Robert Rodriguez has been the manager of the FPA Capital Fund and the FPA New Income Fund since their inception in 1984. He primarily invests in small and mid cap companies, selecting stocks on a fundamental basis. He looks for strong balance sheets, good free cash flow numbers, an understandable business strategy, capable management and unique business characteristics. His portfolio typically contains 25-45 equities and his investment outlook is 3-5 years. Compared to other investors, Rodriguez is relatively more conservative, usually keeping a good portion of his assets in cash when there are not enough undervalued stocks available. His FPA Capital Fund's 10-year cumulative return of 172.9% easily outperformed the S&P 500's cumulative return of 16.4% during the same stretch. In the past decade, Rodriguez has been very bullish on energy stocks and he shared many of his thoughts in his shareholder letters. His current portfolio reveals that his three largest holdings are all in the oil and gas sectors: Rowan (RDC), Ensco (ESV) and Rosetta (ROSE).
The Energy Sector
In his Sept. 30, 2005 letter, Rodriguez stated that he has been "very optimistic about the outlook for energy stock prices for several years because of the likelihood of rising energy prices." He notes that oil and gas prices have exceeded price expectations and sees it as an indication that world energy supplies are losing their cushion, calling it a "fundamental change... whereby the period of low energy prices has ended and a new one has begun with considerably higher prices on average."
In his Sept. 30, 2006 letter, Rodriguez continues his discussion on energy stocks, noting that despite the appreciation in price of energy stocks, energy only represented 10% of the S&P 500, in contrast with the 22% financials weighting. He shrewdly mentioned that he would "prefer to be invested in energy rather than in financial services," perhaps predicting the financial crisis that would occur a couple years later.
He warns that within the next five years, Mexico, China and Russia may all reach their peak in oil production, as decline rates for production in some of the major oilfields have exceeded initial expectations. Rodriguez states that "at current levels of drilling for oil, we are using up and not replacing 67% of our oil consumption or about 55 million barrels per day. This last point is one of the primary reasons we have focused our investment on oil drilling companies because current levels of drilling will not sustain current production. Exploration and thereby drilling for oil must increase to keep production levels from declining over time."
Finally, Rodriguez discusses the ongoing changes in oil supply and demand. He cites ExxonMobil's estimate that by 2015, as a result of the depletion of existing fields and growing demand, the petroleum industry "needs to add 100 million barrels per day... four times the current level of production being added. If correct, this should be a boom for the oil drilling industry." He also predicted exploration activity to increase, with overall rig day-rates rising. Meanwhile, with the increasing demand from developing BRIC economies and continued high U.S. per capita oil consumption, higher oil prices will be inevitable, a factor that has not yet been factored into stocks.
In his most recent shareholder letters, Rodriguez provides a follow up to his portfolio's energy sector stocks. He notes that oil investments act as a "backdoor way to participate in global growth and emerging markets," as developing markets are driving oil demand. He also notes that that stocks hedge against inflationary pressures, as " oil in the ground and equipment used to produce it are real assets that are likely to provide a store of value against potential future monetary inflation." Nevertheless, Rodriguez has trimmed some of his oil investments, as increased valuations have emerged due to the cyclical nature of the industry warranting the reductions. He currently has 20% of his assets in cash and 52.2% of his equity holdings in oil and gas.
Rowan Companies Inc. (RDC)
In the fourth quarter of 2006, Rodriguez owned 2.2 million shares of the Rowan back when it was traded for just under $34. He slightly increased his position in 2007, adding 170,500 shares, but the price of the stock declined sharply in late 2008 down to around $17. Rodriguez stayed steady with his holdings, adding 430,000 shares at the lower valuation and the price has since recovered to its 2007 levels. He currently owns 2,853,300 total shares of Rowan, representing 10.84% of his equity portfolio. The stock closed today at $35.88.
