at a lot less risk.
Cimarex Energy (NYSE:XEC) is late for the party - while its peers have already lost a chunk of their market capitalization, the company's descent has only begun now:
(Source: Google Finance)
The catalyst for the fall was the recent quarterly report, which caused the company's stock to fall below the $100-per-share mark for the first time since 2013. As usual, disappointing top and bottom lines, coupled with massive asset impairment charges, scared investors away:
Cimarex Energy Co. today reported a third quarter 2015 net loss of $763.3 million, or $8.21 per diluted share, including a non-cash impairment of oil and gas properties. The adjusted third quarter net loss was $14.4 million, or $0.15 per diluted share. Third quarter 2015 adjusted cash flow from operations was $178.6 million versus $439.7 million a year ago.
I mean, investors should have expected a few negative figures. No doubt, the company is financially stable with only $1.5B in debt and over $6.3B in assets (and a cash balance of almost $900M). An analyst argued that Cimarex Energy is a high-quality company that deserves above-average valuation despite the disappointing quarterly results. He essentially said that Cimarex Energy has premium production assets with low break-even points, and, even though the asset-based valuation is also rich for the company, it deserves the current share price.
But here is a problem. The market does not value oil and gas companies by their earnings. In the current environment, the market values the energy companies by their assets. The market does not like overvalued O&G properties in the wake of falling crude oil and natural gas prices. And it does not care if the company is currently producing positive free cash flows or not. Besides, as it appears in historical statements, Cimarex's cash flows actually took a big hit during the year:
(Source: Google Finance)
I realize that I am comparing 9-month data for 2015 to the figures for the full fiscal 2014. However, there is no chance on earth that Cimarex will post a level of operating cash flows even remotely close to what it showed a year ago. Assuming no seasonality, the figure for FY 2015 should be in the neighborhood of $750M - $800M, a 50% slash on a year-over-year basis. Also notice that, even though the company also axed its CapEx (by more than 50%), it did not produce free cash flows in fiscal 2014, either. Although the dividends are miniature compared to the operating cash flows, there is a chance they will either be frozen or axed, if the energy prices fail to restore in the next year or two. This will not help improve valuation for sure.
Now let us talk about the assets. The problem is, money managers are not experts in engineering. In fact, their portfolios typically hold so many securities that they seldom are experts in any particular industry. But they know that companies like Cimarex Energy get revenues from selling crude oil and natural gas. The also look at how the market has treated these commodities over the past year or so and realize that many energy companies will go bust, if the crisis persists. A lot of companies will be fine financially and operationally. But they don't want to guess and try to pick a company with "good assets" from a myriad of falling knives. I would not do that, either. Energy is a commodity. An energy company cannot persuade customers its product is somewhat better or unique compared to other like products on the market. Energy companies are all in the same boat in terms of revenues. What they can compete on is cost. Cost-cutting and effective liquidity management can help a lot of energy companies in the short-term. But you can cut costs and capital expenditures only to an extent. You still need revenues - at least a stable stream. Investors are not seeing that.
No matter how good you are, you are sometimes disregarded because of who you are. Apple has always been a unique company with breakthrough technology and mind-blowing products. Nevertheless, during the 2008-2009 crisis, its stock fell below $15 per share (on a post-split basis, otherwise - $100 per share), losing over 50% in 2008 alone. I bet everyone knew what Apple was, how financially stable it was, how well-positioned in was in the market, and so on. Yet, because the market as whole was down, its stock also plummeted. There is nothing personal here - just the systematic risk.
I think that the same is true right now with the energy sector: no matter how good a company you are, your valuation will be axed. And because Cimarex Energy's shares just recently left the orbit, they have a long way to go before the market can say the stock is worth buying. Again, there is nothing personal here - just keep your eyes on the commodities market and keep your cash handy to buy Cimarex Energy at $70 per share (provided you believe in the U-shaped recovery of the energy market)!
Disclosure: I am/we are long LINE.