Investing Into a Crisis — Value Investing or Simply Being Contrarian?
I had an advantage in the case of the BP oil spill in that I already knew the Gulf of Mexico players pretty well thanks to my ownership of ATP Oil and Gas prior to the spill. While my ATP holdings took a beating I was able to buy Stone Energy (SGY), Ensco (ESV), Cobalt (CIE) and Diamond Offshore (DO) with some confidence at very nice prices because I knew the companies pretty well. But often I’m pretty unfamiliar with the companies impacted by a crisis so the decision making is difficult.
Reuters had an article today discussing value investing amidst panic:
Investors who bought BP's stock and bonds when oil was spewing out of its well in the Gulf of Mexico a year ago made a killing in a classic example of turning panic into profit. And in this case it was probably more about smart risk-taking than contrarian luck.
If you had invested in BP at its low point on June 25 — the day British Prime Minister David Cameron suggested the company could be destroyed by the spill — you would now be looking at a return of more than 65% in U.S. dollar terms. It would be even greater but for a dispute threatening its $18 billion tie-up with Russia's Rosneft.
Yields on the company's short-term unsecured notes blew out beyond junk levels to more than 15% from less than 1% in early 2011 but are now back below 1%.
It is a similar story with other companies linked to the disaster. Rig owner Transocean (RIG) is up 80%, Halliburton (HAL), which provided the cement work for the well, has soared 121%, while the manufacturer of the rig's blowout preventer, Cameron (CAM), is up 64%.
Minority shareholders in the BP well are also higher — with Anadarko Petroleum (APC) gaining 123%, and Mitsui (MITSY) up 45% in dollar terms.
It is not unusual, of course, for investors who seek out stocks that have been hammered more than they deserve to jump in during a crisis like this one.
But knowing when to buy and when to leave well alone takes a strong stomach. If investors call it right they end up with a stake in a valuable brand at a ridiculously low price, but get it wrong and they are stuck in a so-called value trap — a cheap stock that is going to get a lot cheaper as the news worsens.
"There were a lot of things working right in this one and what was working against investors was investor psychology," said Glenn Tongue, a portfolio manager at T2 Partners, a hedge fund that made several large bets on BP during the crisis.
Tongue argues that buying BP's shares as they went into free-fall was not just a roll of the dice but a calculated risk.
He said that was far different from the investors who lost their shirts by buying cheaper bank and financial stocks in the months before the financial crisis destroyed some of them.
An estimate of costs based on other spills, BP's profitability and asset base, its importance as one of the world's largest companies, and the chance it could hive off U.S. assets during litigation made BP a good bet, says Tongue.
A year after the spill, BP estimates its likely liability to be $42 billion, far less than the $100 billion that was wiped off its market value at the height of the crisis.
But when the panic was in full swing most people were not prepared to take the risk. BP's shares fell more than 55 percent as the crisis worsened following the explosion on the Deepwater Horizon rig on April 20.
Talk of bankruptcy, years of litigation from local businesses and property owners, and irreversible environmental damage sent most investors scurrying for the door. But there were pickings for the hardy.
UNCERTAINTY AND FEAR
In June, Bill Gross, the co-chief investment officer of PIMCO, the bond giant, said he had bought $100 million of short-maturing BP notes and some Anadarko Petroleum debt, capitalizing on widespread distress in the sector.
At the time Mark Kiesel, head of the corporate bond portfolio management group at PIMCO, argued that the junk yields on investment-grade stock reflected uncertainty and fear of political intervention rather than credit-worthiness.
T2 Partners scaled into BP's stock, buying half when it hit the mid-$30 range around June and using call options to pick up the remainder in the high $20s. That makes for a gain of around 60% on the lowest-priced buys to its post-crisis highs.
"Basically our calculus was to look at comparable situations, see what the costs of those were, then look at what the market capitalization loss of BP was," said Tongue. "In our estimate they were out of sync."
Tongue says they also had a "second bite of the cherry" when the stock fell into the mid-$30s for a second time in late August after the well had been capped.
Tongue has scaled back his BP position but says he is holding out for north of $50 per share that he believes is its intrinsic value. BP's stock is now trading at around $45.
T2 Partners also bought General Electric Co. stock when it slid in the wake of the Japanese earthquake on fear it could face liability over reactors it designed at the beleaguered Fukushima nuclear plant, but they have steered clear of plant operator Tokyo Electric Power Co (TEPCO).
"In a nuclear crisis it is hard to get your hands around the true facts of what is happening," Tongue said.
TEPCO's shares plunged more than 80% after Japan's earthquake on March 11, but recovered part of those losses in the past week and a half.
"I think we had a pretty good handle on what's leaking in the Gulf. I don't know what's leaking in Asia and I don't know what the ultimate liability profile will be," Tongue added.
In the case of GE, it is different. Its risks are seen as limited as Japanese law channels liability for nuclear accidents to the plant operator, and U.S. courts are often reluctant to award damages for accidents that happen overseas.
Barry Ritholtz, director of equity research at Fusion IQ, said buying BP was a far cry from trying to catch falling knives like Lehman Brothers and Bear Stearns as in those cases toxic assets and leverage made wipeouts possible.
"These were ... risk-embracing daredevils and the amazing thing is that they all didn't crash and burn sooner," he said. "Every bubble leaves behind a usable infrastructure which is what value players buy, the exception is financials."
Ritholtz says investors need to do more than look at value. BP may have seemed extraordinarily cheap with a price-to-earnings ratio of 5.5 compared to more than 11 before the crisis, but that does not mean it cannot get any cheaper.
"There is no magic answer to it; it is a qualitative decision," he said.
"There are always these three factors: figuring out what's going on in the world, identifying the variants versus what everybody else believes, and then wondering when will people figure out they're wrong and here's the right analysis."