Tuesday, December 1, 2015
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Corporate Earnings


Canada-Oil Train Derailment

Here’s the summary of Basic Energy Services quarter – it was the same shitty results they had last quarter but with one key distinction:

The environment for oil companies operating in the higher cost fracking regions have declined so dramatically that BAS had to write off their entire goodwill provision in their assets. Now in some respects I had already done this internally. If, for instance, you re-read this article on BAS I posted on September 16, you’ll see I was referencing a debt/equity ratio of 5.4:

Debt for BAS is not unreasonable, and is one of the more attractive aspects of the company. Whereas many of their competitors are in real threat of default, I think BAS has repayment under control with a debt to equity ratio of 5.4.

But, in actuality, at the time BAS did not technically have a debt to equity ratio of 5.4, if you took the corporate equity at their word. They had a debt to equity ratio of 3.2.

The reason I listed then that BAS had a 5.4 debt to equity ratio is precisely because I do not take financial statements at their word.

Well, I guess that’s convenient, because as of now BAS definitely has a debt to equity ratio of 5.0. At least 5.0. Because they had to write off all $82 million in goodwill at once.

The jig is up, boys.

I hope you are ready for some serious fireworks, because BAS will not be the only ones writing off tens of millions this quarter. We are going to watch some serious shit hit the fan and it is happening right now.

I know there’s some people in The PPT keeping an eye on Debt/Equity ratios of oil & gas companies. I’ve been watching quietly. And I know BAS wasn’t even on your list, probably precisely because their official debt/equity ratio was in check until just now.

So here’s what you do. If a company like BAS can see that ratio go to 5.0 in three months, then a company that was already sitting at 5.0 will probably see that triple or quadruple (thank you exponential relationships…). In fact, at every doubling of the ratio, double the rate. So a debt / equity ratio of 5X would probably end up at about 8X (if I use BAS as a guide). 8X gets you 30X.

Cool, now all these companies are dead.

Here’s where I am frightened; somehow, BAS managed to burn $40 million this quarter. They said it was on fucking equipment, but I am super skeptical. Who buys equipment in this environment, even if the purchases are contractually obligated? These are the times when you say “fuck those contracts, take me to court”…because dead shells don’t honor contracts anyway. They have as much cash on hand now as they did in September 2014, but the market wasn’t like this in September 2014.

I have been keeping a tight eye on the old filings from 2009, because if I have to hold them to a measure, 2009 seems like a great point in time to do it. Albeit, the entire sector has twice as much debt as they did in 2009, but it’s still a great starting point to a conversation.

At this point in 2009 BAS had $137 million in cash on hand. And they had only $400 million in long term debt. Today they’ve got $56 million on hand with $800 million in long term debt. My prior optimism was based around their increasing cash to $90 million last quarter…because I had expected them to have over $100 million in the bank by now.

Instead they let their cash reserves get cut in half? Buying FUCKING EQUIPMENT?

Here are some positive takes on BAS’ quarter, I guess. Revenue barely declined, the company is holding the line in that regards. Expenses were pretty constant too, so after we get away from the egregious write down, there was only a $5 million deterioration at play. Basically another ($1.20) loss, not much worse. The company is allegedly restructuring management and workers (which ate up some extra funds), so hopefully they can drop their expenses by $5-10 million, which would at least close the Adjusted EBITA hole that opened up this quarter.

Profit margins aren’t plunging like they were either. Competition is fierce and margins are weakening, but not that badly. The weakest points were Well Servicing and Contract Drilling (obviously), but the other lines of business barely budged lower.

So it looks like this quarter BAS business actually stabilized somewhat. Unfortunately, it stabilized at a point at which BAS (or any similar company) couldn’t hope to keep the doors open.

One of my two sacred cows has just died. BAS lost cash (on the stupidest of reasons). My other (accounts receivables) haven’t been reported yet.

Regardless on what happens specifically with this company, make no mistake – these next three months are going to be the blackest of our lives. The entire US oil and gas industry is coming to a close.

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TIS Had A Decent Quarter

I’m sitting here waiting for the main event. In the meantime, yesterday Orchids Paper Products Company (TIS) reported and beat estimates. TIS is back to trading just below $30 a share.

