Why I bought back into RDC ( UPDATED 3.15.2015 )

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I'm going to keep this relatively short and sweet. 

Back in late December 2014 I bought ( RDC )  at a cost basis of ~$20 for the following reasons:

  • The bulk of RDC's most critical assets are contracted through 2015 and into 2016
  • Strongest balance sheet (lowest debt leverage) compared to other offshore drillers in the industry
  • Management team considered best in industry
  • Long term buyers appeared to defend the $20 share price level
  • At ~$20 the price to book is an absurd 0.5! Simply put you can purchase a $1 worth of assets of for $0.50!

I was able to take profits at ~$23 and ~$22 for an average gain of ~12.5% on the position. Not bad considering the highest the stock price reached was ~$24, before February's run up to $25. 

Fast forward to today. I bought back in at approximately $20.66 with a stop around $19.25 and a price target of ~$24. All of the above reasons still apply plus the following:

  • RDC took ~$430 million in asset writedowns for its 12 oldest rigs. As a result of the impairment charge they reported a loss in Q4 earnings. Therefore the new price reflects this new negative information.
  • Additionally ( HERO ), another offshore oil driller, recently had a long term contract cancelled by Saudi Aramco. All offshore companies and their investors were put on notice that contracts can and will be cancelled if the day rate is too high, and as a result offshore drillers' share prices tanked. Again the current share price reflects this added revenue uncertainty. 
  • The stock price has once again held the $20 level. 

Considering the aforementioned factors I believe this is a solid entry based on the risk/reward setup.

Remember as traders/investors our only goal is to develop the skills to identify and exploit asymmetries in the market. We will never be right 100% of the time, but with proper due diligence, risk management, and belief in the process we can certainly be profitable over the long term. 

UPDATE: Price action was terrible in the week that followed this post, with a violent break towards $19 violating my stop price. With recent reports of still record supply coming online, ( USD ) strength, the price of oil and market sentiment is likely to be suppressed for some time. ( RDC ) is also exposed to concentration risk per the following Seekingalpha report:

“The analyst also sees Saudi Aramco continuing to cause problems for drillers, particularly Rowan (NYSE:RDC), whose exposure to Saudi Aramco is 34.4% of its ~$5.1B backlog, and a potential discount could negatively impact RDC’s gross EPS by $0.45-$0.55/year; ”
— Mar 11 2015, 15:48 ET | By: Carl Surran, SA News Editor

The lesson is stay disciplined with your trades and mentally flexible. Always be looking for new relevant information that could affect your trades/positions. 

Is Canada a short?

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In previous blog posts, I've discussed my bearish stance on the Canadian economy as expressed through ( EWC, FXC ) due to the collapse in global oil prices. My original hypothesis was Canada is a resource/energy based economy and declining oil prices would make the 'expensive' oil produced in the oil sands less attractive economically from a producer/investment standpoint. Let's explore that thesis a little more and see if it's validated by facts.   

Alberta, Canada contains the 'oil sands' deposits and had an estimated contribution of ~18% to Canadian GDP in 2013 - statcan.gc.ca via wikipedia

According to albertacanada.com, energy is ~23% of Alberta's GDP, and the ancillary sector of construction is ~11%. Back of the envelope calculations tell us that ~34% of Alberta's 18% Canadian GDP contribution is energy related. In other words ~6% of Canadian GDP is exposed to Alberta's energy sector.  

$1 per barrel drop in the price of Alberta's oil over 12 months = $215 million less in revenue - alberta.ca

In October of 2014 Bloomberg news reported that Alberta's budget forecast was based on oil prices at $97 a barrel. As of this writing the spot price of WTI crude is $51! That's a $46 gap, or ~47% drop. If crude averages ~$50 a barrel over 12 months that's an estimated ~$9.9B drop in provincial revenues. That will certainly blow holes in budgets and earnings expectations across the board. 

According to a RBC March 2014 provincial economic outlook Alberta was forecast to post the largest real GDP gains of any province for 2014 and 2015. I think that forecast will have to be altered drastically if it hasn't already. As of October 2014, BMO has already slashed Alberta's growth forecast to 2.9% from 3.3%. This might be revised further as the oil drop continues. 

