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Oil Porfolio Allocation

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In my short investing career (8 years approx.) I have only been burned twice - ATPG and SD.  ATPG was a very small allocation and I got out with a enjoyable 30ish% loss but being the highly intellectual guy I am, I decided to take a 5-6% position in Sandridge and I am down an even more enjoyable 95%.  I have decided,  O&G is outside my circle of competence and I will avoid this industry all together.  It has been a learning experience and a mistake I will not make again.

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I have been able to find a silly amount of bargains in the distressed energy space. Nothing producer wise (aside from a couple bonds) but tons of related stuff. I'm surprised to not see a lot of them mentioned on the board but I think most of the people here were burned before. 

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Large secular trends move in waves.  I'm not a technician or anything like that, but these moves have a lot of psychological cycles to them. 


It starts with a cyclical/secular top in the price of the commodity.  Value investors will search for the "bargains" which tend to be lower multiple, higher cost producers.  Investors don't think the commodity will fall under those historically high prices which would cause those stocks to be unprofitable for extended periods of time.  For example the investors who were burned in SD.


Then you get the tourist like value investors who never really invested in the energy space before.  They don't realize how nasty commodities can trade and for how long.  They cause a dead cat bounce and set up for the next big leg down.


Now the majority of energy related names are nowhere close to market estimates of profitability for the next few years.  Investors ignore that, calling it a cyclical thing or the old "oil always comes back" or "low prices are a cure for low prices" etc etc.  Now starts death by a thousand cuts as a lot of investors start averaging down on the trade. 


Capital markets which were widely available at the top are now shutting out even the mid-tier names.  Higher risk premiums on the debt will cause higher risk premiums on the equity and you have another leg lower.


Now you have high profile blow ups, like we recently had with a few energy and junk bond managers.  Stuff starts getting sold at any price because it's clear there are trapped buyers who need to sell. 


Usually it takes a while to play out but this has rolled out really fast.  I mentioned a thread on SunCoke, no one seemed interested, but it was stupid cheap at 3x FCF.  There are a lot of similar things out there but I'm debating whether I want to disclose them anymore.  Then again maybe it doesn't matter, investors here seem much more willing to take the risk to buy CHK, PWE equity instead.

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Picasso - thoughtful post.  I suspect you are right in that until we see major shakeups, the pain hasn't yet fully arrived.  Stepwise deterioration is certainly a potential scenario.  SunCoke seems to be worth a bit more of a dive to get some understanding.  Had a quick look...

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Crestwood (CEQP) also looks interesting.  Raging Capital just put out a detailed piece on it as well.  That's a bit more liquid.


Range Resources has some bonds yielding over 10% on one of the best gas assets out there.  They would be the last player left standing after a bunch of other producers go belly up.  I would expect some change on control redemption on those which can get you a 50% return in a year or two. 


Lots of stuff like that out there. 

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I know I am not an expert in the energy industry.  I find it complex. 

The technology of energy can really change things.  Fracking is making nat gas super cheap - probably for the long term and will help keep a lid on oil.  I think productivity, new technology in fracking and excess supply of labor and equipment will bring costs down even more.  I have no idea of the bottom. 

I also find a lot of the "investors' and CEO's to be optimistic gamblers.  There is a lot of risk in the space so make sure you understand what you have invested in. 


Also - generally the bigger the boom, the bigger the bust. 



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Crestwood is interesting - a yield in the 30+% is insane.  A basket of stocks like that makes me think of Buffett and his Korea bet - PE's of 2-3......it's just cheap.  Some have to work out.  Looks like this particular take or pay arrangement in a company without IDR's (incentive distribution rights) to the general partner holds some promise.  I've tended to be a skeptic on MLP's  - hight payouts always worry me from the perspective of needing really good management to be responsible regarding the payout and business risk.  All you have to do is look at PWE's history to see the bad side of payouts - fund it with debt, drips, and capital raises/dilution.


