After a tumultuous period for energy investors it is beginning to look as if some degree of calm and logic is returning. WTI crude oil has twice bounced off of the mid-$40s level, suggesting that a real bottom has, at least for now, been found. The obvious response of investors is to start casting around for value. Even now that the panic is over there is still plenty to be had. That doesn’t mean, though, that everything which has lost ground is worth buying.
As I have mentioned several times in the last few weeks, buying large, multinational companies, either diversified firms such as Exxon (XOM) or Chevron (CVX) or oilfield service companies like Anadarko (APC) or Halliburton (HAL), is almost guaranteed to pay off in the long term. These are firms that have vast experience of surviving through the swings of a highly volatile commodity market. A period of reduced revenue will hurt, but it won’t be fatal. There are even some smaller, riskier plays worth considering, usually when hedging policy has bought those smaller companies time. There are two areas where investors should exercise extreme caution, though.
Companies that borrowed heavily to participate in the U.S. oil boom when crude looked set above $100/barrel face an obvious debt servicing problem with oil at about half of that. Many are now operating at a loss, but even those that are making money are facing an unattractive cash flow situation. Not only are interest payments that looked reasonable 9 months ago now a serious hurdle, but in many cases, wary lenders are likely to cut revolving credit facilities, forcing repayment out of dwindling cash reserves.
Another area of potential trouble is when a stock’s value is derived largely from dividend payments or distributions, as is the case with Master Limited Partnerships (MLPs). In most of those cases, all bets are off when it comes to future distributions. That is why published yields for these companies should be viewed with a great deal of skepticism.
When a company falls into both categories, it is in real trouble, and that is the case with LRR Energy (LRE).
As you can see, LRE has followed the pattern of most energy stocks, a sharp sustained decline starting in August of last year, followed by a slight recovery this year as oil appears to have found a base. In most cases, that tepid bounce back means that there is still value to be found, even if the absolute bottom has been missed. In a…