Sales jumped 5% but earnings per share fell 7%. The company is highlighting that total earnings also rose, but they are sort of glossing over that the increase wasn’t enough to compensate for new shares outstanding. Still, TIS is growing so I will reserve judgment until I have a good look at the filing.

Anyway the market reaction is positive so the stock is up and that really matters most.

I bought TIS earlier this year.

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BAS Earnings Breakdown

I am watching BAS very closely, for reasons that should be plain. I dug into the most reason filing and have a few observations.

BAS lost $0.45 per share in the most recent quarter ($0.56 per share after further impairment of goodwill), driven by business disruption for lower prices and extreme cold weather. However, this loss was driven entirely by write downs and does not appear to have consumed cash.

Without asset impairment BAS had earnings of $0.11 per share. As of right now BAS operations appear to be conserving cashflow well. The most recent quarter, expenses exceeded revenues by about $10 million. BAS has $59.5 million in depreciation and amortization, leading me to believe that BAS operations are still cash flow positive.

BAS is aggressively cutting into payroll, reducing employees by 10% in the most recent quarter. They are negotiating with their customers, offering concessions to defend business, and even managed to mildly grow revenues in the most recent quarter as a result.

I do not expect BAS to hold this performance. That is asking too much. They are currently expecting revenues to decline by 21% to 26% sequentially. That is an enormous drop and more losses should be expected.

For the moment, BAS is well capitalized. They have $80 million in cash and an addition $233 million in revolving credit.

It is my belief that BAS will weather the storm. I trust their management to make the right moves here; they have done so before so this is not new territory for them. They are watching cash flows closely and will keep expenses in or around those levels to preserve the business.

I believe that BAS will succeed in keeping cash burn to some level that staves off any insolvency concerns for some years, thereby allowing them to outlast the recent downturn in oil prices. I also believe that BAS has competitors that are in much worse position than BAS.

BAS will survive, and BAS will flourish in the aftermath of this oil industry crisis.

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Traders Playing BAS Are Out Of Their Minds

Okay, I’ve read the report from BAS and can comfortably say that those who are pressing BAS shares lower are mentally unhinged.

Today – October 24, 2014 – a prospective investor could purchase shares of BAS for about $13.60. BAS just reported earnings of $0.24 a share, up from $0.06 last quarter. At a current book value of just under $7; and even playing coy and considering BAS earnings of $0.15 a quarter from here forward; BAS is priced with a risk threshold of just 11 years.

At the most recent earnings of $0.24, that threshold drops to a theoretical breakeven point of just under 7 years.

BAS is priced perfectly reasonably, and that gets you exposure to a company that grew revenues an additional 10% in the last three months. Year over year, BAS is growing at a more than 20% clip.

BAS hit these numbers without even factoring in additional operation capacity that is being brought online later this year. Consider for example completion and remedial services, where as of September 30, 2014, Basic had roughly 413,000 HHP up from approximately 351,000 HHP at the end of the previous quarter and 292,000 HHP as of September 30, 2013 – that’s a 42% increase in capacity.

But oil prices are going to render that excess capacity worthless, right? Actually I defer to the CEO on this subject:

“We have not seen a reduction of activity by our customers due to the recent decline in oil prices, and none have indicated reductions in their 2015 growth plans. Early indications of these capital spending programs look to be slightly higher than 2014 levels. We will monitor utilization rates closely and should we see any meaningful pullback, we will react quickly as we have historically.”

So to recap; BAS is a company growing at a rate that makes it the envy of the party, which even excluding any additional growth is moderately priced, down 9% today because people are concerned, mind you, that maybe the industry might slow down (of which there is no indication whatsoever that BAS would be hurt disproportionately or even that that is happening).

Let me put this all into perspective for you. You could go out today and buy shares of BAS for the same price that you could get them last year when the company was losing $0.17 per share per quarter. The market is giving BAS no premium whatsoever for going from an unprofitable company, to a profitable one.

Jesus! – (punches a brick wall in his office) I hate it when the market does dumb shit like this!

