Tell me if this sounds familiar, an investment thesis just isn't working out and a stock we like just keeps spiraling down as bad news continues to pile up. Eventually, the bitter taste of defeat is more than we can handle so we throw up our hands and give up on the stock.
This happens to analysts too who go from really liking a stock to seeing the thesis upended and forcing them to eat some crow when they're forced to backtrack and give up on a stock. We saw it recently happen to the analyst covering BreitBurn Energy Partners L.P. (OTC:BBEPQ) for Wunderlich Securities. The firm's MLP analyst cut BreitBurn to a sell this week and gave it a mere $4 price target after having initially rated the stock a buy. The new price target is almost 27% lower than the current unit price and comes at a time when the company recently raised a billion dollars to fix the balance sheet woes that were causing most of the downward pressure on units. It makes me wonder if the downgrade and new price target might be more of throwing in the towel than anything else.
Off to a promising start
Back in October of 2013 Wunderlich initiated coverage on BreitBurn Energy Partners making it a top new name to buy. The company was given a buy rating and a $22 price target at a time when the company's units were trading around $19. At the time Wunderlich's analyst liked the fact that the company, which got half its production from natural gas, planned to focus future acquisitions on oil so that by the end of 2014 60% of its output would be oil. Given its history as being one of the better acquirers, as its deals were among the most accretive to its distribution in the sector, the analyst thought the company would deliver above-average growth for its already robust 10% yielding distribution.
The analyst was actually spot on with the analysis as BreitBurn did exactly what it said it would do as it completed over $4 billion in deals in the past two years and became the largest oil-weighted upstream MLP after it merged with QR Energy late last year. Those deals not only increased BreitBurn's liquids output to 66% of production but also fueled 8% distribution growth from when Wunderlich rated it a buy to its peak rate just after closing the QR Energy deal.
Fall from grace
Unfortunately, the price of oil has upended this oil-focused thesis as it's down more than 50% from when Wunderlich made its initial bullish call on BreitBurn. This has had a dramatic impact on the company's unit price, which is down more than 70% from when Wunderlich said buy. Ouch!
Obviously, the 50% cut in the oil price has an impact on the company's oil fueled cash flows, which is a driving force behind the sell-off. The other major driving force fueling BreitBurn's sell-off was the fact that it used a lot of debt to go on its oil-fueled acquisition spree. In Wunderlich's sell rating the analyst noted that the company's leverage ratio, even after the recent cash infusion, would stand at 4.8 times, which is well above the industry average of 4.1 times. That high leverage ratio could weaken BreitBurn's balance sheet even further if oil takes another tumble and send units on another leg down.
That excess leverage, at a time when the oil market might not have fully bottomed, is really the driving force behind the analyst's sell call and meager $4 price target. In a sense the analyst has simply soured on the company as the oil focused thesis has been upended by weak oil prices. That being said, if the price of oil has indeed bottomed and is poised to rally as some think, then the $4 target will likely be way too low as units will likely rebound along with oil prices.