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  1. Home
  2. / Investing
  3. / Energy

Here's Why Energy Shares Have Bottomed

And it's not the commodity prices themselves that drive my belief.
By JIM COLLINS
Jan 24, 2015 | 10:00 AM EST
Stocks quotes in this article: FANG, MHR, MHR-E, MHR-D, MHR-C

This is the end. This is it. I am calling a bottom in energy securities. I am not going to try and pinpoint the actual bottom in WTI crude oil prices, but I do believe we are close at $45/bbl. I also believe natural gas prices will not remain below $3/Mcf through the winter.

But it's not the commodity prices themselves that drive my belief that we have found a bottom. It's the technical patterns of certain stocks (common and preferred) that show me that, in terms of the stock market, demand has overtaken supply.

Anything and everything energy-related has been so heavily shorted in the last few months that any positive newsflow can lead to massive reversals in the seemingly one-sided long, lame walk down, down, down the stock charts.

The key is liquidity, and the exploration & production (E&P) companies' perceived lack thereof. Many of these names, especially the smaller independents, are being valued as if bankruptcy were a viable option. Presumably, that would reflect a prolonged slump in hydrocarbon prices, but when I see energy preferred stocks trading at 30 cents on the dollar, I wonder if some short-sellers don't believe that the casualties are going to come next week, not next year.

There will be no casualties in the near-term and, frankly, I don't believe there will be many in the long-term, either. Trading strategies can be thought of on a macro basis, but liquidity and solvency must be measured on a micro basis. Individual companies have individual balance sheets, and to think that there aren't myriad conversations going on between E&P CFOs and their bankers -- both commercial and investment -- is ludicrous.

Also, in the last month, my industry sources have told me hundreds of stories of E&P CFOs calling each other. Anyone that doesn't believe that this huge, largely unforeseen downturn won't lead to a wave of E&P M&A is absolutely delusional. There will be asset sales and corporate takeovers galore in the next six months among E&Ps. It's coming.

And that's where the shorts get fried. When a company that is thought to be cash-strapped gets an equity injection. Bam! When a company that was left for dead is acquired by a stronger company for a hefty premium to the current share price. Pow! Or when a company is able to monetize a non-core asset and bolster liquidity through a sale to competitor (or private equity -- those firms haven't gone anywhere.) Kaboom!

Two signs of a bottom this week:

Diamondback Energy (FANG) announced an equity offering Tuesday and upsized the deal Wednesday with a 17% increase in shares offered vs. the initial announcement. So Diamondback raised net proceeds of $106 million for the purpose of paying down the company's revolving credit facility. The market's reaction to the extra shares hitting the market was to spur FANG shares to close 11% higher than they opened on the day of the offering. The market's realization that FANG has the ability to raise money far outstripped the impact of having more shares traded.

Magnum Hunter (MHR) common shares were destroyed this week on the heels of no fewer than three brokerage downgrades and Magnum's Preferred Series E (MHR-E) reached $8.80 Thursday, or 35 cents on the dollar, implying a 23% yield. Magnum CEO Gary Evans came out swinging Friday in a hastily arranged conference call. Evans noted that the company "doesn't need to spend any" capital in 2015 (slight hyperbole but he did throw out a figure of $20 million) and was able to sell pieces of the Eureka Hunter pipeline "any time we want to" with willing buyers "lined up outside my door." He believes the company's 48% stake in Eureka Hunter is worth "$500 million-700 million" and further noted that the company is seeking partners to joint venture some of its Ohio acreage, which would result in proceeds to Magnum of "$350 million-500 million."

Did these comments assuage the market's liquidity concerns? MHR shares rose as much as 35% in Friday's trading and the Series E preferreds, had, at their Friday peak of $16.80, nearly doubled from Thursday's lows, an almost incomprehensible trading pattern for a security that is essentially a bond.

So cash is king for E&Ps. Indications that the market might be overestimating the cash crunch at a given company will continue to provide incredibly lucrative contrarian trading opportunities. 

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At the time of publication, Collins' firm owned FANG, MHR-C, MHR-D and MHR-E.

TAGS: Investing | U.S. Equity | Energy | Stocks

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