A Hedge Fund Plays Energy and Airlines
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Charles Davidson co-founded the asset management firm Wexford Capital in 1994 and presently oversees the fund's strategic vision. He also serves as portfolio manager for its Wexford Spectrum Funds and Wexford Catalyst Funds. A graduate of the University of California, Los Angeles (UCLA), Davidson also received his M.B.A. from the institution. Wexford manages a number of hedge fund and private equity portfolios and presently has about $5.1 billion in assets under management (AUM), with a $3.2 billion cut of those assets situated in hedge funds. The fund manages three different hedge funds that take advantage of different investment opportunities: Wexford Spectrum Fund (opportunitic and global strategies), Wexford Credit Opportunities Fund (multiple strategies and credit investments) and Wexford Catalyst Fund (energy and industrials).
The following reviews Wexford Capital's top three equity holdings as disclosed in its latest quarterly 13F filing with the SEC (you can view the portfolio here).
Rhino Resource Partners, L.P. (NYSE: RNO) is a small-cap company that owns a number of coal-producing properties and sells a variety of grades of coal. Wexford has held this stock as its top holding since the company made its initial public offering at the end of 2010, meaning that Wexford has lost a fair bit—coal producers themselves have been in a fair amount of woe. According to Department of Energy data, coal demand decreased 18 percent in the first half of 2012, largely due to super-cheap natural gas prices (gas usage was up 32 percent). With the demand for thermal coal expected to be subpar until gas prices, now at $3 per million BTUs, rise above $4 per million BTUs—some time in early 2014, according to futures—coal miners are in a bit of a bind. Slumping demand for metallurgic coal, used to make steel, due to the economic slowdown is not helping either.
While this has not boded well for Wexford, it could nevertheless be an opportune time for investors to enter the coal market. Rhino Resource Partners, L.P. shares are trading at historic lows and at only 50 percent above book value. Though the company is highly leveraged, its financial situation compares favorably to its peers. The most attractive thing, perhaps, about Rhino Resource Partners is that you are paid to wait. The company's dividend presently yields about 11 percent annually.
Let's segue to liquids and natural gas. Wexford's second largest holding is EPL Oil & Gas Inc (NYSE: EPL), formerly called Energy Partners, Ltd. Despite their dip in September, the stock is up 33.5 percent year-to-date, compared to 14 percent for the S&P 500 index. Earlier this month, EPL submitted a purchase agreement to acquire Shallow Water Gulf of Mexico properties from Hilcorp Energy Company (private). As Stifel Nicolaus explained in its downgrade of the company to hold from buy, “the company lowered its 2H12 volume outlook and increased its 2H12 operating expense guidance. We view the recent acquisition as neutral to slight negative in the near-term (3-6 months) since it is not accretive on an EV/EBITDA basis, increases the leverage and decreases the oil weighting.” Shares are down nearly 10 percent since Monday.
After shares stabilize in the short-term, this $550 million acquisition will likely be a long-term growth boost, doubling EPL's proven reserves and increasing its production volume by 10,000 barrels of oil per day. The company's shares are trading between 8 to 10 times forward earnings, which is about average for the sector. We recommend watching this stock over the long-term but would be cautious about initiating a position until share prices stabilize.
Wexford has also found the occasion to dip into the new Continental/United Airlines duo, holding United Continental Holdings Inc (NYSE: UAL) at number three in its disclosed holdings. This large position was initiated during the third quarter 2011, and since then has underperformed the S&P 500 index. What catalysts are there for United/Continental? Most important, perhaps, is the downward trend in West Texas oil futures, which recently sunk below $92 per barrel amidst ballooning supply (particularly from Saudi Arabia). Lower oil prices mean a better bottom line for airlines, even though demand for airline fares is largely flat. [Note: This UAL investment might seem like a non-sequitur, given that Wexford also holds an oil company. This probably means that the EPL play was based on the firm's growth potential and that the Wexford expected something more from the United Continental merger.]
United Continental has a 20 percent market share on the $173 billion airline market. The merger has not exactly been hasty, and airlines have steadily become more inventive in finding ways to cut costs and raise revenues per passenger, but it's hard to see shares, which are trading at only 7 times forward earnings, slumping much further. S&P forecasts earnings per share next year of $4.30, up from an anticipated $2.90 this year. If all goes well with airline demand—quite a qualification in the present economic climate—United Continental Holdings Inc could pay off. Indeed, in a note from May, JP Morgan analysts pegged the fair value of the stock at $38. Presently, shares trade at about $20.
This article is written by Brian Tracz and edited by Meena Krishnamsetty. They don't own shares in any of the stocks mentioned in this article. 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.