These Are the Must-Not-Have Companies In My 2013 Portfolio

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

As a contrarian investor, the topic of this article isn't the Must-Have companies for a high yielding 2013 portfolio. I would rather focus on the Must-Not-Have companies, as their performance could be a real disaster for any portfolio. In my opinion, the following companies will most likely underperform due to fundamental problems and macro headwinds. I am a strong believer that investors will start fleeing the following stocks during the next months to switch to safer companies with lower valuations.  

The Natural Gas To Avoid

Depressed natural gas prices have been a concern for all energy players and I don't see any near term catalyst that will turn things around significantly in 2013. This lack of a potential high impact catalyst will result in low operating netbacks for the  natural gas weighted producers whose cash flow will be severely hit on a quarterly basis limiting the corporate expansion strategy. Gas production in North America is expected to flatten out in 2013 as the momentum from connecting already drilled natural gas wells subsides while lower rig counts kick in.

EOG Resources' CEO Mark Papa believes that the natural gas prices will not rebound  soon, but he sees depressed natural gas prices for the next three or four years. This is why he is shifting his company away from natural gas and towards oil.

This being said, I have Paramount Resources (TSX: POU) on the top of my "Must-Not-Have" ListParamount is a heavily weighted natural gas player that produces only 20,000 boepd (85% natural gas), but its Enterprise Value is $3.5B. So it trades for a monstrous $175,000 per flowing barrel and 58x its annualized Funds from operations (FFO). From the debt front, things are gloomy as the D/CF ratio (annualized) is 9.5x! Such high metrics are beyond my comprehension.

Although Peyto Lake is one of the most idyllic Canadian lakes, which attracts many tourists every year, Peyto Exploration (TSX: PEY) isn't attractive from a valuation perspective. Peyto produces 51,000 boepd (89% natural gas) and if it doesn't acquire an oil player in 2013, its gassy land in Western Canada limits any material increase for oil production in the foreseeable future. With an estimated FFO (annualized) at $300M and net debt of $574M as of Q3 2012, the company maintains a D/CF ratio= 1.9x FFO (annualized), which is not low. Furthermore, based on the Enterprise Value (EV) of $3.9B, it trades as high as $76,000/boepd and 13x the FFO annualized. Is the poor 3,3% annual dividend enough to hold the investors in this overly gassy company? Not me. 

Tourmaline Oil (TSX: TOU) is priced like a precious Sri Lankan tourmaline gemstone. Tourmaline Oil has an exit 2012 production at 70,000 boepd with only 9% oil and liquids. With an estimated FFO (annualized) at $300M and an Enterprise Value of $5.7B, it trades for $81,000/boepd (81% natural gas) and a whopping 19x the FFO annualized.

These companies above haven’t taken a beating yet and their stocks keep hovering close to the highs of the chart. Their sky high valuations are apparent when I compare them to the most richly valued oil-weighted Canadian player, Crescent Point Energy that trades for $140,000/boepd (90% oil and liquids) and only 9.5x the FFO annualized based on its Enterprise Value of $15.5B. 

The Debt Overhang To Avoid

Forest Oil (NYSE: FST) is "lost in the forest" of its debt. After the latest disposition in South Louisiana, it has production of 53,000 boepd that gives an annualized FFO of only $400M. With an EV=$2.6B, it trades for a decent $49,000/boepd (66% natural gas), but the D/CF ratio of 4.5x (annualized) cannot be ignored. The company has been losing money for three consecutive quarters and I believe it will lose money in Q4 2012 too, further hurting its decreasing stockholder equity. 

Quicksilver Resources (NYSE: KWK) is another heavily indebted player that is swimming in a pool of $2.2B long term debt without almost any life jacket. Why am I so pessimistic? Because the EV is $2.7B while the annualized FFO is only $200M. Is the production of 60,000 boepd (80% natural gas) enough to turn things around? I believe no, while the D/CF ratio of 11 is staggering. The losses are pummeling the stockholder equity on a quarterly basis and I don't see any sign of abating as the company keeps spending money on mostly gas wells like the ones in Horn River Basin in Canada.

Despite their dismal situation, both Forest and Quicksilver enjoy a rich premium as they trade with PBV=3 and 5 respectively. To me, this is insane. If the natural gas price doesn't rise significantly or if these two companies don't drill oil, low cost wells with low decline rates then they will be in a "slow death" mode. In my opinion, both companies will face severe fundamental difficulties that will force them to sell assets once again in 2013.

Good Management Is Not Enough

The bulls will support their thesis with the pedigree of the management, which is an intangible. The quality of the management is an important factor and a few CEOs have a good track record bringing seriousness to these subject companies. However, I wouldn't rely on this much as the fundamentals will prevail sooner or later. Either way, I will keep track of the performance of the aforementioned oil and gas producers and keep you posted. 


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