Billionaire Steve Cohen's SAC Capital Advisors owns nearly 10% of Forest Oil (FST) after reporting in a recent 13G filed with the SEC that it had increased its position to 11.6 million shares. This is up from 6.4 million shares in the middle of September.
Forest Oil is an $820 million market cap oil and gas exploration and production company; on average, more than 3 million shares are traded per day and so we would consider it to have plenty of liquidity. The stock is down 47% in the last year.
In the third quarter of 2012, Forest Oil's revenue decreased by 10%. This was entirely due to poorer pricing of natural gas and natural gas liquids, which despite a slight increase in oil prices pushed the weighted-average price per Mcfe down to $5.00 from $5.585 in Q3 2011.
Oil volumes rose 29%, and combined with the decline in natural gas prices -- and fairly steady production of natural gas -- this made oil the largest source of revenue for the company, at about half of Forest Oil's total sales. Natural gas revenue plunged 39%, and sales of natural gas liquids were also down as lower prices offset an increase in production.
If oil production increases further, this would be beneficial as it would shift the production mix even further in favor of higher-priced oil. The high natural gas production volume, while not very positive in recent quarters, also provides some potential upside; there is a case to be made that natural gas prices are temporarily depressed due to a supply glut.
If producers generally cut back on supply (and it is clear that some, such as Chesapeake Energy (CHK), have overextended themselves), then combined with new sources of natural gas demand including exports and continued penetration into the utility market prices could turn up. This in turn would provide pure profit (less any drop in production) for Forest Oil.
Turning back to the company's Q3 financials, Forest Oil wrote down about $410 million in its properties, and also realized significant losses on derivative instruments (as opposed to a gain on derivatives a year earlier). If we adjust for those factors, its pretax losses were about $19 million as opposed to a pretax gain of $28 million in the third quarter of 2011, primarily due to higher depreciation but more generally because higher production increased costs.
Cash flow from operations in the first nine months of 2012 actually did not decrease much, as many of the expenses Forest Oil experienced were non-cash. However, the company has had to issue significant debt in order to help finance its capital expenditures.
Analysts expect 2013 earnings at 38 cents per share, which implies a current-year price-to-earnings ratio of 19. We have noted two obvious sources of potential upside -- increased oil production at the company and higher natural gas prices -- though the latter in particular is somewhat speculative and of course it would benefit other natural gas producers as well.
For example, Chesapeake trades at 17x analyst consensus for 2013 and activist investor Carl Icahn recently forced the removal of controversial CEO Aubrey McClendon. It and other peers might be worthwhile alternatives to Forest Oil. While we can see that Cohen and his team like the stock on the long side, we'd note that the most recent data shows 18% of the outstanding shares held short and so there are clearly a number of bears who consider Forest Oil to be overvalued at the current price.
Forest Oil is a commodity business, and as such its prospects more or less depend on future prices of oil and gas (though the company has strengthened itself from a strategic perspective by shifting its production mix towards oil- while this reduces the upside of higher natural gas prices, it provides some diversification and allows for the capture of the current high spread between oil and gas). As such if an investor is bullish on energy it would be wise to review other opportunities in the industry, including Chesapeake and the oil majors, before deciding if Forest is in fact particularly attractive.