3 Reasons to Sell Plains Exploration and Production
Robert is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Plains Exploration and Production (NYSE: PXP) is an oil and gas exploration and development firm based in Houston, TX. Changes in the energy market compelled the company to respond boldly, buying and selling various assets to improve profitability. While I applaud PXP for its proactive approach to its business, I’m not so sure it’s worth investing in right now. Why sell PXP? Think BEAR.
Business:
PXP has swung away from natural gas to crude oil production. This makes sense as crude oil is more profitable at the moment than natural gas. For example, PXP is shifting resources to its Eagle Ford oil operations in Texas and away from the Haynesville shale gas in Texas and Louisiana. The big news, of course, is the $6.1 billion purchase of deepwater Gulf of Mexico oil fields from British Petroleum (NYSE: BP) and Royal Dutch Shell (NYSE: RDS-A). PXP recently announced details of the $7 billion loan package it will use to buy these assets. These are actively producing fields with significant production upside potential. PXP believes it can realize this production potential with relatively low cost drilling/completion and well makeover opportunities.
While tantalizing, there is no guarantee this production potential will materialize. Consider the chart below from the US Energy Information Administration and how deepwater Gulf oil production is projected to grow modestly. I have to ask the question: will the production from these newly acquired fields generate enough revenue to justify the price tag? Or the resulting debt to equity ratio of 3.3? I also suspect PXP executives pray every day that they don’t have an oil spill like BP had. If they aren’t, they should, because a major spill could sink the company.
Earnings:
According to research on TD Ameritrade, for the past three quarters, PXP's earnings have been below consensus expectations. 3Q 2012 particularly so as PXP reported 35 cents per share as opposed to analysts’ estimates of up to 65 cents. Earnings have declined despite revenue growth, likely reflecting asset trades mentioned above. Return on equity, return on assets, and revenue per employee are only average relative to others in the industry. Deleveraging after the purchase of the Gulf of Mexico oil fields will likely dampen future earnings. Lastly, after the Gulf oil spill in 2010, drilling permits have resumed, but at a slower pace with more environmental reviews, adding expenses and hurting earnings.
Returns
The stock price has traded more or less sideways for the past three years with some volatility. This oscillation might be a good thing for traders, but not for the long term investor. PXP pays no dividend. The PE ratio is 32 times earnings and S&P projects flat earnings for 2012 relative to 2011. Also, price to projected earnings is about 15, a premium for the industry. If earnings or production disappoints, those ratios could shrink in a hurry.
Conclusion:
PXP isn’t a bad investment, just an uncertain one. PXP is in transition, buying and selling assets to re-align itself with more profitable oil production. A sound strategy but with no guarantees of improved earnings. Put another way, it seems to me that in buying PXP, you are paying a premium for a company you hope can achieve greater profits by producing significant oil from a likely but somewhat uncertain source (the Gulf of Mexico fields) at a time when slowing world economies and record American oil production will likely put downward pressure on oil prices. And do so while carrying significant debt.
Alternatives:
To me, rather than pay a premium for uncertainty, pay fair value for confidence. Big oil companies like Exxonmobil and Chevron are both selling under 10 times earnings, carrying miniscule debt to equity ratios, paying a dividend, and experiencing a generally upward stock momentum. Their sheer size and diversity protects them from disappointing returns (or a spill) in any one oilfield. Smaller firms like Concho Resources (NYSE: CXO) or Linn Energy (NASDAQ: LINE) are actively producing oil from proven onshore reserves, have a strong earnings track record, and optimistic guidance. LINE, in particular, is raking it in courtesy of its Hogshooter oil operations, sells for less than 9 times earnings, has a much lower debt to equity ratio than PXP and pays a 6.9% dividend.
This graph from Yahoo! Finance highlights my point. For those who don’t want to risk a turn-around story that might not turn around, my advice is to sell PXP.
There are those who believe PXP is a great opportunity and turn-around story, notably fellow Foolish blogger Matt DiLallo. Look for his analysis “3 Reasons to Buy Plains Exploration” here.
dylan588 has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. 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.If you have questions about this post or the Fool’s blog network, click here for information.
