Monday, January 18, 2016

Investment screw ups (as in my screw ups) part II



Hey yo, welcome back to the “Investment screw ups” series where I make the mistakes so you don’t have to. In this article, I will review the abortion that was my decision to invest and hold on to Sandridge Energy. The thing is that I knew there was a real possibility of me fucking up, seeing as how this was my first O&G investment and all. But looking back at my analysis of Sandridge, I can only conclude that I was down with a case of financial autism at the time.

Lesson number 1: It’s the debt, bitch.

I think I picked out Sandridge as a potential investment candidate because it had the lowest level of indebtedness among the O&G companies I screened. This is ironic as hell since part of the reason the company is currently in the shit is because of its crushing level of debt. It certainly didn’t help that the company went on to add almost a billion in debt after I bought the stock.  However, the main problem was me screening for companies in the O&G space with the lowest debt/equity ratio when I should have been looking out for the debt/EBITDAX or EBTDAX/interest ratios. I left out the EBITDA ratios because I thought that oil prices wouldn’t take long to bounce back. I thought that I would be underestimating the company’s financial health if I calculated its EBITDA based on oil prices back then. Of course, oil prices are so bad today that I would literally get sexually aroused if oil prices went back up to the levels they were at when I published my analysis of Sandridge. Fuck $80 oil, I’ll settle for $45 oil for the time being.

The debt/equity ratio can be an illusion of financial strength, especially for natural resource companies whose assets can get impaired real bad when the commodities they produce see a significant drop in price. At the end of the day, you need them cash flow to make interest payments and convince your creditors to roll over your debt. What’s the point of having more assets than debt if the future cash flows from those assets are going to be significantly lower than what was assumed when the assets were last valued. Eventually the company would have to write down the value of its assets and shatter the illusion.

Lesson number 2: Markets can remain depressed longer than a company can remain solvent

It was Sandridge’s hedge position that convinced me to actually buy the stock. At the time I bought the stock, the company’s hedges would allow it to enjoy high prices for its oil for about a year. I was like oil will surely bounce back within a year, it ain’t no thing. A year has almost passed and the price of oil has hit an all time low. Just fuck me.   

If this lesson sounds familiar, it’s because it is the same damn lesson from my Alpha Natural Resources case study in part I of the “Investment screw ups” series. At least the time between my purchase of Alpha and my purchase of Sandridge weren’t that long. So, I don’t think I’m guilty of the cardinal sin of repeating the same mistake twice. Not yet, anyway.

Lesson number 3: you need to have hustle if you want to find better opportunities  

I should have also widened the number of smaller sized O&G companies in my screening process. I’m sure that I could have found something better if I just looked a little harder. Better yet, I should have used the yahoo finance screener that I learned about way back when I was still in university. Turns out randomly clicking on related companies below a stock quote in Google Finance isn’t the best way to go about finding potential investments.

Lesson number 4: See the writing on the wall

I should have known that it was unlikely for the price of oil to rebound to levels that would be comfortable for Sandridge by 2016, especially after oil’s rally to $55+ per barrel faltered. I could have exited my position in Sandridge at a significantly higher price had I just seen the writing on the wall a bit earlier. 


Alright, that does it for this article. I hope you learned something from my fuck ups. Thank you for reading. Take care and stay rational.

Thursday, December 24, 2015

Analysis of Oasis Petroleum



We in the shit now, somebody gotta shovel it

Hercules Mulligan, I need no introduction

When you knock me down, I get the fuck back up again

–Taken from Hamilton the musical



Please read the disclaimer here:http://greedydragoninvestment.blogspot.com/p/about-greedy-dragon.html. Enjoy the article, bitches!




Hey, how have you guys been holding up? So, I recently found songs from “Hamilton” the musical on YouTube, and I’ve been listening to them non-stop. I have great reverence for the revolution that created America, so naturally I would fall head over heels for a musical about a founding father. I highly recommend that you check out some of the songs from the musical as they really are mind blowingly awesome. I think I will reward myself by flying to America to see the play when I reach my next financial milestone (hopefully Hamilton is still running then). Anyway, let’s get down to business.


Update on the Greedy Dragon portfolio: I recently added to my position in Natural Resource Partners. Please do your own research before making any investment decisions. I will NOT be responsible for any of your losses.


