Warren Buffett's No. 1 investing rule is to never lose money. While that's easier said than done, we can get closer to achieving that goal by helping you avoid stocks that have little chance of paying off. Here are three companies that are more likely to take your money than create more of it for you.
DryShips Inc: The dangerous seas of dilution
DryShips (DRYS) spent the bulk of last year shoring up its balance sheet after sinking shipping rates overwhelmed its finances. However, those efforts paid off, since the dry bulk shipper entered 2017 back on solid ground. In fact, the company even had the financial flexibility to spend money on rebuilding its decimated fleet. That said, instead of undertaking a methodical rebuild, DryShips went on a buying binge, spending $765.5 million to buy 17 vessels since the start of the year. The problem with this is that the company issued a boatload of new stock to finance these purchases, unleashing a flood of shares into the market. Through the end of the first quarter, the company had sold a whopping $570 million of new shares, which is a breathtaking amount of dilution considering the company's minuscule market cap. In fact, over just the past few weeks the company's outstanding share count has spiked 370%. This unrelenting dilution has crushed the company's stock price, which has fallen nearly 100% since the start of the year.
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Despite the weight of this dilution, DryShips is showing no signs of slowing down. The company appears poised to exhaust its current share sale agreement with a private investor, which could see it sell another $82.9 million in shares over the next two years. Those sales will likely cause the value of the stock to continue plummeting, resulting in more losses for investors.
California Resources Corp: There's leverage, and then there's this
Like many oil companies, California-focused oil producer California Resources (CRC) entered the oil market downturn with too much debt. While the company made several moves to reduce leverage last year, it still has a nearly insurmountable pile of debt on its balance sheet. The interest payments on its debt alone will consume almost half of the company's expected cash flow this year, leaving it with barely enough capital to finance the new wells it needs to drill just to maintain its current production rate.
To put the company's leverage into perspective, it entered the year with a net debt-to-EBITDA ratio of 8.5, which it estimated would fall below 8 if oil averaged $55 per barrel this year, though given where crude is these days, that's a long shot. Contrast that level with most other U.S. independents, which have an average leverage ratio of just 2 this year. That's a level California Resources wouldn't see until 2020, and that's only with the return of $75 oil. Given its leverage situation, at best California Resources will tread water for the next few years, while another deep and lengthy decline in oil prices could sink the company into bankruptcy.
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Unit Corporation: The wrong kind of diversification
Unit Corporation (UNT) is a diversified energy company in that it not only operates an oil and gas exploration and production business, but also a contract drilling division and a midstream segment that gathers and processes natural gas. Typically, diversification would be a good thing because it would help smooth out earnings since one business should thrive when another is not. However, in Unit Corporation's case, its diversification only leverages its direct exposure to volatile oil and gas prices. That's because slumping commodity prices not only negatively impact the profitability of its E&P business, but also the utilization of rigs in its contract drilling business, as well as earnings at its midstream operations since more than a third of its margin has direct commodity price exposure.
That outsized exposure to commodity prices has been apparent in its results over the past few years. Adjusted EBITDA, for example, plunged from a peak of $787 million in 2014 to just $252 million last year after earnings in all three of its segments contracted. That earnings plunge put pressure on the company's junk-rated balance sheet, forcing it to cut spending on new oil and gas wells. That has resulted in the Unit underinvesting in new wells, causing production to decline 8% last quarter. While the company expects to start reversing its decline later this year, that's partially due to a recent acquisition. Meanwhile, if commodity prices take another dive, Unit's stock will likely plunge given its financial situation and leveraged exposure to those prices.
Investor takeaway
These three companies have two things in common. First, each has outsized exposure to earnings volatility due to their reliance on market prices to support cash flow. On top of that, they each had stretched balance sheets, which became a problem when prices plunged. While all three have taken steps to address that situation, they still have outsized exposure to volatile pricing and less-than-ideal finances. Because of that, these three stocks could cause investors to lose a boatload of money -- especially if market conditions deteriorate again.