Rowan Companies Inc. provides onshore and offshore oil and gas contract drilling services in the United States and internationally. The company offers its contract drilling services through its fleet of self-elevating mobile offshore drilling platforms and deep-well land drilling rigs
In 2006, Rodriguez wrote in his shareholder letter that he believes "the offshore-drilling business environment is extremely attractive currently and we expect this trend to continue for a very long time." As a result, he increased his position in Rowan, as "the company has no net debt while selling at less than 10x this year’s earnings. With a shortage of jack-up rigs internationally along with a balance between demand and supply in the Gulf of Mexico , offshore drilling day rates are extremely attractive for Rowan."
Rowan's second quarter report this year revealed revenue for the quarter was $223.5 million, down 21% from last year's $282.2 million due to lower average day rates offsetting higher activity from rig fleet additions. Gross offshore drilling margin was 53% of revenues, down from last year's 63%. The company indicated that rig start-ups impacted its financial performance in the quarter, with many having been delayed due to more rigorous regulations and unrest in the Middle East. Overall net income from continuing operations for the quarter was $44.4 million, down from last year's $83.4 million. However, the company sold its manufacturing business during the quarter, generating an additional after-tax gain of $424.5 million.
The company has been focusing exclusively on its core offshore drilling business, having completed the sale of its manufacturing division for $1.1 billion and reaching an agreement to sell its land drilling division for $510 million in the quarter. It expanded its fleet by ordering two ultra-deepwater drillships and commenced operations in the North Sea as well as entered the Southeast Asia market. Offshore rig utilization increased over to 70% from last quarter's 65%, though this is down from last year's 75%. Over the past three months, backlog of drilling revenue commitments increased to $2.6 billion.
Rowan has a market cap of $4.4 billion. The stock trades with a P/E ratio of 7.2, below its six-year average. Its P/S ratio is 2.6, roughly consistent with its six-year average. Its P/B ratio is 1.0, below its six-year average. The company has strengthened its balance sheet over the past four quarters after debt-to-equity spiked to .457 in late 2010, reducing it to.271, though this is still higher than its declining 2007 and 2008 values. The company also generated its lowest free cash flow numbers in years at a loss of $536 million, though this was offset by its sale of its manufacturing division. GuruFocus has awarded Rowan a 3.5-star predictability rating.
Ensco Plc (ESV)
In the fourth quarter of 2006, Rodriguez owned 2.3 million shares of Ensco back when the stock traded just under $50. In 2008, the stock's average price peaked to $71.35 and Rodriguez slightly reduced his holdings by 180,000. Soon after, the price of the stock plummeted to $27 and Rodriguez sold another 280,000 shares. In his most recent move, Rodriguez slightly added to his position, purchasing 30,200 shares at an average price of $55.09. He currently owns 1,900,800 total shares of Ensco, representing 10.75% of his equity portfolio. The stock closed today at $48.21.
Ensco International Plc, formerly ENSCO International Incorporated, is a provider of offshore contract drilling services to the international oil and gas industry. The Company owns and operates drilling rigs including jackup, ultra-deepwater semisubmersible and barge rigs. The Company provides drilling services on a day rate contract basis. Under day rate contracts, it provides the drilling rig and rig crews and receives a fixed amount per day for drilling the well. Its customers bear substantially all of the ancillary costs of constructing the well and supporting drilling operations.
According to Ensco's second quarter report, revenues in the quarter were $564 million, up over last year's $411 million. However, $151 million of the $153 million increase was related to the Ensco's acquisition of Pride International in a cash and stock transaction on May 31. Both contract drilling expenses and G&A expenses increased in the quarter as a result of the Pride International acquisition; excluding its impact, contract drilling expenses decreased $14 million and G&A expenses decreased $4 million. Overall, net income attributable to Ensco was $101.9 million, down from last year's $126.3 million, with earnings per share decreasing from $0.89 to $0.59.