Oasis Petroleum, which I own shares in, is a U.S. oil & gas company that operates in the Williston Basin. The low end of the company’s 2015 production guidance is for 49.7 thousand barrels of oil equivalent per day (MBOEPD). 88% of the company’s production consisted of oil in 3Q 2015. The company has 26,000 barrels of oil per day hedged at $54.85 and 21,000 barrels of oil per day hedged at $52.96 for the first half and second half of 2016 respectively. Just a few months ago, I wouldn’t have imagined myself being psyched over $50+ crude oil swaps. This just goes to show how screwed up things are right now. As at September 30, 2015, the company had 506 thousand net acres in the Williston Basin of which 86% was held by production. The company has 296 net operated proved undeveloped drilling locations with 122 net locations located in the core of the basin. The company has 1,772 net operated non-proven drilling locations with 345 net locations located in the core. Oasis expects that it will complete 66.8 net wells in 2015.

  

The following table illustrates the costs associated with producing a barrel of oil equivalent (BOE) for Oasis. The figures in the table are estimates, and may differ significantly from the company’s actual results. 

WTI Crude Oil
 $    34.50
Differential1
 $      4.50
Realized oil price
 $    30.00
Realized natural gas price (converted to BOE)2
 $      7.80
Realized BOE price (excluding impact of derivatives)3
 $    27.34
Lease operating expenses4
 $      8.25
Production taxes5
 $      2.73
Gathering, transport & marketing6
 $      1.65
General and administrative7
 $      4.81
Operating profit per BOE
 $      9.89

1 The differential of $4.50 is the midpoint of the company’s 4Q 2015 differential guidance.
2 I calculated realized natural gas price by taking the $1.63 per mcf the company got for its natural gas in the quarter ended September 30, 2015 and cutting it down to $1.3 per mcf because natural gas has committed hara-kiri recently. I then multiply $1.3 by 6 to convert mcf to BOE. 
3 As 88% of the company’s production consisted of oil in 3Q 2015, realized BOE price was calculated as: ($30*0.88) + ($7.80*0.12).
4 Lease operating expenses of $8.25 is the midpoint of the company’s lease operating expenses guidance for 2015.
5Production taxes are calculated as 10% (the high end of the company’s 2015 guidance) of the realized BOE price.
6 Gathering, transport & marketing expenses of $1.65 is the midpoint of the company’s 2015 guidance.
7 I simply used the 3Q 2015 general and administrative expenses of $4.81.


Assuming that the price of WTI crude stays at these levels, I estimate that the company’s O&G division would generate $176.99 million in operating profit next year (excluding the impact of derivatives). For the purpose of this article, operating profit was calculated as operating profit per BOE × daily production × 360 or 9.89 × 49,700 × 360. No, I’m not touched. I know that there are more stuff involved when calculating operating profit. I’m just trying to get a rough picture here. If you annualize the company’s 3Q 2015 interest expense of $36.51 million, this would result in annual interest expense of $146.05 million. After deducting interest expense, the company would only have $30.89 million leftover for its capital expenditure program which really isn’t all that much considering the scale of Oasis’ operations. However, the company still has a significant portion of its production hedged which does help. With oil prices at current levels, the company’s hedges would give it an extra $165 million in cash flow. The company also has its well services and midstream businesses. Operating profit from those businesses for the 9 months ended September 30, 2015 was $25.05 million or $33.41 million annualized. So, Oasis’ total operating profit including the impact from derivatives would come up to a grand total of $229.3 million.


According to Oasis Petroleum’s 3Q earnings call transcript on Seeking Alpha, the company expects to spend $350 million on drilling & completion of wells in 2016 which it estimates will result in flat to a slight growth in production. While the company may not be able to completely fund its drilling & completion program with the cash generated from its operations with oil at $35, the shortfall isn’t huge. Although I’m not sure if it’s the best use of capital to bring all those wells online right now with oil prices being so depressed. By all means drill the damn wells since it’s cheap to rent rigs today, but you can wait to complete the well when the price of oil recovers. If buying back bonds offer a higher return than completing a well, then I hope management diverts some of the capex budget towards retiring the company’s bonds. The last time I checked, some of Oasis’ bonds were trading at 60+ cents on the dollar which sounds like a pretty orgasmic proposition to me. I would like to try my hand at investing in distressed bonds, but I don’t know how to actually buy a bond because I’m a moron. I also need to educate myself on how to analyze a bond, less my ventures in the bond market end up in my “Investment Screw Ups (as in my own screw ups)” series.


