BWEN Breaks Out!

BWEN (Broadwind, Inc), has been in the process of forming a multi-month base, and recently broke out to the upside on good volume. This is looking like a strong stock!

On the fundamentals side, Congress recently renewed the ARRA 30% cash grant for renewable energy projects for one more year, so that should provide good support for wind turbine manufacturers like BWEN.

BIDU Blow-off Continues

I prematurely posted about BIDU going parabolic a month ago. The rally continues, but keeping an eye on the bigger picture makes me think that the rally will soon run out of steam.

The monthly chart above shows how extreme the rally has been. Notice that after 17-18 months of strong rallying, BIDU has now blasted off in a classic blow-off formation.

The more interesting phenomenon appears on the daily chart. Notice that BIDU has recently consolidated in a triangle formation, and triangles often precede the final move in a trend. Furthermore, there is MACD divergence forming. So I believe that when this up move finishes, BIDU will begin a multi-month downtrend.

Why Sadar Biglari's proposed compensation package from BH is a fair deal for investors

After being invested in Steak and Shake (SNS) last year from $5.80 to $9, I've continued paying attention to them. Today the company has changed its name to Biglari Holdings (BH ) and trades at $320 (They reverse split 20-1, so its $16 when compared to my shares).

I noticed that their stock price has dropped from as high as $418 in early April, and wanted to see why. Apparently one big reason is because of the new proposed compensation package for the CEO, Sadar Biglari. Here is the gist of it:

1. Biglari is selling his other company, Biglari Capital, to BH for $1. Biglari Capital is the general partner of The Lion Fund, L.P., a Delaware limited partnership that operates as a private investment fund. The Lion Fund manages about $50mil, and Biglari Capital was paid 25% of any returns over a 5% annual hurdle with "high water mark" stipulations.

2. In return, Biglari would now be paid an incentive bonus based on the increase in Book Value of BH. Again there will be a 5% annual hurdle before any bonus is paid out, at which point his bonus would be 25% of the gain in excess of 5%. There is also a "high water mark," stipulation in place. Finally, Biglari would be required to use 30% of bonus money (at least 50% after taxes) to purchase BH shares within the next 120 days after issuance.

Thus far, investors have been screaming bloody murder on the message boards and even well respected (by me at the very least) NFI has sent a letter to BH against this package. However I feel that this package is quite fair and that investors will actually end up quite satisfied with their returns if Biglari makes a lot of bonus money. Let me go over my logic:

There are three main ways BH book value will go up:

1. Profits from Operations

2. Increase in the value of company investments

3. Purchase of other companies through issuance of stock

The first two ways are clearly beneficial for investors as in the long run the stock price will follow if the company's value increases in those ways. The third way is where investors could be hurt, because new stock being issued to purchase another company would potentially dilute current investors, yet possibly create a situation where Biglari could receive a bonus. However, I believe that Biglari will only use stock to purchase other companies when they represent a good long term value because he holds a lot of BH stock and the value of his shares would fall by more then his potential bonus.

Here's what BH's book value has been the last 5 years:



Now lets look at how investors might benefit long term vs how much Biglari will benefit. In the chart below I've assumed that Biglari delivers earnings of 10% of Book Value each year, giving him a bonus of 12.5% of the increase in Book Value.


As you can see, investors do quite well for themselves, pocketing 8.75% yearly gains, while Biglari receives a yearly bonus in the $3-4mil range. I feel like many CEOs at publicly traded companies make quite a bit more whether or not they deliver long term performance figures that would be as solid as these.

I think it is clear that Sadar's long term plan is to emulate Buffet and Berkshire Hathaway. He will take cash from Steak and Shake and other future acquisitions and plow it into investment opportunities which he feels will yield higher then 10% returns. I bet that in a few years the bulk of the yearly Book Value increase will be due to the increase in the value of investments owned by the company. At that point, one could consider BH to be a hedge fund, and Biglari's bonus to be his management fee. Personally, his fee structure is much more appealing that the typically 2%+20% of profits.

