After years of being beaten down, bargain energy stocks are everywhere. The deepest values may be found in these post-bankruptcy companies.
The energy industry has been through a remarkably difficult time in the past seven years. The collapse of oil prices in mid-2014, from over $110/barrel to less than $25/barrel in early 2020, exerted immense stress on energy companies, particularly those that were bloated with debt from their overzealous pursuit of growth. At the same time, capital markets curtailed their financing of energy companies, worn out by the chronic lack of free cash flow. Several of these companies slid into bankruptcy, yet now look like bargain energy stocks.
When companies file for bankruptcy, they enter a complicated legal realm with its own rules. Shares of most companies in bankruptcy become worthless; you don’t want to buy those stocks.
However, if companies have good assets but too much debt, they can be restructured, with debt holders usually becoming the new shareholders. In some cases, once a company emerges from bankruptcy, its new equity will return to publicly traded markets. A post-bankruptcy company can emerge re-energized, more efficient and more focused, with a discounted share price – often a good combination for new shareholders.
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In the ideal case, a newly-emerged company will have fresh leadership (the former leadership that got them into trouble isn’t likely to do much better the second time), a minimal debt burden, fewer legacy legal or contractual liabilities and strong, profitable operations. The shares often can be available at an unusually discounted price that is temporarily weighed down by investors with bad memories of the pre-bankruptcy company who avoid the newly-emerged shares and by former creditors that offload their accidentally-acquired shares.
Listed below are three recently-emerged energy stocks. They have a mix of appealing traits and some notable risks, yet all stand to benefit from rising oil and natural gas prices.
We are modestly optimistic on energy prices – domestic production will likely remain subdued while global demand has essentially returned to pre-pandemic levels even though some petroleum-driven demand for gasoline and jet fuel hasn’t fully recovered yet.
Investors want to make sure that managements adequately balance their production declines with strong capital discipline. And production discipline from the OPEC+ countries is a wildcard but so far has continued to be a tailwind. While the shares have surged year-to-date, they appear meaningfully undervalued today.
3 Bargain Energy Stocks to Consider
Bargain Energy Stock #1: California Resources Corporation (CRC)
This company is a true California business: it operates only in the state and is the state’s largest oil and gas producer. While the state’s stringent regulatory environment is widely recognized, what is not widely known is that California is the second largest petroleum basin in the United States, with likely even more oil yet to be discovered. Many of CRC’s wells produce high quality oil – which yields premium prices – and have moderate decline rates, so they have relatively more reliable and enduring production. The company owns much of its processing and transport pipes as well as an integrated power plant, helping it control its destiny. California Resources was spun off from Occidental Petroleum in 2014, yet ironically the weight of its $5.1 billion in debt that funded a dividend to its former parent drove it into bankruptcy in July 2020. Newly emerged in October, it eliminated all but $1.7 billion in debt and was relieved of other financial obligations. The company is searching for a new CEO to lead a full-scale business review that will likely result in divestitures of lower-ranking assets. The board is entirely new, with one member being the chair/CEO of Oasis Petroleum. The company has hedged about 75% of its 2021 oil production and promises to spend no more than 60% of its sizeable discretionary free cash flow on new drilling, helping produce returns for investors.
Bargain Energy Stock #2: Denbury (DEN)
Denbury is an unusual oil and gas producer that focuses on using CO2 to push oil up from older wells. It sources all of its CO2 from naturally occurring underground deposits and from industrial plants where it is an otherwise unwanted byproduct. Denbury then links these sources to its oil fields through a proprietary pipeline network. The company emerged in September 2020 after a brief 53-day bankruptcy process, relieved of all but $154 million of its previous $2.1 billion in debt. Four of the seven board members are new, and, coincidentally, one is the CEO of Whiting Petroleum. Perhaps not ideal: the CEO and CFO remained in their seats following emergence, although they are now focused on avoiding the debt problems of the past. Another issue is that some of its oil is produced in the Rockies, which sells at a discount to benchmark oil prices, but this is often offset by the premium it can receive on its Gulf Coast oil. Denbury has hedged about 58% of its 2021 production, providing some downside protection to its cash flow if oil prices slide.
Bargain Energy Stock #3: Weatherford (WFTLF)
Weatherford is a global energy service company that was created by an aggressive, decades-long acquisition strategy that worked well as long as oil prices remained high. However, when oil prices collapsed, its unintegrated mash-up of businesses was unable to service its hefty $10 billion debt burden, despite an impressive turnaround effort by a new CEO, leading to its July 2019 bankruptcy. Still carrying $2.6 billion in debt when it emerged in December 2019, the company narrowly avoided another bankruptcy in 2020 when lenders extended all of its debt maturities to 2024. With a new lease on life, a new leadership team, and improving energy industry conditions, Weatherford can continue to rationalize its operations and rebuild its franchise. While the debt burden will remain a chronic overhang, the company has a realistic chance of turning the corner.
Editor’s Note: This post was excerpted from a recent issue of Cabot Turnaround Letter.
Bruce has more than 25 years of value investing experience, managing institutional portfolios, mutual funds, and private client accounts. He has led two successful investment platform turnarounds, co-founded an investment management firm, and was principal of a $3 billion (AUM) employee-owned investment management company. Now he is helping his Cabot Undervalued Stocks Advisor readers find those undervalued stocks that let you buy low and sell high!Learn More >>