Is NEP already buying more drill rigs?

In my previous post, my 2010 projection for NEP, I based my revenue projections for newly acquired Tiancheng Drilling on the assumption that the company was going to operate 7 rigs for the duration of 2010. In figured this made sense to be conservative even if NEP bought more rigs at some point during the year.

I've been looking through the 10-Q again as I work on my long term projections and I noticed that on Sept 30th 2009 the company showed prepaid expenses for:
Deposits paid for puchase of drilling equipment $3,363,753



I can't think of any scenario other then Tiancheng had already contracted to purchase more drill rigs. I have no idea how much one of these would cost, but based on the $12mil in fixed assets they gained buying Tiancheng, I'm guessing a Rig costs anywhere from $1.5-2mil. In this case its possible that NEP is buying 2 or 3 more rigs, assuming a 33-50% prepayment.

Any thoughts or further information on this?

Parabola's reverse hard

Check out the chart below and see if you can figure out what it is:

Can't guess? It's a flipped chart of gold. Notice the clear parabolic action in the past few months. Today we got a panic $60 selloff in gold (rally in this chart). Either we get one more panic buying spree in gold to complete the parabola, or start a sharp downtrend. Regardless of the short term action, I think gold's days are numbered. I think we may be witnessing an irregular ABC flat correction, where Wave-B goes higher than the previous peak. In this case, we will see an extremely sharp counter-move which should break below the Wave-A low. I could see a drop to 600 in gold. This would be excellent to destroy the bullish sentiment that has developed on metals.

Another reason why I'm bearish on gold is that many of the mining stocks are looking ultra-bearish. Take a look at ABX above. Even in the midst of nearly-1200 gold, ABX couldn't make a new high. Furthermore, it has carved out an extremely bearish ending-diagonal pattern. This foreshadows a drop to at least $25, but I would not be surprised to see a drop to $15.

Not Looking pretty

Hang Seng is also looking very, very weak. Good luck out there for longs!

Notice it formed a very clear ending diagonal. This puppy looks ready to crash to at least 19,500, if not start a new leg to retest the lows.

Let's not forget

Let's not forget where we stand in the bigger picture. 10520 in the Dow is a very important resistance, and at the very least, I expect a few weeks downside from here.

The 3-day chart above shows that price is retesting a long-term downtrend line on $DJI. Also, Wave-C = Wave-A at 10,520, so the entire correction may be nearing an end. People seem to assume now that the market won't drop, and that the dollar will continue dropping. Good conditions for a contra-move.

NEP 2010 Earnings Projection

Introduction

Even though we haven't finished 2009, China NorthEast Petroleum (NEP) has given us a solid, yet conservative guidance for Q4, so I am looking forward to 2010 with my projections in this post. I've come up with four scenarios to present, based on what oil prices might do next year. My nature is to be conservative when I create forward looking projections, so just know that when looking at the numbers.

In order to make the projections I've split NEP into their two operating segments, Drilling and Oil Production. We don't have much more information on the Drilling segment then what I presented in my last post on NEP, so I will be basing my estimates mainly on info from the press releases and the 10-Q.
As for the Oil Production numbers, I have been keeping a detailed spreadsheet of NEP's past financial results, as well as projections based on those past results, for two years now. At this point I feel that I have a very good handle on what levels of expenses to expect based on oil production and oil price levels. In my projections I won't be showing all the details, just the projections for producing wells, average oil price, revenues, and net income. But know that these numbers come from my more detailed spreadsheet.

Lets quickly look at the major factors to consider when projecting revenues and expenses. This only applies to the oil production as for Tianchiang I've simply assumed they will drill 220 wells, receive about $185k per well, and have a 30% profit margin.

Revenues
Obviously the main consideration is the average oil price. My brother (see his last post here) and I believe that the US Dollar will strengthen in the coming months, and I also expect the US to relapse into a 2nd recession next year, so I'm not one of those people expecting oil over $100 again next year. The other factor is the level of production. I've assumed increasing production as the year progresses based on NEP's stated plan to add another 60-70 wells.

Expenses
Cost of Sales:
Production Costs: NEP incurs about $5/barrel
Depreciation: This numbers ran between $9.50 and $10 per barrel in 2009.
Government Oil Surcharge: China charges a tax on on oil revenues when oil is higher then $40/barrel. This tax starts at 20% and increases to 40% on the price over $60. See NEP's explanation on page 29 of their 10-Q
General and Admin:
NEP has low G&A costs. Typically they have about $1mil in general operating costs, and then another $750-1000k interest and amortization expenses on the loan they received in 2008.
Taxes:
NEP's tax rate this year has been about 32%.

Scenarios:
Now that we've gone over my assumptions, here are the four scenarios:

1. Oil stays in a tight band all year between $60-70, averaging $65 each quarter (extremely unlikely but a nice base scenario). In this case NEP would have about $1.21 EPS in 2010.


2. Oil moves down in the first half of the year and then back up, but finishes next year lower then it is today. This is my favorite conservative projection. In this case NEP would have about $1.07 EPS in 2010.