I have just mentally budgeted an additional 10% of my asset allocation solely for the purchase of BAS shares until such time as I shall be either satisfied, or badly wounded.

Today, my account stands about 95% long. I am willing to take it to 105% on margin exclusively for the acquisition of BAS shares, not counting on any other purchases I might elect to make or future sales.

First buy order comes at $12.

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On HCLP and Secondary Offerings In General

Following the glory of obscene growth potential yesterday – in the form of long term supply agreement amendments being announced – HCLP followed up by declaring a secondary offering. After hours and to the open, the price was off 5%.

I cannot in good conscience sit by and allow this to pass unaddressed. For you see, many of you have a very cliche, knee jerk opinion of companies raising money, which I have commented on before now.

Why is this? What is it about secondary offerings that you hate so much?

Myth One: They’re Dilutive

There is a major opinion in markets, unquestionably, that secondary share offerings inherently ruin the performance for existing shareholders.

The logic goes something like this – ahem – “ABC makes $100,000 per quarter, with 1 million shares outstanding, and I earn $0.10 a share. If they issue another 100,000 shares then I only make $0.091!”

Let’s just quickly break down this scenario and why it’s wrong.

First off, if a company sells shares, they take money onto their balance sheet. Especially right now, where new shares are routinely sold at prices FAR beyond their worth, the new cash on the balance sheet more than overcompensates for the loss of earnings, at least in the short term. If my company is selling stock at 20-30X earnings, it’s sort of a buffer to that dilution fear, isn’t it? Actually, lots of secondary offerings immediately make money for existing shareholders.

I only clearly lose if management is somehow selling stock for less than it’s worth; in which case they will most likely be sued up a tree. If they’re selling it at par, for fair value, then by definition it’s a wash (fair value including some form of discount for future earnings potential).

And then there’s the biggest question: what is management planning on doing with the money? Are they squirreling it away in non-marketable warehouses they plan on building, perhaps somewhere in Antartica? Or are they, like most businesses, trying to grow? And what is the potential of that growth? If opportunities that attract that new money have higher earnings per share than existing net operations, then all prior shares in existence will have benefited from the new equity.

Claim: whether or not a secondary offering is dilutive depends very much on what management is going to do with the money.

Myth Two: Debt Is Always A More Effective Way To Finance A Company

There’s another specious tidbit circling business community colleges. “So you have an opportunity to pursue; equity or bonds? Well offering bonds to finance the job will always have a bigger payoff for shareholders.”

Again, I find this claim to be wanting. The argument is weak from the onset. But please first note what I am not about to argue. I am not arguing that this claim is always false. But it is clearly also not always true.

If I raise money on a project, at best existing shareholders will be able to make a return above both the principle of the notes and the interest you owe on the bonds.

How is this that different from raising new money?

To start, the principle of the bond corresponds to the price per share of the equity raise. Turning these two objects over, we can see that, at least in our present environment, new shares being sold for more than they’re worth, from one perspective secondary offerings have a superior element to them for existing shareholders – existing shareholders can actually make money off the transaction (see above).

If my company issues debt, how have I benefited besides through “future possible earnings”? I cannot make money on the transaction. By nature of issuing a bond, every cent will need to be repaid (or else carry severe implications for myself as a shareholder). I personally have not directly benefited.

If my company issues stock at a big mark up – like they can right now – as a shareholder I have probably made money. New shares in a healthy market add more to the balance sheet than the new money receives in return.

After turning over the principle/equity issue, now let’s look at the dilution. Well, surely dilution corresponds to the interest on the bonds, does it not?

Where do you suppose interest gets paid? From the Ether? It comes directly from existing operations. If you’re lucky, the new/expanded business venture management is pursuing earns enough to offset both the principle of the bond and the interest and you, as a shareholder, make money on top. Otherwise, it’s a drag on earnings and…you guessed it – dilutive.

Now it could be parsed over here that debt’s return is finitely, contractually limited, so if a company raises debt to finance a project and that project has a fat payoff, then equity will always get more than in the alternative world where the project was financed through a secondary.

