Wednesday, July 8, 2009

Harvest Energy Trust: Of The Damned, But Not Of The Doomed

[Note: Corrected:
-currency error and]
-declaration error]

Harvest Energy Trust [NYSE:HTE] is a stock that's been pounded down so much, its chart almost looks like that of a pre-bankrupt. At today's closing price of $4.60, HTE's dropped almost 26% over the past month. Its chart also looks like that of a high-flying high-P/E stock that's announced a "slight earnings revision."

It's neither, though. Harvest currently pays a per-share distribution of 5 cents Canadian per month: about 4 cents American at current exchange rates. This distribution is likely to be continued at the same rate - the company's already pre-announced July's of 5 Canadian cents - so the annual payout can reasonably be pegged at 48 U.S cents/share. Even at its May high of $7.27, it still yielded 6.6% on that basis. As of May 12th, right after it announced its 1Q results, its P/E was 5.3. This company hasn't been out of the Low P/E Bin all year.

The stock looks even more of a bargain when book value's factored in. As of March 31st of this year, net tangible equity is C$10.99 per share or US$9.34. At the current price of $4.60/share, Harvest is selling at a little more than half book value.

Why it's been pummeled comes, ironically, from the reason behind its 1Q '09 earnings and cash flow success. Back in August of 2006, Harvest management was shrewd enough to pick up a downstream operation to hedge its upstream operations. The widening of its 1Q '09 crack spread more than cushioned the collapse of its upstream earnings, which were negative but cash-flow positive. The crack spread has recently collapsed, to the point where Harvest's downstream segment will be barely profitable if its own crack spread equals the current one on the commodities market. Using the company's own figures as found in its quarterly report [.pdf file]and current crack-spread statistics, and adding a margin of safety, I can assume that its own crack spread in the second quarter will be a third of what it was in the first quarter*. Further assuming that 2Q production will be the same as 1Q's, which it won't because Harvest is scaling back its downstream production for maintenance, the gross margin would be chopped by C$120 million**. Its earnings from downstream operations was C$120 million in 1Q '09: if all costs had remained the same and production had not been interrupted, then 2Q downstream earnings would be a flat zero. I'm assuming that the lowered variable costs due to the maintenance will balance out the lowered revenue due to same, so I'm using a guesstimate of zero for 2Q. Since there's no planned third-quarter slowdown, and given the risk that oil, gas and distillate prices will collapse further, this guesstimate could be realistic for 3Q '09. For 2Q '09, it's almost provably overpessimistic.

The upstream consists of 29% natural gas and 5% natural gas liquids. The oil price has gone up considerably, but gas prices have plummeted considerably. A suitably harsh margin-of-safety calaculation would leave 2Q upstream earnings unchanged from 1Q***: C$-44,282,000.

Putting them both together gets a net loss of C$44,282,000, or $38,084,000 in U.S. dollars. That's a loss of 24 cents per share, assuming the number of total shares outstanding remain the same.

Note that I'm assuming that the 2Q results will the the same as indicated by a brute-force calculation using oil, distillates and natural gas prices that are just about the lowest that 3Q has seen. It's unrealistically harsh for 2Q, but it might not be for 3Q. Even if this wildly pessimistic scenario plays out for 2Q, Harvest's book value will only shrink by 24 cents - to C$10.75/share, or US$9.14/share.

Even if the second, third and fourth quarter has the same loss as calculated above, Harvest's book value will be whittled down to C$10.27/share, or US$8.73, by the end of 2009. Its earnings for the full year of 2009 would be -36 cents/share, or about C$-57 million. Harvest's largest annual loss was 2007's -19 cents/share, during a year in which it still paid out monthly distributions on schedule. That's because its cash flow from operating activities, net of capex spending, was positive C$442.59 million. Even with a net loss of C$57 million, a depreciation/depletion estimate of $500 million****, $100 million shrinkage in cash flow due to working capital and non-cash items*****, we still have gross cash flow from operations of C$343 million. Only C$2.632 million of debt has to be paid in 2009. In order to have enough cash to pay out 60 Canadian cents in the year without further drawing on its line of credit, Harvest need only cap its 2009 capex spending at about C$340 million. It's already spent C$122.445 million in the first quarter, so it need only scale its 2Q-4Q capex to 2007's full-year amount [C$198.72] to have more than enough cash to make the 5 Canadian cent per month distribution.

At its current price of $4.60/share, it's selling at 53% of a projected book value using a brute-force calculation governed by quite harsh assumptions+. Put simply, it assumes that the average price fetched for crude, distillates and natural gas in the last three quarters of '09 will be equal to today's prices. Once again, I note that today's prices come on the heels of a recent sharp drop.

To get back to plain English, Harvest has plummeted because the market is assuming 1Q's good earnings news will turn into bad news. In a very simple manner, I tried to anticipate how bad those results will be using a basic calculation with near-doomsday assumptions embedded in it. I still get, at today's closing price, an '09 year-end book value of almost double today's close. Despite the negative earnings that HTE seems destined for in the third quarter, if not the second, Harvest is a dollar selling at a little more than fifty cents - and will stay so at least until 2010 using today's closing price for the stock.

I should warn, however: this stock has been very volatile to the downside. I bought the dollar for my actively-managed Marketocracy mock fund at about seventy-five cents, so I have a huge mock-fund loss on it already. It may well plummet further, and it will almost certainly take its time climbing up. Its current yield is 11.26%. As sketched out above, there's enough leeway for Harvest to maintain its current 4-US-cent monthly payout for the rest of the year.

Oil, gas and distillate prices have been creamed recently because of widely-anticipated drops in demand meeting rising inventory levels. These drops have occurred in the teeth of what could be described as a mild global depression. For Harvest's book value to be gutted, and for it to be sufficiently crippled as to further chop or eliminate its distribution, we would have to see a full-blown deflationary depression emerge. Given where we are now, this outcome is extremely unlikely. In all other cases, Harvest is about a fifty-five-cent dollar with a double-digit yield.


*: Harvest's downstream operations sold 3.321 million barrels of gasoline, 3.494 million bbls of ultra-low-sulphur diesel and jet fuel, and 2.370 million bbls of high-sulphur fuel oil. Its average crack spread in 1Q '09 was $15.18/bbl. I substituted current crack spreads, using the heating oil crack spread for diesel and jet fuel, and got an average of $6.02/bbl. The margin of safety consisted of using the lower crack spread when in doubt, and chopping the $6.02 down to a third of $15.18: $5.06. I also used the current crack spread, not an average over the last quarter, as my goal is to see how pummelled Harvest's earning could be. I'm sure that Harvest's real crack spread in 2Q will be well above the number I got from my brute-force averaging.

**: Its gross margin for 1Q '09 was C$177,231,000 million. A third of that value is C$59,077,000. The difference between the two is C$118,154,000.

***: A brute-force averaging, applied to the percentages of light oil (45%), heavy oil (21%), and natural gas + NGLs (34%) using current prices for average prices, gives revenues equal to 119% of 1Q '09's. If production and all costs remain the same, net earnings from upstream would be approximately -C$14,237,000. I want to be harsh for this exercise, though.

****: 2008's was C$519.81 million; 2007's was C$526.7 million.

*****: This estimate assumes more shrinkage than in 2008, 2007, 2006 or 2005.

+: In order for the less extreme full-year scenario to play out, the global economy would have to not recover in '09. In other words, the assumptions I'm making for the $10 book value calculation would be close to what the deflationist doomsayers were predicting.

No comments:

Post a Comment