From the standpoint of will the business continue - will need to look into who their pipes service.  Obviously the storage and arbitrage business won't go away.  That's likely where the margin of safety would come from. 


Nice find Picasso.  I'll keep digging.  It's this type of thing that makes me think shooting fish in a barrel and material portfolio impact.......

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I own what now amounts to somewhat of a basket of commodities or commodity related companies:

-A gold/silver/antimony producer

-An O&G service business

-A Natgas/coal producer

-A canola farm financing company

-A potash project

-An appliance recycler (dependant on scrap metal prices)

-A Mongolian RE company (indirectly dependant on Mongolian mining)


I have no illusion that everything will work out but those that do should more than make up for those that don't. No special detailed analysis like the WS experts on this board, I just look at the big picture and the price I pay, if I feel comfortable with the risks in place versus potential rewards, I spare a few $ for the cause


My largest commodity position (and overall) is the O&G service business so that's where my oil allocation mostly is at. 20% of portfolio, a little too heavy for my liking but I had to average down because it got nonsensically cheap and is relatively safe (a growing, well managed business trading at 1/3 of liquidation value lol)



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I've been sucked into commodity related companies too.


- big 20 % position in Macro Enterprises. O&G service business, very very cheap

- medium sized position in Altius Minerals

- small position in Consol Energy, coattailing Einhorn

- small position in Suncoke Energy, coattailing Picasso, thanks for the idea =)

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I think valuing these on dividends (I mentioned this in the KMI thread) is wrong.  I prefer looking at FCF to the equity holders and EV/EBITDA.  I'm not too worried about dividend cuts if they're doing the right things with the capital.


SXC suspended their dividend yield of over 20% and the stock went up substantially.  But that was because the complex traded for 5x EBITDA and the majority of the value of SXC came from SXCP.  So supporting delevering efforts at SXCP will retain and grow the value of SXC as well.  In that case a dividend cut is actually a positive.  A dividend cut at KMI is different because the cash basically goes into a black hole of further capex and debt repurchases at par when they come due.  It also traded for 10x EV/EBITDA and it will take a long time to get any cash out of the business.


With the excess cash created now that the dividend was cut, SXCP is buying up their own debt at $60.  They spent around $33 million this quarter to retire $43 million of debt.  The longer those bonds keep trading in those ranges, the more debt they can repurchase, get further away from a covenant breach in case they get some bad news from a customer next year (they are at 4x now versus covenants of 4.5x), and if we're still valuing this on EV/EBITDA then that cash is still accruing to equity holders.  SXC/SXCP doesn't have a lot of capex so you're getting some very high probability returns with the debt repurchases. 


CEQP was also trading around 3x FCF.  Let them cut the dividend and repurchase stock or something, it doesn't matter that much.  In the case of CEQP, their bonds were trading around 10% yields and so I felt a lot more comfortable owning the equity.  That said there are a few customers I don't like but it didn't deserve 3x FCF. 

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But on the topics of dividends, management stated that SXCP will keep paying out distributions as long as customers aren't defaulting on them.  At a 30%+ yield currently it is covered around 1.4x.  I think you'll see that yield for a while but you never know.  SXC has made it clear they plan to support SXCP and they generate enough cash to do so.


AKS could put in a 2-year notice in 2016 but around 80% of their blast furnace coke comes from SunCoke.  It doesn't make a lot of sense to put those furnaces in danger for imported coke which isn't price competitive for the risk involved.  They also have some small recently purchased capacity with Dearborn, but not enough to replace SunCoke.  The steel industry is also a relationship business and I can't see AKS just throwing their critical supplier under the bus.  Usually there is some volume + extra contract duration in negotiation but AKS isn't upping their capacity for that to make sense.


The Convent terminal also has some risks, but there are also take-or-pay contracts with the rail connected to that terminal.  It's the only terminal in that area with direct rail access and I don't know where Murray/Foresight would be looking to sell their coal if not into the export market. 


I think SXCP is still really attractively priced here and might buy more but it's already a big position and I'm moving into different energy related bonds.

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