Time to Sell Ultra Petroleum?

Should you sell Ultra Petroleum (NYSE: UPL  ) today?

The decision to sell a stock you've researched and followed for months or years is never easy. If you fall in love with your stock holdings, you risk becoming vulnerable to confirmation bias -- listening only to information that supports your theories, and rejecting any contradictions.

In 2004, longtime Fool Bill Mann called confirmation bias one of the most dangerous components of investing. This warning has helped my own personal investing throughout the Great Recession and the recent volatility throughout early August. In this series, I want to help you identify potential sell signs on popular stocks within our 4-million-strong Fool.com community.

Today I'm laser-focused on Ultra Petroleum, ready to evaluate its price, valuation, margins, and liquidity. Let's get started!

Don't sell on price
Over the past 12 months, Ultra Petroleum is down 7.2% versus an S&P 500 return of 9.1%. Investors in Ultra Petroleum are no doubt disappointed with their returns, but is now the time to cut and run? Not necessarily. Short-term underperformance alone is not a sell sign. The market may be missing the critical element of your Ultra Petroleum investing thesis. For historical context, let's compare Ultra Petroleum's recent price to its 52-week and five-year highs. I've also included a few other businesses in the same or related industries:

Company

Recent Price

52-Week High

5-Year High

Ultra Petroleum

$37.78

$51.20

$102.80

Continental Resources (NYSE: CLR  )

$56.76

$73.48

$83.80

Range Resources (NYSE: RRC  )

$60.04

$67.33

$76.80

Petrohawk Energy (NYSE: HK  )

$38.47

$38.51

$54.50

Source: Capital IQ, a division of Standard & Poor's.

As you can see, Ultra Petroleum is down from its 52-week high. If you bought near the peak, now's the time to think back to why you bought it in the first place. If your reasons still hold true, you shouldn't sell based on this information alone.

Potential sell signs
First, let's look at the gross margins trend, which represents the amount of profit a company makes for each $1 in sales, after deducting all costs directly related to that sale. A deteriorating gross margin over time can indicate that competition has forced the company to lower prices, that it can't control costs, or that its whole industry's facing tough times. Here is Ultra Petroleum's gross margin over the past five years:

Source: Capital IQ, a division of Standard & Poor's.

Ultra Petroleum is clearly having issues maintaining its gross margin, which tends to dictate a company's overall profitability. Ultra Petroleum investors need to keep an eye on this troubling trend over the coming quarters.

Next, let's explore what other investors think about Ultra Petroleum. We love the contrarian view here at Fool.com, but we don't mind cheating off our neighbors every once in a while. For this, we'll examine two metrics: Motley Fool CAPS ratings and short interest. The former tells us how Fool.com's 180,000-strong community of individual analysts rate the stock. The latter shows what proportion of investors are betting that the stock will fall. I'm including other peer companies once again for context.

Company

CAPS Rating (out of 5)

Short Interest (% of Float)

Ultra Petroleum

*****

7.7

Continental Resources

****

9.5

Range Resources

***

8.3

Petrohawk Energy

****

4.6

Source: Capital IQ, a division of Standard & Poor's.

The Fool community is rather bullish on Ultra Petroleum. We typically like to see our stocks rated at four or five stars. Anything below that is a less-than-bullish indicator. I highly recommend you visit Ultra Petroleum's stock pitch page to see the verbatim reasons behind the ratings.

Here, short interest is at a high 7.7%. This typically indicates that large institutional investors are betting against the stock.

Now, let's study Ultra Petroleum's debt situation, with a little help from the debt-to-equity ratio. This metric tells us how much debt the company's taken on, relative to its overall capital structure.

Source: Capital IQ, a division of Standard & Poor's.

Ultra Petroleum has been taking on some additional debt over the past five years. Even with increasing total equity over the same time period, debt-to-equity has increased. Based on the trend alone, that's a bad sign. I consider a debt-to-equity ratio below 50% to be healthy, though it varies by industry.  Ultra Petroleum is currently above this level, at 135.9%.

The last metric I like to look at is the current ratio, which lets investors judge a company's short-term liquidity. If Ultra Petroleum had to convert its current assets to cash in one year, how many times over could the company cover its current liabilities? As of the last filing, Ultra Petroleum has a current ratio of 0.79. This is a bad sign for Ultra Petroleum. The company's current liabilities are greater than its current assets, which means it could have liquidity issues in the short term.

Finally, it's highly beneficial to determine whether Ultra Petroleum belongs in your portfolio -- and to know how many similar businesses already occupy your stable of investments. If you haven't already, be sure to put your tickers into Fool.com's free portfolio tracker, My Watchlist. You can get started right away by clicking here to add Ultra Petroleum.

The final recap

Ultra Petroleum has failed four of the quick tests that would make it a sell. Does it mean you should sell your Ultra Petroleum shares today solely because of this? Not necessarily, but keep your eye on these trends over the coming quarters.

In order to do that, I strongly recommend clicking here to add Ultra Petroleum to My Watchlist  to help you keep track of all of our ongoing coverage of the company.

Jeremy Phillips does not own shares of the companies mentioned. The Motley Fool owns shares of Range Resources and Ultra Petroleum. Motley Fool newsletter services have recommended buying shares of Range Resources. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


Read/Post Comments (2) | Recommend This Article (4)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On August 31, 2011, at 11:44 AM, MarkGillCPA wrote:

    Wow! What a completely worthless analysis. This is not an large cap industrial. This is not how you analyze oil and gas e&p firms. Almost all mid cap e&p firms like UPL have negative free cash flow because they are drilling as fast as they can. That means they are taking on more debt to do so. The only thing a gross margin analysis will tell you is whether natural gas prices are up or down. UPL is one of the lowest cost producers of nat gas in north america. You have to look at growth in proved reserves, NAV of those proved reserves, etc.

  • Report this Comment On September 01, 2011, at 8:47 PM, showmethefacts wrote:

    This kind of checklist analysis is not helpful with respect to Ultra. You are urging people to "sell low." The only reason to sell now -- which is a multi-year bottom -- is if you think natural gas will remain in a state of permanent oversupply and the commodity price will never improve.

    This company has the lowest cost of production in the US. It makes -- prints -- money even with natural gas priced at the current low-low price of $4. Ultra has consistently grown its reserves, year after year. It has acquired valuable new drilling sites... and over 90% of its sites are still undeveloped. Management is conservative with how it books reserves, resulting in a pattern of under-promising and over-delivering. Only commodity price has held it back.

    The only problem with this company is one the article didn't mention: management's financial incentives are not sufficiently aligned with the shareholders. Instead, the CEO gets big bonuses when he produces more gas, grows reserves and improves future prospects. All good things to do -- but it would be better if improving the shareholders' value was also a factor. We are, after all, his boss... So the CEO has made truly outrageous money while shareholders have watched the stock price decline. If the institutional investors who own a big majority of the shares would wake up and demand that management's financial incentives get more in line with the shareholders, you'd see some better stock price action, even with gas in a state of glut.

    But even if that never occurs, the low-cost structure of Ultra means that when the commodity price finally starts to go up again (an inevitable event for the clean, domestically produced fuel that Ultra produces), Ultra;s stock price will shoot up faster than peers who ALL have higher costs of production. Ultra's stock price hit bottom. The company is growing reserves; it's well-managed. Smart money will buy now in the low 30s and see a double or more when natural gas prices improve.

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