The company's average day rates in deepwater and jackup decreased year-over-year, although the Pride acquisition added a midwater drilling segment to Ensco's operations. Rig utilization for deepwater increased from 77% in the first quarter to 86% this quarter, though this is still down over last year's 91% utilization. Rig utilization for jackup increased from 72% last quarter to 75% this quarter, flat over last year. Midwater drilling operated with 79% rig utilization. The company maintains over $9 billion in contract revenue backlog. During the quarter, the company's new ENSCO 8500 Series rigs operated with 99% utilization.
Ensco has a market cap of $11.1 billion. The stock trades with a P/E ratio of 16.8, slightly above its six-year average. Its P/S ratio is 6.2, also above its six year average. Its P/B ratio is 1.0, consistent with its recent two-year average though under its six-year average. The company has a debt-to-equity ratio of .473 as a result of its acquisition, a tremendous increase from its under .1 values between 2008 and 2011. GuruFocus has awarded Ensco a 4.5-star predictability rating.
Rosetta Resources Inc. (ROSE)
Rodriguez held more than 4.4 million shares of Rosetta back when the stock was trading for $18.30 in 2006. When average price fell to as low as $5.80 per share in early 2009, Rodriguez did not sell, instead adding 75,700 shares the next quarter at an average price of $8.00. Since then, the price of the stock has increased and Rodriguez has slowly unloaded his shares, selling more than 2.7 million shares in 2010 and 2011 at average prices ranging from $16.32 to as high as $45.60. He currently owns 1,819,091 total shares of Rosetta, making up 9.95% of his equity portfolio. The stock closed today at $47.11, more than double its 2006 price.
Rosetta Resources Inc. is an independent exploration and production company that engages in the exploration, development, production and acquisition of onshore oil and gas resources in the United States. It owns producing and non-producing oil and gas properties in South Texas, California, the Rockies and the Gulf of Mexico.
Rodriguez first added Rosetta in 2005, noting in his third quarter, 2005 newsletter that it was a semi-public/private entity at the time. Rosetta acquired the energy assets of a company going bankrupt that desperately needed liquidity. Rodriguez called these assets "under-utilized" and "not actively developed," and after talking to management, reached the decision that the company could be very profitable. He was able to acquire his position at less than 4x estimated pre-tax cash flow and less than 8x earnings.
In his second quarter, 2011 newsletter, Rodriguez specifically mentioned Rosetta as having a strong quarter, increasing production from 7mcfe/day to 90 mcfe/day in its Gates Ranch location and making up 60% of the company's total production. He notes that "the economics of these wells are extraordinary," as "each well, on average, should recover 7.2 bcf per resource of oil and natural gas. This translates to a per well PV-10 of over $13 million." He continues saying Rosetta may have more than 250 wells to drill in its Gates Ranch location and other valuable assets elsewhere in its Southern Alberta Basin locations. He notes that the balance sheet has "improved significantly with debt coming down from $350 million to $250 million." Despite the stock's recent upward movements, "the economics of the Gates Ranch area, the potential in other areas in the Eagle Ford and the Southern Alberta Basin, leave room for further upside."
According to Rosetta's second quarter report, revenues were $11.6 million, up over last year's $68.6 million, with 58% of revenue generated from oil and NGl as compared to 31% last year. Net income soared to $25.4 million, up over last year's $4.3 million, riding on a 20% increase in production to 161 MMcfe/day. The increased production was largely a result of production growth from the Eagle Ford shale, up from 29 MMcfe/day to 129 MMcfe/day. Oil, condensate and NGLs averaged approximately 12,300 Bbls/day for the quarter, almost tripling last year's 4,300 Bbls/day. Estimated proved reserves doubled the prior year's estimates, from 479 Bcfe to 970 Bcfe. As well, the company plans for 85% of capital spending to be directed towards developing its activities in the Eagle Ford shale.
Rosetta has a market cap of $2.5 billion. It has a P/E ratio of 56.0, way down over its past year's triple digit numbers. Its P/S ratio is 6.5, above its four-year average. Its P/B ratio is 4.5, also above its four-year average. As Rodriguez mentioned earlier, its balance sheet is strengthening, with debt-to-equity at .457, its lowest in more than two years.
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