Should Fairholme Capital's New Buys Be Your New Buys?

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

Fairholme Capital Management is one of the leading investment advisers and offers investment services to individuals and corporations. The hedge company manages around 205 accounts, amounting to around $10.1 billion in assets as of March 31. Before investing, the fund conducts extensive research and uses a focused value-oriented approach. By using this approach, Fairholme posted a return of 31% and outperformed the S&P 500 by more than 15% in 2012. As per its recent 13F filing with the SEC, the company’s three new buys are:

<table> <thead></thead> <thead> <tr><th> <p><strong>Company</strong></p> </th><th> <p><strong>Percentage of holdings</strong></p> </th></tr> </thead> <tbody> <tr> <td> <p><strong>Chesapeake Energy <span class="ticker" data-id="203108">(NYSE: <a href="">CHK</a>)</span></strong></p> </td> <td> <p><span>3.47%</span></p> </td> </tr> <tr> <td> <p><strong>Genworth Financial <span class="ticker" data-id="203767">(NYSE: <a href="">GNW</a>)</span></strong></p> </td> <td> <p>0.11%</p> </td> </tr> <tr> <td> <p><strong>Canadian Natural Resources <span class="ticker" data-id="206912">(NYSE: <a href="">CNQ</a>)</span></strong></p> </td> <td> <p>0.45%</p> </td> </tr> </tbody> </table>

Let’s see if Fairholme's three new buys have the potential to bring high returns to investors.

Focus on improving capital efficiency and adopting new techniques

Chesapeake is focusing to improve its capital efficiency. With this concern, the company is trying to reduce the cost of drilling wells with new pad-drilling technology. Pad drilling involves drilling multiple wells in the same region. It increases the speed of the drilling process, is cost effective, and improves economies of scale. With the implementation of this technique, the average time to drill a single well in Eagle Ford Shale has been reduced to 18 days, from 25 days. It's further expected to reduce that time to 13 days by the end of this year.

The technique also reduced construction costs from $9 million per well to $7 million. That number is expected to drop to $6.5 million by the end of the year. Pad drilling will have a meaningful impact of 15% to 30% on capital efficiency this year, maximizing return by lowering drilling costs. Additionally, due to a rise in natural gas prices, Chesapeake shifted focus to increasing its sweet, light crude oil production. The company observed significant growth in the production of oil, to the tune of a 54% year over year, in the first quarter of 2013. As production continues to increase, it is planning to allocate more than 80% of its drilling spending on oil production. Chesapeake dramatically raised its oil-production goal from 9.3 million barrels last year to 37-39 million barrels this year. Because oil prices are very volatile, the company hedged around 85% of its oil production at $95.45 per barrel this year, increasing the year’s total revenue.

A new universal life insurance product

In today's era, life insurance is an essential part of every individual’s financial planning. It has become a form of financial security available to the family when needed. This has led to an increase in demand for life insurance covering multiple needs in a single product. Therefore, Genworth launched its first index universal life insurance product, Asset Builder Index UL, in the U.S. last month. This product provides a combination of death benefits with other benefits such as:

  • The opportunity for growing the value of the policy as it is linked with S&P 500 Index for crediting strategy
  • Protection from market downturns
  • An optional Accelerated Benefit Rider, or ABR, for long-term care service
  • Additional income for retirement. If there is sufficient cash generated by the policy, the policyholders will receive the advantage of withdrawing and policy loans to supplement income.

With the new launch, the total premiums earned by Genworth are expected to increase from $1.2 billion in the first quarter of this year to $1.31 billion by fourth quarter of this year.

To improve the operating performance of the business, Genworth announced a cost-saving plan last month. The company plans to sell its underperforming wealth-management business in California, comprising around 400 employees, and cut spending related to IT programs. This will generate savings of approximately $80 million-$90 million annually on a pre-tax basis. Genworth will remain focused on its decision to improve business while delivering value to its shareholders.

Expansion of two major projects

Phase 1 of Canadian Natural Resources' Horizon project in Canada has attained strong growth in production volume of approximately 86,000 barrels per day (bpd) in the first quarter of 2013. The project is located in Alberta, which is rich in energy resources to produce synthetic crude oil, or SCO. The company plans to expand Phase 2 and Phase 3. Phase 2A is expected to commence in 2015 and will increase production capacity by 10,000 bpd; Phase 2B will increase production capacity by 45,000 bpd in 2016. Finally, Phase 3 will increase production capacity by 80,000 bpd in 2017. Additionally, Phase 1 expectations for this year were raised from 100,000 bpd to 108,000 bpd. Per-barrel cost for SCO is between $25 and $35. Production capacity will eventually be raised to 250,000 bpd. This will generate free cash flow of more than $4 billion annually in 2015.

Meanwhile, Canadian oil sands have the world’s largest deposits of bitumen and other natural resources. Kirby South Phase 1 is the major Canadian Natural project in the thermal division. This is a steam-assisted gravity drainage, or SAGD, project in Canadian oil sands. SAGD is an advanced technology to produce crude oil and bitumen; it is cost-effective and drills horizontal wells accurately and efficiently. Kirby South Phase 1 is configured to produce 40,000 bpd of bitumen. Since the project is running ahead of schedule, it is now expected to commence in August instead of November of this year and is currently 97% complete. As the region has massive natural resources, the company plans 40,000-60,000 bpd projects every two to three years. The Kirby South Phase 1 project will boost Canadian Natural’s revenue for this year to $15 billion from $14 billion in 2012.


Adapting new technology will reduce production costs and lead to improved capital efficiency. Also, the hedged oil price will boost Chesapeake’s revenue.

With the help of its cost-saving initiative, Genworth will improve its operating performance. The new universal product will meet customer demand for multiple options in a single product and boost the company’s sales.

Expansion of two major projects will enhance the production of bitumen and SCO, which will increase Canadian Natural’s revenue and generate free cash flow annually.

Therefore, I recommend buying all three stocks.

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Shweta Dubey has no position in any stocks mentioned. The Motley Fool has the following options: Long Jan 2014 $20 Calls on Chesapeake Energy, Long Jan 2014 $30 Calls on Chesapeake Energy, and Short Jan 2014 $15 Puts on Chesapeake Energy. 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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