3. The world enters another serious recession and deflation hits. Oil drops from current levels to about $35/barrel in the 2nd half of the year. I really doubt this would happen, but wanted to put it in to show that NEP will still earn about $.60 EPS even in this "shit hits the fan" scenario.

4. Continued inflationary pressures and a greater concern by the market that peak oil has arrived pushes prices up throughout the year to end 2010 at about $100/barrel. This would be ideal for us and NEP would have about $1.45 EPS in 2010 if this happened.


2010 NEP price expectations

Having been invested in this great company for two years now, I have come to realize that the stock will never move like you would expect it to. Still, 2010 seems primed to become the company's best year yet, and thus I do expect the stock to have a nice run-up in the next 12 months. Assuming that NEPs meets their projections of $.80/share in 2009, today we have a stock with a TTM PE of 6.5 ($5.20/$.80), that will likely earn between $1.05 and $1.10 next year even if oil drops 15% from today's prices, and will earn $.60 even if oil tanks back down to early 2009 levels.
I find it hard to believe that we will still sport a PE under 10 in a year (although its not impossible), so I think that we should see this stock hit $10 by next fall. that's a 100% gain from today's levels. If more institutions find the stock and it gets on a roll, it would not be out of the question to see a PE of 15-20 on it, which would move the stock to $15-20. This is what all of us owners are dreaming about, but I'm certainly not expecting this yet.
Of course, caution is also warranted because if oil prices move down to the $35-40 range again, I'm sure we could see this move under $3.50 again, and possibly down to $2.50. Just know that at that level you'll be picking shares up for 4x their worst earnings potential.

The bottom line is that this a very well managed company that isn't taking crazy risks in order to increase their stock price. Management is clearly thinking long term and I believe that that in 10-15 years any stockholders that have held the stock the entire time will be very happy, but I will go more into that in my next post.

EUR/USD breaking down

As I mentioned in this post, I thought that the EUR/USD would continue to weaken because of the divergence that it was showing against the US Dollar index. We've had choppy downward action, and I think we're getting ready to start the fast phase of the decline. Watch 1.46 as a downside pivot.

You can see in the daily chart above that EUR/USD finally closed convincingly below the uptrend line that has been supporting price action since March. Unless we get another quick spike back above the trendline, I think we'll be in for continued weakness. Keep an eye out on this.

NEP's newest addition, Tiancheng Drilling and Oil Services

On October 1st, China Northest Petroleum (NEP), announced that they acquired another company, Tiancheng Drilling Engineering Co. Ltd. As NEP put it in their press release, the "Acquisition Expands Company's Vertical Integration Within China's Oil E&P Industry." At the time I was interested to see the purchase, but also curious as to what the net financial effect would be, so I decided to wait until the Q3 10-Q before coming to a conclusion.

In the initial press release we received some nuggets of info on the new company and what it might add to NEP's overall revenues and earnings. Some highlights are listed below:

-NEP paid $13mil in cash for the entire company
-Seven rigs in operation.
-320 employees
-Capacity to drill 220 wells annually
-One of three PetroChina- licensed private drilling operators
-NEP has not utilized Tiancheng for drilling services in the past.
-2008 revenue of approximately $14.7 million, net profit of $5.2 million
-cash flow positive from operations.

For me the two key points from this release were the $5.2mil profit and the fact that they were also cash flow positive from operations. $5.2mil is extremely good considering it only cost $13mil to buy the whole company, so I wondered if perhaps 2009 was not being so kind to Tiancheng and thus I couldn't wait for the 10-Q to come out.
On Monday we were finally able to see Tiancheng's results during the first nine months of the year, and NEP also provided us with some addition pieces of information about their acquisition throughout the 10-Q. I've copied some from pages 28-29 below:

"Tiancheng enters into drilling contracts with PetroChina and other private oil companies to provide oilfield drilling services, and generates revenue based on the depth of each well drilled for clients. Clients will typically pay 30% of the total projected drilling costs as a down payment to start the drilling process, and pay the remaining balance within 12 months according to the specific contract term.

In the first nine months of 2009, Tiancheng has completed contracts to drill 80 shallow wells, which include 74 wells for state-owned PetroChina Jilin Branch and six wells for non-state-owned Daqing Shunwei Energy Development Co. Ltd. The total drilling depth accomplished this year is 105,896 meters (~347,428 feet), with the revenue of $14,700,455 and net income of $4,820,661 or $0.22 in fully-diluted, pro forma EPS for nine months ended September 30, 2009. Tiancheng currently has existing contracts to drill 86 additional wells, and more contracts are under negotiation to increase the utilization of rigs and continue to grow sales revenue"

Page 8 also shows the combined 3-month and 9-month results of the two companies. Below are three tables showing revenues and net income for NEP and Tiancheng as separate entities, and then results of the combined company if the transaction had occurred at the beginning of 2009.

A couple things also popped out at me looking at the numbers:
1. through the first 9 months Tiancheng completed 80 wells, generating $14.7mil in revenues, or about $185k per well.
2. NEP expects to generate about $13mil in Q4, which would mean completing 70 wells if the average revenue per well stayed the same.

