6 Energy Stocks in the Short-Sellers' Sights

I was recently perusing a list of the most-shorted stocks in the Russell 1000 (an index of approximately 1,000 of the largest U.S. equities). Being an energy nut, the following names jumped out at me:

Source: Bespoke Investment Group.

This is an interesting mix of companies, as some are beaten down, while others are flying high. Let's start with a look at the laggards.

Taking a dim view of solar
SunPower has been dogged by concerns about foreign competition from low-cost Chinese rivals, and the former high flyer is now trading barely above its tangible book value of $10.47. That's exactly where analyst Mark Bachman said the firm should trade back in April, when SunPower traded hands at around $18. The short case has been borne out, but I don't see why bearish investors would be pressing their bets at this point.

(It was once the case that SunPower "A" shares traded at a big premium to the "B" shares, which created a long-short opportunity to bet on a collapse of the spread between share classes, but that's over with, so the continuing short interest must be an expression of negative sentiment toward the company itself.)

As we saw in the case of Energy Conversion Devices (Nasdaq: ENER), it doesn't take too much good news to set off fireworks in the face of low expectations and heavy short-selling. It may well be that there are more financial fudges remaining to be uncovered, but this looks like a risky short to me.

All washed up?
Diamond Offshore is an offshore drilling contractor that has really lost favor with investors this year, having shed about as much market value as Transocean. This, despite having no involvement in the Macondo disaster. Diamond looks pretty cheap (as do most peers), but the firm does have one of the oldest deepwater fleets around. I think there's a valid concern out there that in the case of a continued difficult market, Diamond will be hit disproportionately hard as its rigs lose work to more capable competitors. I forecasted a challenging 2011 even before the Gulf spill, so there may be more choppy waters in the near term.

Digging in the wrong sandbox
Our final bedraggled short target is Comstock, a natural-gas-focused E&P. Three years ago, the company sported a market cap of $1.3 billion, proved reserves of 851 billion cubic feet equivalent of natural gas, and daily production of 236 million cubic feet equivalent. Today, those numbers are $990 million, 726 Bcfe, and 219 million per day. The company does not appear to have much to show for the past few years of heavy capital investment.

Long-term disappointments aside, the more immediate concern among investors is likely Comstock's exposure to natural gas, at 94% of reserves. Specifically, Comstock is highly exposed to the Haynesville shale, where the numbers haven't been adding up for me. The shorts have figured this out as well. Comstock is a cut above hypester Goodrich Petroleum (NYSE: GDP) and a certain Cotton Valley competitor that will remain nameless, and the firm's liquidity position is solid, with an undrawn $500 million line of credit. It no longer looks like a compelling short, but there are better buys in natural gas.

My overall take on this trio of despised energy stocks is that short-sellers have had good reasons to ride these shares down to date. That said, I don't see a lot of further gains to be had on the short side. Now how about the remaining stocks?

Let's break a deal
The Mariner Energy short may be a wager that the firm's pending merger with Apache could be called off following the recent explosion of a Mariner platform. That seems unlikely, but I suppose the risk/reward here is favorable, since it would take a lot to sharply move the shares of Apache upward (which would drive up the shares of Mariner via merger arbitrage, and scorch the shorts). It's not the worst bet I've ever seen.

I'm guessing that First Solar and Core Laboratories are short targets largely based on valuation. The former has long had its share of detractors -- including yours truly, on occasion. It's usually a bad idea to short based on rich valuation alone, however, when a company is actually performing. Core Labs, in particular, looks like an insane company to short.

In February, I told you not to buy this stock if you hate free cash flow. For those who don't hate free cash flow, and bought the stock, you've done well. This company is highly profitable and takes care of its shareholders. Shorts should probably pack up and move on to more deserving targets.