How important is Alberta to Canada's economy? theglobeandmail.com reports:

“Alberta contributed one-third of Canada’s economic growth last year, and is by far the fastest-growing province in the country again this year. Since the beginning of 2013, nearly half the jobs created in the country were in Alberta.”
— http://www.theglobeandmail.com/report-on-business/industry-news/energy-and-resources/panic-time-as-oil-goes-so-does-canadas-economy/article21116012/

Civeo Corp. ( CVEO ) lost 53% of it's value on Dec. 29 after announcing a suspension of its dividend and closing sites - bloomberg.com

Why should you care? 

“Civeo Corporation provides workforce accommodations in the Canadian oil sands and the Australian natural resource regions. The company offers solutions for housing of workers with its long-term and temporary accommodations; and provides catering, facility management, water systems, and logistics services.”
— http://finviz.com/quote.ashx?t=cveo

( CVEO ) is on the front lines of Canadian oil sands production and announced it would cut staff in Canada by 30% and in the US by 45%. CapEX will drop ~78%! This is telling me that the fallout from the collapsing oil prices has only begun as capital budgets get cut across the board. 

Several oil majors have already cut or suspended major oil sands projects. Reportedly there is a tendency towards significant cost overruns for large scale oil sands production projects, that when paired with declining oil prices, make projects economically impractical. 

“The Joslyn oil sands mine has been shelved indefinitely, a result of rising industry costs that made the $11-billion project financially untenable.”
— http://www.theglobeandmail.com/report-on-business/joslyn/article18914681/
“CALGARY – Royal Dutch Shell PLC told regulators it is halting work on its Pierre River mine in northern Alberta’s oil sands and that it has no idea when it may revive the blueprints”
— http://business.financialpost.com/2014/02/12/shell-halts-work-on-pierre-river-oil-sands-mine-in-northern-alberta/?__lsa=09a5-a82e
“CALGARY — Statoil has put its Corner oil sands project on hold for at least three years as it grapples with rising costs.

The decision means about 70 jobs will be cut, the Norwegian energy firm said Thursday.”
— http://business.financialpost.com/2014/09/25/statoil-puts-corner-oil-sands-project-on-hold-for-at-least-three-years-cuts-70-jobs/

That's a pretty grim outlook moving forward, however there are risks to this thesis that must be noted and factored into any trade or investment decision. 

  • As oil price declines oil consuming provinces like Ontario stand to benefit
  • Oil prices in conjunction with a declining ( CAD ) make Canadian exports (including energy) cheaper for international buyers (primarily the U.S.), which is likely to offset some of the declining domestic economic activity
  • If Canadian exports rise enough to offset the domestic energy fallout   ( EWC ) may bottom more quickly than expected and even rise in the face of negative investor sentiment.
  • Canadian manufacturer's which use oil as an input also benefit from the declining oil price and may be in position to increase sales as consumers in other provinces and the U.S. have more discretionary cash to spend, again potentially causing ( EWC ) to bottom more quickly than expected and even rise in the face of negative investor sentiment.

I'm still bearish on ( EWC ) but not as aggressively as I was previously. In fact I think a long ( USD ) short ( CAD ) position may be a better, more direct play to capitalize on the current global macro dynamics. 

What I'm Watching ( Week of 12.15.14 )

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Canada iShares ( EWC )

Canadian assets are facing major headwinds in the current environment. 

1. The fall in global oil prices hurt producers' bottom line. Alberta is bracing for a decline in GDP into next year as a result. Click for links to articles.

Quarter of new Canadian oil projects vulnerable if oil falls below US$80: IEA 

With oil trading below US$60, provinces brace for impact of global oil price shock

The above chart shows that there are some producers' breakeven Oil price as low as $45. That estimate may well be tested. My concern is that Canada has the lowest return on net cumulative capital cost according to Barclays et al. 

