Another Stock Only a Computer Could Love: The Sequel

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Citron Now introduces Whiting Trust USA (NYSE:WHX).

Just three weeks ago, Citron introduced readers to GNI, a stock with a fixed liquidation date, at which point it simply dissolves, worthless.  On any computer dividend screener GNI seemed like a nice conservative play, but in reality it is ticking bomb.  Within just three weeks, GNI has lost 1/3rd of its stock price. (and is still handsomely overvalued.  It is Citron’s opinion that it likely has further to fall. )

No fraud, no big earnings miss, just simply a reminder that computers cannot do all of the work of man.

At the time, Citron figured GNI was a one-time anomaly in the market.  But here is another one that shares the same attributes.

Meet Whiting Trust USA.

In the most basic terms, WHX is very similar to GNI.  With 100% certainty, it also goes to a zero value.  No fraud, no deception, and fully disclosed in its filings.

WHX has been bid up to a level completely detached from its real value, having been erroneously included with comparable “real” dividend and cash flow stocks that have an enduring asset base.  While the details differ slightly, the insane mispricing of this stock is even more extreme than GNI.

The Details, But No Devil

WHX’s 10-K’s and 10-Q’s all plainly state that it is an income trust, with rights to revenues from 90% of oil and gas property sales, up to a maximum of 9.11 MMBOE (barrel of oil equivalence), a gross measure of hydrocarbon energy.  At the point where 9.11 MBOE is sold from the trust, it liquidates.  It has no other assets, and minimal cash.

10-K here:  http://www.sec.gov/Archives/edgar/data/1417003/000095012310024760/d71538e10vk.htm

“As of December 31, 2007, the Trust had no assets other than a de minimus cash balance from the initial capitalization and had conducted no operations other than organizational activities. In April 2008, the Trust issued 13,863,889 units of beneficial interest in the Trust (“Trust units”) to Whiting in exchange for the conveyance of a term net profits interest (“NPI”) by Whiting Oil and Gas. The NPI represents the right for the Trust to receive 90% of the net proceeds from Whiting’s interests in certain existing oil, natural gas and natural gas liquid producing properties which we refer to as “the underlying properties”. The underlying properties are located in the Rocky Mountains, Mid-Continent, Permian Basin and Gulf Coast regions. The underlying properties include interests in 3,086 gross (381.7 net) producing oil and gas wells. Immediately after the conveyance, Whiting completed an initial public offering of Trust units selling 11,677,500 such units. Whiting retained ownership of 2,186,389 Trust units, or 15.8% of the total Trust units issued and outstanding.

The NPI will terminate when 9.11 MMBOE have been produced and sold from the underlying properties (which amount is the equivalent of 8.20 MMBOE in respect of the Trust’s right to receive 90% of the net proceeds from such reserves pursuant to the NPI), and the Trust will soon thereafter wind up its affairs and terminate. As of December 31, 2009, on an accrual basis 2.77 MMBOE of the Trust’s total 8.20 MMBOE have been produced and sold and 0.02 MMBOE have been divested.”

Note that GNI’s liquidation date is determined by calendar, where WHX liquidates when its resource allotment of oil and gas is produced and sold.  But the effect is just the same.  Zero is zero.

As of November 2010, this trust, established in 2007, has now produced and sold about 43% of its allocated resource in just 11 quarters.  (3.54 MMBOE of its net interest of 8.20 MMBOE)  At current run rates it will pass the “half-gone” point next quarter.

If its current production run rate is maintained, the trust would liquidate in just 15.3 quarters.  However, production in mature wells tends to decline, so the payout rate may decline and stretch out over a longer timespan – but this wouldn’t add to its value….it just delays when the shareholders get their returns.  While energy prices might be higher in outlying years if the payout slowed, production costs would burden those lower yields.  A longer payout path also reduces the net present value of the income stream.  The bottom line:  the timeline is not friendly to investors either way.

WHX gives investors gas

The energy market since 2008 has changed dramatically for oil and gas pricing.  These commodities used to trade close to energy equivalence.  The WHX Whiting trust was designed around this assumption — the revenue structure treats oil and gas production for sale more or less interchangeably.