In this analysis, we’ll think of the $350 million as maintenance capex. Of course, the company also needs to spend on infrastructure which the $350 million doesn’t include. However, I don’t think that maintenance capex for the company’s infrastructure will be large enough to be a deal breaker. Oasis expects to incur capex of $150 million for its infrastructure program in 2016. However, based on the company’s 3Q earnings call transcript, its infrastructure program in 2016 is largely focused on bringing an asset online so I wouldn’t really consider it maintenance capex. The company also mentioned that it intends to bring in external capital to fund its 2016 infrastructure program.


Yes, it isn’t exactly good times holding on to a company that doesn’t have positive free cash flow. But Oasis’ operating cash flow should surge with any meaningful recovery in oil. Holding all other things constant, the company’s operating profit will rise by $14.17 million for every $1 increase in the price of WTI crude. The price of oil needs to go up to $55 for Oasis to generate enough operating profit from its O&G division to fully fund a drilling & completion program similar in size to the one estimated in 2016. Yeah, WTI crude oil at $55 kinda seems way up there from where we at right now, but stranger shit have happened. But even if WTI just goes up to $45, the company would only be short $140 million give or take from completely covering its maintenance capex with its operating profit. The company’s maintenance capex may even come down some as its production decline rate might further slow down due to its portfolio of producing wells becoming more mature. The cost of bringing a new well online may also decline, although I don’t think O&G companies will experience quite as much cost savings as they did this year. I sure wish that Moore’s law (I hope I got the right fucking law) applied to the shale producers as well.  


As at September 30, 2015, the company had liquidity of $1.35 billion ($1.339 billion available borrowing capacity under its senior secured revolving line of credit and $12.26 million in cash). The company had $2.380 billion in debt. Oasis’ debts start maturing from 2019 onwards, which gives it some breathing space.


The revolving line of credit does have a covenant that requires the company to maintain a ratio of consolidated EBITDAX to consolidated interest expense of no less than 2.5 to 1.0. To be real with you guys, this covenant has been a source of worry for me ever since oil plunged to the mid thirties. I don’t exactly know how Oasis calculates EBITDAX for the purpose of this covenant, but it seems that the company adds derivative settlements when calculating adjusted EBITDA in its quarterly report. According to my calculations, if WTI crude stays around $34.5 per barrel, Oasis would have a forward 12-month EBITDA/interest ratio of 2.59 after taking into account the impact of derivatives. Excluding the impact of derivatives, I estimate that oil needs to go up to around $45.5 for the company to maintain an EBITDA/interest ratio of 2.5.


I think that the EBITDA/interest ratio is calculated on something like a trailing twelve months basis. This could buy Oasis some time in the event things get worse as the quarters in 2015 will probably be more profitable than the quarters in 2016 if oil stays at $35. The company also adds back stock based compensation when calculating adjusted EBITDA, so I guess it will help if the company follows the same practice when calculating the ratio. However, things are still being cut a little too close for my liking. At least the company only has $185.2 million outstanding under its revolving line of credit as at September 30, 2015. Yes, I know that oil prices went up by a bit since I started the article when WTI crude was below $35. That just goes to show you what a lazy asshole I am that a mini rally occurred and I’m still dicking around with this article.



Well, 2015 has been…yeah… Maybe one day I get to look back at 2015 as the year I planted the seeds of wealth. But right now, I can’t wait to get the hell out of 2015 and start hustling in 2016. Thank you for reading. Have a merry Christmas and a happy New Year! Take care and stay rational.

Sunday, December 13, 2015

Drinks with the Dragon: 3,000 Ringgit in spilt milk, OPEC lifts imaginary ceiling, diversification




Spilt milk

Hey guys, welcome back to another edition of Drinks with the Dragon where I shoot the shit about random business and investing stuff. Remember in my previous article where I mentioned that I chose to take a gamble and hold on to my stake in Comstock Resources? Well, I learned that I have really shitty gambling luck. As some of you may have noticed, the price of oil, natural gas (for some strange reason) and O&G stocks have plunged after OPEC decided to lift its production ceiling. This situation has forced me to wake the fuck up to the increased actual business risks faced by Comstock Resources. I decided to be prudent and sell the position, albeit at a price significantly lower than what I would have got just 2 weeks ago. I thought it was too risky to wait for a rebound as the stock could have went a lot lower. And considering that the investment has become riskier due to falling natural gas prices, I didn’t want to stick around to find out whether or not the company gets permanently impaired. To add insult to injury, the stock rallied about 20+% the very same day I sold it. It was like the universe decided to send me a giant middle finger.

