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When oil prices started collapsing in mid-2014 from over $100/barrel to under $27/barrel, most oil and natural gas exploration and production companies (E&Ps) were caught over-extended. Debt that previously was easily serviceable, especially with new drilling technologies opening up vast new oil and gas fields in North Dakota, Texas and Appalachia, quickly became unsupportable. Some companies, particularly the larger ones with less leverage, were able to adjust and regain their footing. Others struggled, with over 100 filing for U.S. Bankruptcy Court protection.
While the liability side of these companies’ balance sheets was unwieldy, the underlying assets often were still attractive, buoyed by the partial rebound in commodity prices (to around $50/barrel), improved technologies and lower drilling costs resulting from over-capacity at the oilfield service firms. The American bankruptcy process (often referred to as “Chapter 11,” which is the applicable section of the bankruptcy law) is designed to release the value of good assets from the shackles of debt. Typically, the company reorganizes by exchanging new equity for much of its debt, either heavily diluting or wiping out the old pre-bankruptcy stockholders.
When companies utilize the Chapter 11 process properly, they can emerge as lean and strong competitors; but many investors shy away from these companies coming out of bankruptcy for a variety of reasons: They don’t understand how the bankruptcy process makes the company stronger; their view of the company is tainted by memories of its earlier problems; the stock isn’t yet covered by Wall Street research and trading can be thin and volatile as former creditors sporadically unload their stock. This often results in the post-bankruptcy stocks being undervalued for some time.
Since the start of 2016, over a dozen energy companies have emerged from bankruptcy as public companies. Knowledgeable distressed investors have not been able to soak up this large supply of new post-bankruptcy stocks, leading to their stock prices being even softer than usual. We think many of these post-reorganization oil and gas stocks look like good bargains right now.
The most recent Turnaround Letter highlights several post-Chapter 11 stocks that look particularly attractive, together with a few that narrowly escaped bankruptcy and now offer interesting turnaround potential. Read the full article here.