I was asked by a comment on my blog by someone named Jason to comment on what I think of ATP Oil and Gas (ATPG - Nasdaq). I honestly don't know anything about the company other than one of my holdings, General Electric (GE), has had some dealings with them. I have never read any analyst reports nor have I read any comments by CanadianValue (a blogger was mentioned in the comment by Jason). I have read some of Canadianvalue articles but they contain little substance regarding returns on capital.
I took some time reading ATPG's 10-K and here is my quick and dirty.
1) ATPG hasn't earned a dime in profits as a corporation.
2) Their business model is feeding off the leftovers of the majors.
3) They have ran into some major financial difficulty (and the BP issues hurt them big time in GOM hasn't helped).
4) They are hugely leveraged as debt to equity is something like 5:1.
5) They borrow money at 12.75%. If that is what the bankers demand the company is basically up against the wall with a gun to their head.
6) If oil prices fall this company is toast.
7) It doesn't take long to see why short interest in the stock tops 50%.
I personally hate losing money more than I like making it. Now that makes me ultra conservative so I wouldn't touch ATPG with a ten foot pole. If oil prices fall you will lose your entire investment (even if they are hedged). I would never take such a risk.
To be fair I asked an opinion of a fellow blogger who is long and this is what he wrote me in an email.
I'll just bullet a quick rundown of all the positives and negatives for ATP now:
- Very high long-term debt with a high interest rate that gives them high fixed costs, and an even higher rate of future borrowing.
- Management is continually over promising and under delivering. The good news is they have become aware of this finally, and have begun to withold projections. If you say a well will be 7-10K barrels and it's 6.5K the market gets mad. If you say 5-7, that is a surprise; I believe the light bulb went on based on recent conference calls.
- At the mercy of Washington and future regulations. (Their drilling rig the Titan is state of the art, their management spent most of the summer in Washington teaching the politicians things about safety, and new regulations have been based on the Titans structure).
- If one of their wells turns out to be less than desired stock will sell off really quickly (98% success rate in developing their wells).
-Daily production started the year at 13.5K barrels per day and it's currently around 30K (will find out more at tmw's conference call at 11 AM).
- A couple smaller wells are expected to be brought on prior to year end.
- When they receive permits to drill their next two Telemark wells that will be a catalyst, and there will be some short covering.
- Have hedged 1/3 of next year's oil production in the low 80s. I expect/hope that they have hedged a lot more since oil has entered the mid 80s.
- They have about a 65-35 mix of oil to natural gas in their wells; natural gas prices are finally rebounding.
- Entrada: They bought this for about 200K which judging by the excitement in management's voice should be a location for future production growth sometime around 2012/2013.
- Their Octabuoy right is already monetized which will give them new production in the North Sea in 2012.
- No financial covenants on their most recent debt.
- Capital expenditures are fully funded for 2011 based on the Titan Monetization: They do not sound as if they will need to take each of the last $50 million draws, but the money is there if they are short on cash.
- I have them cash flow positive with 32K barrles/ day at $80 oil and $4 natural gas; I feel like they are there, and have the production growth to stay there and in 2012 start to pay down that debt.
The only point of Kyle's that I wouldn't agree with is the point on the finacial convenants on the debt. They actually have a number if you read the 10-K. I quote from page 48 of the 10-K.
Covenant Requirement during the
Amendment Period (4)
1. Minimum Current Ratio (1)(5) Greater than 0.8 to 1.0
2. Ratio of Net Debt to EBITDAX (2)(5) Less than 4.0 to 1.0
3. Ratio of EBITDAX to Interest Expense (5) Greater than 2.0 to 1.0
4. Ratio of PV-10 of Total Proved Developed Producing Reserves based
on future prices to Net Debt (3) Greater than 0.5 to 1.0
5. Ratio of PV-10 of Total Proved Reserves plus 50% of Pre-tax Probable
Reserves based on future prices to Net Debt Greater than 2.5 to 1.0
If you read the 10-K it also explains how they are just barely keeping these amended convenants. Secondly, guys like CanadianValue might believe the total proved reserves don't matter but they definitely do to the bankers. To be a successful investor you must think like a banker.
Now, I don't understand why so called "value investors" continually go for high risk investments like this. This one has red flags all over it. I have an investment checklist that I use and let me highlight a few on ATPG for the readers.
1) Is the business simple and understandable?
Definitely not. Now it would take significant time to breakdown what ATPG actually owns. They have sold off royalty stakes in all different areas of their business. It is definitely one big mess.
2) Does the business have a consistent operating history? NO
3) Does the business have favorable long term prospects? Not Easily Determined.
4) How much income tax was paid last year?
Now this one is interesting because oil and gas companies can shelter taxable income with drilling tax pools. If you do own an oil and gas company and they have never paid any income tax that is an immediate red flag they aren't earning any returns on capital. Now small startups can shelter income tax if capex continually creates tax pools, but you much be able to read the financial reports accordingly.
As for ATPG, I already mentioned they haven't earned a dime in profits over it's history. Enough said.
5) What is the EBIT/Enterprise value? Zero.
6) How much leverage does the company employ? Way, way too much. Personally I hate debt, both personally and in businesses I own.
Now I could go on but I don't feel it's necessary. Why do investors feel like they have to jump through so many hoops in order to justify an investment? As Warren Buffett has said, "degree of difficultly doesn't matter in investing." If you followed Buffett's policy of 20 spot punchcard for your allowable investments in your lifetime would you waste a punch on ATPG?
This investment can't be explained on the back of a napkin, doesn't earn outstanding return on capital, doesn't have any competitive advantage, and it has a terrible operating history.
I'm sorry I have to stick to my guns and toss this one to the too hard pile (and I would add not worth my time anyway). This is where I scratch my head and ask where are the true value investors?
I previously have posted nine stocks on my blog that should return 10-15% per year for the next 5 years quite easily regardless of factors like where oil price will trade in the next few years. I will add that some have moved up substantially this past week so use your own judgement.
If you feel you are a value investor and take Buffett's investment strategy seriously please comment as I am deperately interested in meeting some fellow value investor over the internet. Comment Below or send me an email.
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