Update on the Greedy Dragon portfolio: Sold Comstock Resources and Fossil, increased my stake in Oasis Petroleum and Northern Oil & Gas. I didn’t want to sell my position in Fossil, but maintaining a healthy amount of liquidity is especially important in these challenging times. Please do your own research before making any investment decisions. I will NOT be responsible for any of your losses.

The messed up thing is that I knew that I should have sold the stock. You can read my previous article, Update on the Greedy Dragon Portfolio, where I said that I would sell my Comstock shares if I were a professional fund manager. Had I sold the stock the day I published that update, I wouldn’t have flushed around 3,000 Ringgit down the toilet. Considering that the goal of the Greedy Dragon portfolio is to prove to the world that I can be a successful fund manager, I should be more professional in my decision making instead of acting like some degenerate gambler. Just because I’m Chinese, doesn’t mean I need to gamble. Not all Chinese are gamblers (got to be a little bit PC brahs!).

OPEC’s imaginary production ceiling

So, OPEC decided to remove its production ceiling which sent the price of oil tumbling. I just have one question, though. What exactly has changed? OPEC has pumped above the ceiling they set for the past 18 months (source: Bloomberg). It’s not like they have been controlling production all this time, and will start flooding the market now that the ceiling is lifted. They have been pumping like crazy since the end of last year in an attempt to gain market share.

Now, I don’t know what the price of oil will be next week. But I think that the price of oil could experience some recovery in the medium term, maybe even sooner than people might think. A lot of oil companies have been slashing their capex budgets which could lead to a drop in production somewhere down the road. The demand for oil is still growing as people from countries like India are getting richer, and they want more of that awesome black stuff. However, investors should keep in mind that things could get worse for oil. The world could plunge into recession which could in turn cause the demand for oil to get fucking hammered. OPEC could further increase production by a significant amount, especially when sanctions are lifted on Iran. But overall I think that the price of oil is more likely to rise than fall in the medium term as I think that people are way too pessimistic when it comes to oil right now. But that’s just my opinion.

Diversification

If you have been following the O&G sector this year, you would have heard the term ‘high-grading’ come up a lot this year. Well, I did my own version of high-grading when I used the proceeds from the sale of my Comstock Resources shares to increase my positions in Oasis Petroleum and Northern Oil & Gas. I think that these 2 O&G companies are in a significantly better position to survive this crisis than Comstock Resources. However, these investments have increased the Greedy Dragon portfolio’s exposure to the natural resource sector, and that got me thinking about diversification.

A lot of really rich people tend to focus on 1 company or 1 industry. One of the Original Gangstas of value investing, Warren Buffett once said “Diversification is protection against ignorance. It makes little sense if you know what you are doing.” When I first started investing in the natural resource space, I did try to take small positions and not get overexposed to the sector. I know it’s pretty stupid, but I’m the kind of guy who just charges in and take small positions after learning what I think are the important stuff about a certain industry. I expect that some of my earlier investments will have a lower chance of working out, but will nevertheless help me learn more about the sector. I don’t regret that some of my early picks did end up failing so much as I regretted doubling down on some of those positions when I apparently didn’t know my shit. Anyway, I significantly increased my exposure to the natural resource sector after I developed my knowledge to the point where I was confident I could tell whether or not something was dog shit. Whether or not I’ve really attained enough knowledge to make some “fuck everybody” money in the O&G and coal industries remains to be seen. For all I know, I could just be overestimating what I know, and end up crashing and burning like a little bitch.

Concentration risk is still, and will always be, a thing when selecting my investments. But I think that it’s possible to keep concentration risk at a low level even if the portfolio has heavy exposure to a certain industry. Look, if there are 2 potential investments with more or less equal risk/reward profiles, I would invest in the company from an industry which I have less exposure to (assuming I understand both industries). But I wouldn’t forego what I believe to be better investments just for the sake of diversification. I’m a young man who’s hungry to prove myself and become a success; I’m not a wealthy old chap looking to preserve his wealth. I’ve diversified my portfolio to the extent where I won’t get wiped out, but that’s all. I will still be significantly set back if most of my natural resource investments get permanently impaired (and judging by my recent performance, that’s something that could happen). But that’s a risk I’m willing to take. I’m taking my shot mofos!


Well, I guess it’s time to wrap this article up. I hope that you at least found this “drinking session” fun if not informative. Thank you for reading. Take care and stay rational.