David Einhorn, the famous billionaire hedge fund manager, just found his next target: U.S. onshore E&Ps or the oil fracking companies. He laid out his short thesis during the annual Sohn Investment Conference in New York. The share price of Pioneer Natural Resources (PXD), EOG Resources (EOG), Concho Resources (CXO), Continental Resources (CLR) and Whiting Petroleum (WLL) dropped just as he mentioned them in his speech at the conference .
He called shale oil fracking a “business that burns cash and doesn’t grow anything.” “The banks are clearly incentivized to help the frac-addicts” by financing “The most expensive method of extracting oil, the industry simply can’t withstand lower oil prices”. He specifically cited Pioneer Natural Resources as the ‘Mother Fracker’ (and EOG Resources, the ‘Father Fracker’, if you are wondering).
He thinks PXD should trade closer to $78 a share, instead of the near $170 current levels. PXD stock suffered an almost 2% loss on the day, and continued to drift lower in after hours. EOG stock was able to roll off Einhorn and managed to end the day flat (EOG has relatively stronger balance sheet with 2014 Debt-to-EBITDA ratio at 0.6 vs. PXD at 0.9).
|Source: Yahoo Finance, May 4, 2015 4:18pm US CST|
We think in general Einhorn’s view may be justified as many smaller E&Ps have outspent their cashflow in the past few years with poor balance sheet positions. This is also confirmed by Moody’s,
[The oil and gas sector] liquidity-stress index (LSI) more than doubled to 9.8% in March from 4.4% in December as negative cash flow, borrowing-base redeterminations, and increased potential for covenant breaches pressured liquidity.
One better news is that Moody’s noted,
.. the [LSI] index is still well below its 26% peak in March 2009 during the last oil price slump.
Another piece of better news is that Moody’s also indicated the energy sector’s liquidity pressures are not spreading to other sectors. The composite LSI excluding oil and gas hit a record low 2.6% in February before finishing the quarter slightly higher at 2.7%.
Meanwhile, despite the success in his Lehman call, Einhorn’s track record this year is not that impressive. According to CNBC, Einhorn’s main main fund fell 1.7% for Q1, net of fees, vs. a gain of 1.92% for the average U.S. stock-focused hedge fund. CNBC also said the fund’s short bets against stocks and a long stake in Micron Technology lost money (perhaps that’s why he is switching to energy).
So should you follow Einhorn? Our advise is to be very selective in long or short positions of E&P stocks. Not every E&P company is as Einhorn described. But with 110+ publicly traded E&P companies in North America (excluding the integrated oil companies like ExxonMobil), the sector is long overdue for a shakeup. Quite a few highly leveraged and poorly managed frackers have been able to hide under the cloak of high oil prices in the past few years. The new lower-for-longer oil price environment is putting all of the E&Ps to a harsh reality test.