Bottom line, low prices make new projects uneconomic and projects with a higher cost basis return even less than before. This is a net negative. 

2. The $USD continues to strengthen relative to other global currencies. This is especially true for the commodity currencies of Australian and Canadian dollars. 

Therefore $1 USD will in effect be able to buy more Oil when priced in CAD effectively increasing U.S. purchasing power for Canadian production. 

I'm actively looking for a trading opportunity here to the short side. Oil prices are weak, and the producers' currency is declining in relative value. Here are the setups I'm watching in charts. 

What I Saw ( Week of 12.8.14 )

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Tuesday of this week I expressed a mildly bearish sentiment regarding the broad market. Based on stock market internals including weakening market participation, the duration and velocity of the near vertical bounce off of the October lows it seemed increasingly likely that we would see some profit taking and some sort of correction. Let's see if this estimation was validated by the market. 

I would say it looks like market participants did decide it was a good time for profit taking/risk reduction. Overall this week, SPY/$SPX is down ~ -3.5%. As of this post on Tuesday down ~ -2.7%. Let's take a look at the other major indices. 

Let's break it down by sector. This way we can see if the selling was concentrated and if so which sectors are out(under)performing. 

Note the difference in calculated weekly performance. The top chart is a bottom up calculation by finviz.com generated using all the available stocks within each of their sector categories. The second chart is from stockcharts.com and it is the trailing 5 day return of the S&P SPDR Sector ETF's relative to ( SPY ). 

After that clarification, we can clearly see the selling is concentrated in the Energy ( XLE ) and Basic Materials ( XLB )  sectors. This reflects current analyst and investor sentiment regarding potential 'demand slow down' in the face of rising raw material supply. 

Also note the strong relative performance within utilities ( XLU ), cyclicals aka consumer discretionary ( XLY ) and consumer staples ( XLP ). This indicates buying based on two trends.

1) The US consumer is back in a major way due to the continued persistent decline in oil prices (more on that later).

2) Defensive re-balancing taking place (read: lower expected risk). The correlation between broad market weakness and defensive sectors like consumer staples/utilities is buoyed by the following simple concept: 

A LOT of the largest institutional investors (mutual funds, pension funds, insurance funds) have "long only", "fully invested", or "cash balance maximums" mandates imposed on their stock investment strategies. Therefore profit taking, or risk reduction, means they cannot sit on excess cash. It must be reinvested. Well that means if, as a portfolio manager,  you believe market risk (volatility) is high (increasing), considering the aforementioned constraints, you must decrease your exposure to stocks that are really sensitive to market changes (high-beta, growth, momentum, high leverage) and increase your exposure to stocks that are less sensitive to market changes (low-beta, value, defensive, low leverage).

See below:

Hard to argue with the above. This chart shows the last 5 days' performance for a few of the largest US utilities, the S&P Spdr Utilities ETF ( XLU ),  all relative to ( SPY ); SPY 5 day performance is = 0%. This gives us a much clearer picture of the relative outperformance of the utilities sector vs the broad market. 

Oil is still a blood bath. 

OIL -13%

Brent -10.45%

WTIC -13.06%

YTD:  - 40%+

What I'm Watching ( Week of 12-8-14 )

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How long does equity optimism last without correction?

Over the weekend I examined the market internals and came away mildly bearish at these levels. Extreme optimism and lack of participation among the broad indexes make this a week ripe for profit taking and I've been aggressive with my trailing stops etc during the last 2 trading sessions. 

When will OIL finally bounce? Have investors finally capitulated?

I'm short oil via the Inverse ETF SCO ( wish I had more size ) however this has been a profitable position ever since OPEC's decision not to lower production targets. Clearly this is an example of geopolitics setting up incredible trade opportunities. However the contrarian value hunter in me knows the devastation in energy producers' stocks is likely a case of throwing the baby out with the bath water. There are plenty of firms out there able to produce at a profit even in today's low oil price environment. I will be looking to rotate into those as soon as it's prudent to do so. 

If you bought SCO the day after the OPEC decision you would be sitting on an approximate 17% gain based on today's levels!