All That Glitters Is Not Gold

Declan is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

The market has been offering a number of stocks trading higher on strong volume.  Even on days when the market has closed lower, the number of individual stocks enjoying surges remained strong.  Two stocks which have enjoyed recent strong accumulation are DigitalGlobe (NYSE: DGI)  and Harvest Natural Resources (NYSE: HNR), but not all may be what it seems.  While heavier volume buying is typically bullish, the reasons for it are not always clear.  It's sometimes the case on digging a little deeper, it subsequently becomes apparent such 'bullish' opportunities are best left to others.

DigitalGlobe could be viewed as a case of glass half full, or glass half empty.  The glass half full crew will view a stock which has enjoyed consistent gains over the past 6-months, rising on higher volume and easing back on low volume.  The glass half empty crowd will see the 6-month gain as just a slog back following a hard fall, and a journey far from complete. This fall was not one triggered by the credit crisis, but one built off fears of a drop in government defense spending. However, the recent buying surge was attributed to an Antitrust Clearance for a merger with GeoEye (NASDAQ: GEOY). This merger will ensure the sustainability of the company as a drop in military contracts put in jeopardy the survival of two companies.  In the case of GeoEye, domestic government contracts accounted for two-thirds of revenues, with foreign government contracts accounting for a quarter, leaving just a small portion of revenue associated with the private market.  GeoEye recently announced a deal with the Indian government, although the total value of the deal was not disclosed.

What would the merged revenues of the bigger DigitalGlobe possibly look like?  For the most recent quarter, Total Revenue would have come in at $194 million with a Net Income of $16.1 million; not bad.  In annual terms, DigitalGlobe reported a loss in 2011 of $28.1 million, but GeoEye came in with a profit of $46.9 million, offsetting the loss.  We can assume any merger will bring 'cost efficiencies' (aka Layoffs) which will boost Net Income.  Assuming all Shares Outstanding of GeoEye were converted to DigitalGlobe at the proposed 1.425:1 ratio, there would be 32 million new shares of DigitalGlobe (+24.8 million Float); this would bring the total number of Shares Outstanding to 79 million with a 60.5 million Float.  An approximate annual EPS for the merged company would be 0.24, with a trailing P/E of 119 based off DigitalGlobe's current close. This would give pause for concern at DigitalGlobe's current price, and is significantly higher than GeoEye's existing P/E of 17.9 (DigitalGlobe with an annual loss has no P/E to report).  The merger is a good thing for both companies, but it might be a little early to be jumping aboard as a buyer.

Harvest Natural Resources had experienced strong buying throughout December and early January to push the stock into the $10s. As is often the case after such surges, it takes a few days for a stock to digest the gains, and Harvest Natural Resources has steadily declined on low volume as traders gauge its next move.  A recent downgrade by Wunderlich and a 'sell' call by Jim Cramer has probably kept stock speculators away from this oil and natural gas company, but such downgrades will have also cautioned investors looking for a value entry.  Its January surge was attributed to an oil discovery off the coast of Gabon, but the news was light on specifics.  There was no mention as to how much oil was discovered, its grade, or how recoverable it might be.  Others attributed the volume buying to an expected approval on the sale of its share of a Venezuelan Petrodelta joint venture to Indonesian state-owned PT Pertamina, but the Chavez situation muddies the waters for this deal completing.  Venezuela has too many unknowns with regard to attitudes towards foreign investment and ownership within the country.  The actual truth for the buying probably lies in the middle, but there is not enough in either story to suggest there is a slam dunk here.  The New Year recovery in Natural Gas Prices, along with a continued improvement in Crude Oil pricing should have been a more encouraging news item for the company, but the inconsistent (non-existent!) revenues for the past few quarters make evaluating the company difficult.   And nobody likes to be buying a stock which isn't posting revenues.  If you like your risk high, there may be something here for you, but the company is just too opaque and inconsistent for my liking.

These stocks have their merits, but on first appraisal they can appear as something more than they actually are.  There is nothing to suggest these stocks can't go higher (and in all likelihood, given prior momentum, will in the short term), but when markets eventually catch their breath, it will be stocks like DigitalGlobe and Harvest Natural Resources which will probably find themselves feeling the pain first.  Buyer beware. 

fallond has no position in any stocks mentioned. The Motley Fool recommends GeoEye. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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