Disclosure: Don't own any BH at the moment, but seriously considering buying some right now.

NEP's earnings restatements - What do they mean?

If you are like me, then you've been trying to figure out why NEP has had so many issues with their accounting, and what those issues actually are. A couple weeks ago I got a good lesson about how and why companies have to take a loss based on the change in fair value of warrants. Today I read up on the other big write-down, which is related to the impairment of oil properties.

NEP had to take a $13.2mil impairment charge on their oil properties in Q4 of 2008, and another $13.8mil charge for Q1 of 2009. I did not understand what these were for, but after doing some reading up on the subject, I think I understand what happened.

In short, accounting rules require companies to make sure that the capitalized oil and gas properties as listed in their balance sheet are not higher then the current "SEC" value. This value is figured out by the company based on their current proved reserves, current oil price, and expected future production schedule. If the oil and gas assets are higher then their current "SEC" value, then the company must immediately write-down the difference and take it as an expense in the current quarter.

What this means is that if oil prices plunge, as they did in Q4 and Q1, then the "SEC" value of oil and gas properties will decline, and thus an impairment charge might be necessary. In NEP's case this resulted in a $27mil combined charge for the two quarters.
What is interesting about this charge is that the company cannot add back to the value of the properties later on if oil prices do go back up, which we know they did. Thus the company has charged off $27mil of its oil assets which would usually have been taken over a period of years as Depletion.

So what does this mean?
NEP's future stated income will be higher because there will be less future depletion expenses.
We also know the NEP's future stated income will be higher when the warrants are exercised.

When all is said and done, nothing has changed operations wise for NEP. They accounting department clearly needs some improvements, but I would argue that they actually hurt themselves more then anything because the company paid about $7mil more then it needed to in income taxes over the last couple years due to their understating non-cash expenses.

Updated NEP Q4 and 2010 projection

China Northeast Petroleum (NEP) announced their preliminary Q4 production and drilling results today. The results were slightly better then their projections back in November, which I have come to expect from the company as they do a great job of giving solid yet conservative projections. Below are the results for both divisions of the company:

Oil Production

Back in November I projected that the company would produce about 231,000 barrels based on how many new wells they were projecting to add. The company managed to add 5 more wells then expected and must have also completed them more quickly, because actual production was 236,774, about 2.5% higher then my projection. Oil prices during Q4 were also higher then NEP's estimate of $65 for their projections. If we use the average Cinta monthly price from to approximate the price NEP will receive, they should average about $70/barrel for Q4, which translates to revenues of about $16,575mil. Assuming approximately 30% profit margin, their operating profits from production should be about $5mil.

Drilling Services

Tiancheng completed drilling contracts for 60 wells with total drilling depth of 99,161 meters (325,331 feet) in the fourth quarter of 2009. This is very impressive considering that before NEP acquired it, the company had only drilled 80 wells totaling about 106,000 meters during the first three quarters of the year! Assuming that their revenue per meter remained the same in the 4th Q, revenues will be about $13.75mil. Thus I expect profit for this division to range from $4.6mil to $5mil, depending on the profit margin.

Combined Q4 Results

Overall, the company should announce revenues between $30mil and $30.5mil for Q4. Before all the restatements that will happen, I would have projected net income to be somewhere from $9.5mil to $10mil, or about $.35-.36 EPS for the Q. These numbers are clearly better then the estimates I came up with in November. It's nice to see the company continuing to impress in their operations.
Restatements and Potential Dilution

Unfortunately, because of the restatements that NEP will have to do, it will be harder to compare results. Personally, I don't like the way that FASB requires companies to handle in the money warrants because it actually makes it much harder for potential investors to analyze past results. Hopefully the company will do a good job breaking out their operating earnings from the expenses they will be taking on the warrants. I wish I had an idea of how much it will be, but looking at the information given in the press release only made me realize that I have no idea how to figure out the potential impact. I do expect it to be quite large though because we saw the price of the stock almost double during Q4.

