The last month or two have seen energy stocks, and oil and gas exploration and production (E&P) stocks in particular, become the victims of a “perfect storm.” Oil prices, on which the value of their assets is based, have been steadily falling. The stock market in general has been under pressure as traders anticipate the end of Quantitative Easing by the Federal Reserve, which also raises the prospect of higher interest rates. That is bad news for E&P companies that are generally quite highly leveraged due to the high upfront costs of acquiring land and then drilling for oil and gas. With their assets losing value, their stock being dragged down by general market weakness and the prospect of higher borrowing cost on the horizon it is little wonder that most have fallen precipitously.
When faced with a falling market such as this, however, investors would do well to heed the words of the “Sage of Omaha”, Warren Buffett. He once famously said that we should be “…greedy when others are fearful…” and on a Thursday morning appearance on CNBC’s Squawk Box he showed what that means. Buffett revealed that his Berkshire Hathaway (BRKA; BRKB) had been buyers during the big drop on Wednesday. When asked if he was worried that the market would continue to fall he responded that the opposite was true. He hoped it would fall further so that stocks would be even cheaper next week.
Of course, not all of us have the capital, let alone the ability, to take that attitude all of the time, but the fact remains that corrections such as we are currently enduring represent opportunity more often than not. When assessing where the best opportunities lie it is best to look for companies whose stock is being dragged down with the trend even though they have seen decent results. One example would be Cimarex Energy (XEC).
The 1 year chart for Cimarex certainly doesn’t look pretty on the right hand side. The stock has lost around 20 percent after hitting an all time high of $150.71 on July 24th of this year, which is even worse than the energy sector as a whole. The S&P Energy ETF (XLE) has dropped around 13 percent in that time. The actual news and results from the company, though, don’t appear to warrant that.
By the most basic measures of a company’s well-being, revenues and profits, Cimarex is doing fine. Their earnings release on August 5th showed an increase in both revenue and profit on both a quarter to quarter and year to year basis. Even so, this move down would make sense if the company was wildly overvalued, but at 16.6 times trailing earnings that would hardly seem to be the case. Heavy debt could also explain it, but when compared to their peers, Cimarex is not heavily leveraged. Their debt/trailing 1year EBITDA comes out at around 0.8x compared to a peer average of over twice that.
So if it isn’t performance or debt then it must be the fall in the price of oil, right? That, combined with a general aversion to risk is most likely what has caused the 20 percent drop in XEC, but in reality oil at these levels is not as bad news for them as it is for some. Most of their assets are in the Mid-Continent and Permian Basin plays where the cost of production is relatively low. According to a Credit Suisse research report reported here, Cimarex will still be making good money should WTI fall to $80/Barrel.
It seems, then that the only real reason that XEC has taken a hammering in the last couple of months is because the market in general has, with other E&P stocks being hit particularly hard. That doesn’t mean that the stock is sure to turn around immediately, but it does mean that if you have a long term view and can deal with the possibility that this may not be the absolute bottom, Cimarex looks like a good way to take advantage of the current market conditions.