For more than a year now, we have seen the stock prices for oil and gas companies drop precipitously. This has created a lot of different situations. There are companies that have been severely strained financially and could take years to recover, and there are plenty of solid companies that could be bought for huge discounts. At the same time, though, there are some companies that, despite the declines in share prices and prospects, still look to be not worth an investment today.
We asked three of our energy contributors to highlight a company in the energy space that still looks overvalued in the midst of this down market. Here's what they had to say.
A lot of investors seem to think that eventually oil prices will return to $100 per barrel and shale drilling will resume at record levels, and everything will be dandy for companies such as Whiting Petroleum (NYSE:WLL). I don't think that's the case, and Whiting, in particular, may have a long road ahead.
In the company's second-quarter report, which revealed a loss of $0.73 per share, management touted $300 million in asset sales that would help fund $2.15 billion in capital spending during 2015. The problem is, Whiting's operating cash flow is falling, debt is rising, interest payments are climbing, and the company is losing money.
Today's shale oil companies are banking on the idea that oil prices will rise in the near future, something that I don't think will happen. Meanwhile, production rates are falling because shale depletes faster than traditional wells and drillers aren't able to mask that depletion with ever more drilling. The shale industry is being crushed, and with $5.2 billion of debt at the end of last quarter and little hope of making money in the near future, I think Whiting Petroleum has further to fall.
One oil company that's been having a great year is Callon Petroleum (NYSE:CPE), which is up a stunning 53% in 2015 because of management's aggressive drilling schedule that is expected to increase production by 70% in 2015 and 20% in 2016.
Wall Street has been impressed with Callon's ability to cut expenses 37% over the past year, and combined with its strong hedging portfolio, it's been able to maintain impressive margins despite a greater than 50% collapse in oil prices. However, in my opinion, the main problem with Callon's strategy is that it's an incredibly risky bet on a quick oil price recovery in 2016 and beyond.
For example, over just the past three quarters -- when almost all other oil companies have been trying to pay down debt -- Callon has almost quadrupled its long-term debt to $375 million to pay for its drilling efforts. In fact, Callon just announced that its borrowing base was increased 20% to $300 million, which will allow it to potentially borrow an additional $225 million.
Callon also faces the prospect that the volume of oil it has hedged will decrease nearly 60% between Q4 2015 and Q4 2016. Its growing oil production will combine with falling hedges to decrease the percentage of its hedged production for Q4 2016 to 30%, compared with 74% for Q3 2015. What's more, the average hedged price per barrel will decline from $67 to $58. If oil prices rebound above $60 by then, it won't matter, and Callon will see probably see its profits, and share price, soar yet further.
But if oil prices stagnate or fall further, then Callon will be stuck with a relatively enormous mountain of new debt and declining cash flows. Should its creditors end up cutting its borrowing base below its existing debt levels, it could be forced to recapitalize.
The bottom line is that investors in Callon need to know that this stock is a highly speculative short-term bet on oil prices, one that could end disastrously.
I'm a little conflicted when it comes to Cheniere Energy (NYSEMKT:LNG). When it comes to the business fundamentals, Cheniere looks to be headed in the right direction. Its two LNG export terminals are supported by a strong portfolio of contractual agreements, with customers to protect it from commodity prices for close to 20 years. So once those facilities are up and running, they will have a steady flow of cash to work from.
The reason I'm conflicted about Cheniere is that the company's current stock price just doesn't seem to line up with what you would consider a reasonable return. The company says it anticipates that the combination of its contractual sales and its spot market LNG sales will generate $2.3 billion annually. Today, the company has a total enterprise value of $28.9 billion. That means that the company is trading at a total enterprise value to its projected 2021 EBITDA of 12.5. Even a company generating that much EBITDA today would be considered a high-priced stock. So to think we need to wait six years until it grows into that frothy valuation seems a bit absurd.
Cheniere is one of those classic examples where, as investors, we need to remember that we are buying both a business and a stock. Sure, the company's foundation looks relatively solid, but the fact that you need to pay such a high price for it today makes me think that there will be better opportunities to invest in Cheniere down the road.
Adam Galas has no position in any stocks mentioned. Travis Hoium has no position in any stocks mentioned. Tyler Crowe has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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.