One thing that the restatements did cause me to do was to look back through NEP's previous quarterly reports to figure out exactly how many warrants and options are outstanding and at what prices. As of 12/31/09, NEP had 27,715,818 shares outstanding. We know that Lotusbox exercised another 867,438 warrants in January, which I've assumed is all the exercising that will occur in Q1. If I'm correct, then below are all the remaining options and warrants which have not been exercised.



Updated 2010 Revenue and Earnings Estimates

Based on their results and on oil prices so far this year, I have updated my 2010 estimates to reflect my current expectations. I've increased the number of wells I expect NEP to drill in 2010 from 65 to 70, as well as increased to average oil price from $65 to $70 (note that Q1 oil prices are already set at about $73/barrel).
Finally, I've assumed that Tiancheng will drill 100,000 meters each quarter and get paid about $138/meter.



If we throw a PE of 10 on NEPs non-diluted EPS, the price of the stock would be about $13.50. Throwing a PE of 12-15 on their fully diluted EPS would lead to a price of $14-17.50. I think that by the end of this year NEP will be trading above $15 unless we see a tremendous drop in oil prices again like what happened in the late 2008.

Please feel free to post any questions or comments

NEP is still undervalued

The title above may come as a surprise considering that this blog's last couple posts have been decidedly negative towards the prospect of further price appreciation from NEP. But its simply explained by the fact that my brother and I have a difference of opinions on NEPs future returns.

My brother is technically right when he says that "long-term (1-3years) share-price prospects for NEP are substantially lower at this price", but NEP will still have excellent returns going forward, especially on a longer term horizon (5-10 yrs). Will it return 5288% in the next 3.5yrs? NO. So in that sense my brother is right. Still, I think that it will still return at least 25%+ per year over the next few years.

My brother is a chartist and based on the chart I too agree that this move from $5 to $10 has happened very quickly and at some point I think we will see a substantial correction. But this correction might not happen until the shares reach $11, 12, or even $15. I did finally take some profits because NEP had become 75% of my portfolio, but I still hold most of my shares and plan to for a long time if the underlying business continues to improve like it has over the last several years.

I took a quick look at NEPs historical earnings on Morningstar. Their combined profit from 2004-2006 was about $.03/share, or 1 cent per year. This year we expect earnings to be $.73, and for them to jump to $1.20+ next year. So I would argue based on this that the price of the stock still has catching up to do, since its "only" up 5288%, while earnings are up 7200%.

I've spent some time the last several days creating a detailed long term valuation model for NEP. It's close to being finished, but I'm trying to figure out how to post the data succinctly in an easy to follow way. However I will post a couple main points now:

- Based on what I believe was a conservative scenario which assumed no further leases are signed and only slow growth in the drilling segment, NEP has a Present Value of $13/share if you apply a discount rate of 15%. This means that an investor wanting to receive a 15% annual return on his investment from now until 2022 would be will to pay $13/share assuming that NEP issued their free cash flows back to him each year.

- I will post details later this week, but its important to realize that this valuation assumes that management will fail to acquire more leases or other value-adding acquisitions. Management has proven to be quite good over the last few years, so I believe that there will be new acquisitions within the next year or so that will add more value.

- I assumed that oil prices would only increase by 7%/year over the next 13 yrs. I think they will in fact increase much more, which would also increase the PV.



The Bottom Line is that while I agree with my brother that the price of the stock is becoming extended on a technical basis and may retrace a portion of the incredible gains we have seen this last month, NEP is most certainly still UNDERVALUED. Thus if your horizon is longer then a few months, I feel confident that the stock is still a good purchase at $10/share. Just don't go all in.

You be the Judge

I stand by my previous hypothesis that the long-term (1-3years) share-price prospects for NEP are substantially lower at this price. Is this not a parabolic chart?

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?

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.

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.