But since the huge discoveries of shale oil in the US, and the relative inelasticity of gas demand, gas prices have plunged relative to oil   Last quarter, gas was 40% of WHX’s energy production, but only 20% of the revenues.

The only hope for a investors to recover today’s price in WHX would be soaring energy prices before the production quotas are reached.  But while the spot price of oil is now high (near the company’s average sales price in 2008), gas has fallen by nearly half, depressed by the supply glut due to the huge shale discoveries brought on line in the US, and is not expected to recover in coming years.   So the blended energy price (appx 60% oil, 40% gas for WHX’s production portfolio), hedged as they are, and weighed down by low gas prices for the foreseeable future, is unlikely to produce a windfall, and a poor play on oil price spikes.

Check Please!

For a normal company, dividends are a quarterly reminder of the health of the company’s sustainable cash flow.  But how do you value a company that depletes and goes away?   Standard runoff calculations are based on the present value of future payment streams.  For our model, we’ve assumed the current run rate continues, having explained why a longer run rate only defers estimated income, and won’t create additional revenue.

In our model, WHX pay 15.3 quarterly distributions plus about .20 in cash per share when the trust is liquidated appx., April 2015.

So what does WHX earn?  Since stabilizing its payouts in 2009, WHX has paid .60 to .80 per quarter.  So we analyzed the net present value of 15.3 quarters of distributions for WHX, with quarterly estimates up to 50% higher than its last 7 quarter average, and we get a most likely value below $10.00.  Even in the “best case scenario” (not likely because a huge spike in energy costs would pressure inflation and push up the discount rate), there’s just no way we come up with anything north of $15.00.

Discount rates
Estimated Quarterly 2% 4% 6%
0.60 ($8.16) ($7.28) ($6.54)
0.70 ($9.52) ($8.50) ($7.63)
0.80 ($10.88) ($9.71) ($8.72)
0.90 ($12.24) ($10.93) ($9.81)
1.00 ($13.60) ($12.14) ($10.90)
1.10 ($14.96) ($13.35) ($11.99)
Liquidated cash
0.20 ($0.19) ($0.18) ($0.17)

So what is this stock doing north of $22 a share?  How Can This Be Possible?

In a world where single-stock research is rapidly becoming extinct, drowned by the massive waves of quant funds and computer generated trading, the above detail – that this company is soon to become extinct – has been entirely forgotten.

Don’t take our word for it:  look at these references to WHX in articles titled “Best Yielding Stocks”, “Top Net Cash Flow Stocks”….etc., where it is compared to other stocks that …… well ….. won’t cease to exist on April 2015.   So the computers go about their merry way,   (We’re convinced that, as well as executing most trading, most of these articles are written by computers, too.)

Premise:  Hunger for yield: (12/3/2010)

http://finance.yahoo.com/news/Hunger-For-Yield-Props-Up-indie-4143308691.html?x=0&.v=2

Premise:  Highest yielding sectors: (11/29/2010)

http://finance.yahoo.com/news/HighestYielding-Sectors-indie-1660524582.html?x=0&.v=1

Premise:  Watch for gains:

http://www.zacks.com/research/get_news.php?id=013l1139

This must be a first!  … An analyst Citron agrees with.

You can’t fault Ray Jay for putting an “underperform” on this issue, with a 10 target, when the stock was 22 in May.  Even though Ray Jay was the underwriter for this issue, the facts are just the facts.  However, in the case of a normal stock, a 10 target wouldn’t be subject to depletion.  In the bizarre world of WHX, the two quarterly distributions since the date of that target actually bring it 1.44 closer to zero.  So in current terms, this Ray Jay’s 10 target is really now a market-adjusted $8.56.

Conclusion:

Any valuation above $12,00 for WHX would require a huge leap of faith. (Generally, persistent high oil prices would spur inflation, and would tend to correlate with higher discount rates.)    Based on today’s market, a market-neutral estimate would get you about $8.50, which is right in line with Ray Jay’s 10 target, less the last two quarterly distributions.

Just like GNI, the above articles simply ignore the fatal flaw in their investment premise – that this company has ongoing enterprise value, which it simply does not.

The science of stock picking , which begins by reading the filings is apparently Not Dead Yet.

Cautious Investing to All