Strong Balance Sheets Can Signal Opportunities in Oil

Oil is down, and with it, the S&P 500.  As the Middle East continues on their mission to “thin the herd,” value investors can start purchasing dollar bills at a discount.

Since the beginning of 2015, 48 North American oil and gas producers have filed for bankruptcy.  As of February 7, 2016 six more filed for bankruptcy with all indicators suggesting there will be more to come.

Low oil prices have put many of these young, highly leveraged producers out of their misery.  The subsequent sell-off on the doom and gloom commentary surrounding oil has also drug down the stock prices of large, well-established producers. If investors have learned anything from the past, perhaps they can profit in the future.

In March of 2009, in the midst of the housing crash, real estate investment trust Simon Property Group (SPG) was selling for a deep discount of around $21 a share. This was down from previous highs in October 2008 of over $60 a share. At $21 a share, SPG was considered a value with a P/E of less than 12, and P/B of 1.2. Today the company is trading at $191 with P/E of 32 and P/B of 11. Being greedy when others were fearful would have served investors well in this case.

Free falling oil prices have created investing opportunities much like the housing crash. Although the industries differ, company fundamentals will reveal if underlying value exists.

The possibility of a shale boom in the U.S. led to oil and gas producers taking on large amounts of debt to expand operations for their piece of the pie. Low price per barrel, high interest payments and weak balance sheets have been the demise of many of these players.

The housing crash should have taught investors that overall market sentiment toward a particular industry can make good companies seem bad. Stock price eventually reflects underlying fundamentals.

Atwood Oceanics, Inc. (ATW) has good fundamentals and could be a nice value pick for investors. Currently the company’s market cap stands at $403M and it has total assets of $4B. With a current price to book ratio of .14 investors assume minimal risk for a company with a strong balance sheet and good cash flows from operting activities. Currently, ATW is trading at $6.20, down from a $53 last July.

The strength of Atwood Oceanics balance sheet can be seen in their ratios below.

A current ratio of 4.45 points to strong liquidity. The debt ratio is calculated by dividing debt by total assets. A debt ratio of less than 1 tells us that a company has more assets than debt which is desirable. ATW’s debt ratio of .37 is well below 1 and is much the best of any of the close competitors listed above. Finally, the debt to equity ratio is used to measure financial leverage. A high debt to equity ratio is a sign of a weak balance sheet. ATW’s debt to equity ratio of .59 should not be concerning in any industry.

The oil market is cyclical. Based on a brief analysis of a few financial ratios that lend some insight into balance sheet strength, ATW is clearly a company that merits a closer look as a value pick. Market sentiment toward oil appears to have drug down ATW’s stock price which clearly undervalues the company’s assets.

Oil will recover just like the housing market. It may not be a smooth ride, but by looking into the past, its obvious that the greatest opportunities exist when the masses are fearful.