While this is technically true when peered at through the very narrow lens of a profitable, big payoff growth story, it overlooks two important points of view. The first is that 1) the game changes completely if a project does not make money, in which case the equity raise if vastly superior to the debt issuance (since the new equity will have diluted the loss for existing shareholders) whereas the debt, being a higher claim than stock, will compound the losses. The second being 2) a company can always just raise debt after a secondary (or vise versa) – and frequently many of the impacts of either a secondary or a debt issuance can be reversed or even transformed in the other direction (market prices permitting).

Claim: whether or not debt is superior to secondary offerings depends very much on a case by case basis for a company. Current debt levels, the possible payoff of the business growth, downside risks, interest rates, and market premiums for secondary must all be carefully considered. This business rule of thumb is overly simplistic.

Beware Billionaires Pushing Leverage

I couldn’t just let this stand unchallenged. Sometimes debt is the answer, but other times it’s best to just issue some more equity. It isn’t fair to turn the choice into a bumper sticker that management has to adamantly follow.

And so often, raising debt is exactly the wrong answer.

Some of the biggest pushers of corporate debt are so often big activist shareholders with goals ill-aligned with the regular mom and pop retirement accounts; people looking for a quick buck and possessing dubious intentions. Guys like Dan Gilbert in Detroit who are just too happy to fuck over an entire company of hardworking employee shareholders in a start up tech advertising company, then leave them holding nothing (and subsequently being supported by Michigan’s Supreme Court…cough cough). (For the record, that had nothing to do with debt, I just felt like spelling out what a piece of shit Dan Gilbert is).

It’s a long standing favorite of activist shareholders to take a big position in a lackluster company with low leverage, then pressure them to take on as much debt as possible, fling it around on the balance sheet to beat some poorly defined analyst metrics and make an illusion of growth, spice it up into a popular position, then unload the company for a fast gain on multiples expansion.

The only way it gets better for the hedge fund guys is if they can pay out as much of that leverage to themselves, either in special dividends, or – better – by bullying management into buying their private assets at a premium (you don’t have to share with anyone else that way).

At the end of the road, you have a lackluster and profitable company transformed into a glitzy and unprofitable one. That isn’t growing a business; it’s liquidating one.

It’s all fun and glam right now, with interest rates so low. However, as debt needs to get turned over next decade, we’ll get to see who was actually working for their company versus who was trying to rob it.

It All Comes Down To Trust And Timing

Do you trust your management, or don’t you? Secondary offerings and debt issuance can both go bad if the mood is right. What is the money being used for and what are the risks?

Is the company pulling a lot of strange moves on their filings? Are the cash flows pages telling the story of a company that isn’t actually taking in more cash, despite a great “growth” story? Are classes of shares being thrown around like a bowl of alphabet soup?

And what are prospects of the business looking like? Is demand for products growing? Does the company have more business than they can possibly service? At the end of the day, this is likely to be the biggest factor in the success or failure of any business. Debt versus secondary offering will probably play a backseat, if management is working as a proper fiduciary in a hot business cycle.

Update: I purchased more shares of HCLP for $62.47

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This Market Is A Real Bummer

One of my newest positions, ETP, co-reported earnings (alongside ETE, a familial body) that rose 50% year over year, soundly crushing estimates. The partnership is putting out almost 7% in distributions annually and distributable cash flow lifted 11%.

The partnership is modestly priced and more than a fair buy here. The only conceivable issue in the report I saw was that they’re paying out a little more in distributions than they take it, at the moment (and not for long if this kind of growth keeps up). And a little over a month ago ETP announced plans to build a new pipeline from the figurative gold mines in the Bakken region in North Dakota to their existing distribution network in Illinois…and the new capacity is allegedly already filled.

So following what can only be described as a stunning performance, the market is roundly bidding up units of ETP, correct?


ETP has given back all the morning ramp following the exciting earnings beat, and ETP is now struggling to hold just half a percent gain on the day.

That’s just the kind of market we have right now. You can hear the oxygen rushing out of the trading floor. I have a couple similar positions that have all left analyst estimates in the dust (mostly after having already been revised higher), and yet they just can’t catch a bid.

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