Seeing the Forest for the Trees

 | Sep 18, 2012 | 11:30 AM EDT
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Forest Oil (FST), an oil-and-gas exploration-and-production company primarily positioned in Texas, disappointed the market in July when it declared that it would cut its capital expenditures. The move would slow the development of its shale acreage, though it was meant to improve its finances. At this point, the stock is down 37% year to date -- partly due to the announcement and partly due to some large earnings misses the company announced earlier this year.

However, billionaire Steve Cohen and his team at SAC Capital Advisors have concluded that the stock has been beaten down too much by the Street. The large hedge fund recently disclosed ownership of 6.4 million shares, which comes out to 5.4% of the total shares outstanding. The stock is currently priced at $9 per share, having rebounded from its lows last summer of around $6. But it appears SAC has only recently purchased enough shares to put them the firm over the 5% mark.

According to Insider Monkey's database of 13F SEC filings, SAC still might not have the largest position in the stock among hedge funds. Jeffrey Altman's Owl Creek Capital Management owned 10.2 million shares as of the end of June, though this stake was down 10% from the end of the previous quarter, and Owl Creek may have continued to sell shares.

Forest Oil's revenue dropped 27% in the second quarter vs. the same period last year, so it is understandable that the company might need to trim spending going forward. According to the relevant 10-Q, volumes of natural gas and natural gas liquids were about even from a year earlier, with oil production rising. What took down sales was a drop in pricing, including natural gas prices falling by more than half. Forest Oil reported a large net loss, which was primarily due to an asset writedown and large income-tax payments. Cash flow from operations dropped as well -- by 9% year over year for the first half -- but the decline here was less severe than that for earnings.

Wall Street analysts expect Forest Oil to perform better next year than it did in 2012, likely given expectations for a rebound in natural gas prices. Analysts expect 2013 earnings of $0.49 per share, which represents a forward price-to-earnings multiple of 18x. Investors should also note that the most recent data show considerable short interest in Forest Oil: The short ratio comes in at 6.2, with 23% of the float held short. While SAC seems to be optimistic about the stock's prospects, other hedge funds and short sellers disagree. The company also carries substantial leverage, with market capitalization of $1 billion but an enterprise value of $3 billion.

There are a number of shale-focused exploration-and-production companies that make for good peers for Forest Oil Corporation. Three of these -- ones with similar levels of market cap -- are EXCO Resources (XCO), Gulfport Energy (GPOR) and Carrizo Oil & Gas (CRZO). EXCO seems to be in a similar boat to Forest Oil: Its revenue and market cap have declined over the last year, and it actually trades at a forward P/E of 30x. From a value point of view, Carrizo and Gulfport seem to be more appealing, with the stocks respectively trading at 18x and 16x trailing earnings.

Sell-side analysts anticipate little change in Gulfport's earnings per share next year, and expect strong growth from Carrizo. For the P/E ratio relative to growth, as well, both of these companies sport a below-0.7 figure for the past five years.

A larger peer, and one that's been in the news this year as its shares have plunged, is Chesapeake Energy (CHK). The company received an investment from activist investor Carl Icahn, but is still working to raise capital by selling off some of its assets. Due to the possibility that the company will be forced to sell at fire-sale prices, the stock trades at only 16x forward earnings estimates, even though its market cap, at $13 billion, makes it a considerably larger company in those terms. Of these names, Carrizo and Gulfport seem to be the safest ways to invest in shale from a value perspective.

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volatility is quite low here, and we could see some downsides here in the short term. ...



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