It will be interesting to find out how almost as many wells will be done in the 4th Q as during the rest of the year. I assume that they are fully booked at the moment and that earlier some of their rigs were not being fully used, or perhaps some of the rigs were only purchased mid-year. Another possibility is the fact that drilling can be difficult during the rainy season.

What is clear to me is that this was a phenomenal purchase by NEP's management. Not only does this diversify the company's source of revenues, the purchase also increases the top line of the combined company by about 50% and the bottom line by 65% for 2009 (using Q4 est provided)!! NEP now has another steady source of cashflows that will allow it to continue its expansion program even if oil prices fall into the $40s again.


PS: Watch for my 2010 pr0jections post coming in the next couple days.

NEP update after 3Q results

China Northeast Petroleum (NEP) announced their 3rd Q earnings this morning, along with 4th quarter and full year guidance. As usual, the company set another quarterly production record and had solid positive earnings.
In this post we will examine the company's performance over the last few years. I am also working on a 2nd post which will present my projections for the company in 2010 and future years.

I have had a substantial (for me anyways) position in this stock for two years now and what has been very interesting for me to see is that so far the performance of the actual company has far outperformed the stock performance. That is pretty impressive considering that the value of my position has doubled.

Historical Performance

The table and chart below show actual results for NEP's last 15 Qs, as well as projected data for the 4th Q09 based on estimates provided by the company in their recent earnings release. It is important to note that the estimates for Q4 DO NOT include projected revenues ($13mil) and net income (est about $4.6mil) of NEP's newest acquisition, Tiancheng, an oil drilling and services business. I have expressly left this new source of revenue and income out of the Q4 Est in order to show only the oil production results. The new company will be an important source of new revenues which I will discuss in the 2nd post.

Q4 estimates assume $65/barrel average oil prices based on the Mean of Platts Singapore index during the months of Sept, Oct, and Nov (this is because NEP is paid the previous month's price for oil delivered each month). This index requires a paid subscription, but thanks to Nawar on the Yahoo MBs, we can use the average price of Cinta crude on the Indonesian Crude Price index as an appr0ximation (recently Cinta has been about $1/barrel higher then the MOPS price received by NEP as per their recent 10-Q).



The company has clearly done an excellent job exponentially increasing both revenues and net income over the past four years. This growth has come mainly due to a 12-fold increase in production, with some help from higher oil prices. During the middle of 2008 the company was clearly helped by record oil prices, but it also proved that it could earn a reasonable profit even with oil averaging $40 as it did in Q1 2009. As can be seen by the chart below (courtesy of Stockcharts.com), investors were worried that the company would have serious issues making a profit on $40 oil, driving the price of the stock down to $1.25/share in March 2009. An $.11 EPS for Q1 2009 was enough to show investors that their fears were unfounded, and subsequently the stock price moved from $1.25 to over $5 in the next three months.



Today the stock trades at $5.16, with TTM earnings of $.78/share, meaning that the company trades at a trailing PE of about 6.6. Not a bad deal for a company whose revenues and earnings are both at least 12 times higher then they were 3 years ago.

In the next couple days I plan to post my projections for 2010 earnings, as well as look at what we could expect this company to look like in 5-10 years.

If anyone has any questions they would like answered in the next post or comments, feel free to leave them.


PS: Thus far, I have not fulfilled my part of the plan my brother and I had when we started themarketbrothers blog. Going forward I am planning to continue making contributions. You'll notice quickly that my posts will tend to be more fundamentally oriented, while my brother prefers technical analysis.

US Dollar Index Divergence with EUR/USD

A week ago, I noted that /DX had made a lower low while many of the major currencies in the basket which comprise the USD index did not make similar higher highs. Today, the divergence continues, and until it is canceled, it looks like /DX could have a serious rally in store.

The above 1h charts are /DX on the left, and EUR/USD on the right. Notice again that EUR/USD has yet to breach the previous high, whereas /DX has clearly breached it twice now. This is bearish divergence for the EUR/USD, and looks bullish for /DX, as long as EUR/USD does not rally to new highs.

MON Update

Just an update on Monsanto (MON). After breaking through a bearish channel, MON has retested this breakdown zone on a short-covering rally inspired by a reaffirmed guidance from management. This is a picture perfect opportunity to add to shorts. If price closes above the trendline for 2-3 days, then it's time to consider covering. Thus the exit strategy on the downside could be to cover if price breaks above 78.71 and closes above the trendline.

WTF???

/DX made a new low today. Only 1 other major USD pair has made a similar move (GBP/USD). The other major pairs, especially the heavily weighted EUR/USD, have not reflected this new low in /DX. I don't know what to make of this, but it seems that there are some short term manipulations in play, because it is not possible for USD to be at a new low when 5/6 other currencies don't reflect this. This could imply that /DX is washing out the bulls before a strong blast-off.

The top-left chart is /DX. Notice it made a new low. Clockwise from /DX, you can see EUR/USD, GBP/USD, USD/CAD, USD/CHF, and NZD/USD. Was GBP/USD's breakout really strong enough to bring the whole /DX index to a new low? Seems doubtful to me.

Edit: USD/JPY and USD/MXN (two other relatively import trade partners used to calculate /DX) are also both high off their lows.