In the extended bull market of 2021, value investors may still have an opportunity to find upside by investing in what are known as special situations.
Special situations are unique corporate events such as mergers, recapitalizations and spinoffs. They can have an impact on a company’s stock price and create gains, regardless of fundamentals or market direction.
“This category produces more steady absolute profits than [undervalued stocks] do,” Warren Buffett wrote in his 1964 letter to investors. “In years of market decline, it piles up a big edge for us …”
A current devotee of special situations is Harris Kupperman, founder and president of Praetorian Capital Management. His fund soared 127.5 per cent in 2020, bringing its average annual return to 9.1 per cent since inception in 2003 (unaudited figures).
Valaris is the world’s largest offshore contract oil and gas driller. “I like the offshore segment because it has been harder hit than the onshore segment, and it has less restrictive regulation,” Mr. Kupperman said.
The company emerged from bankruptcy in May after holders of its US$7-billion debt accepted equity. The dilution caused by the new shares put downward pressure on the stock price, providing value investors with a chance to buy at an even greater discount.
Valaris now has a clean balance sheet and cash of more than US$500-million. New contracts were announced in recent quarterly reports. ARO Drilling, the joint venture with Saudi Aramco, is also expected to provide important drilling contracts.
Calfrac Well Services provides hydraulic fracturing and other services to oil and gas firms. The company’s enterprise value is currently less than the replacement cost of equipment, Mr. Kupperman said.
“Pressure pumping is an awful business,” he added. Calfrac recently exited bankruptcy and converted most of its debt into equity. Second-quarter results were disappointing, but company guidance points to a recovery in the second half of 2021, he said.
Thungela Resources, a thermal coal miner, went public in June after Anglo American spun it out to shareholders. Many of them had ESG (environmental, social and governance) mandates, so initially many investors sold their shares.
“At one point, the company was valued only a few per cent above the net cash balance,” Mr. Kupperman recalled. It was around that time that he bought shares.
He doesn’t think that Thungela should be avoided over ESG issues. A Black African management team and thousands of South Africans are employed there. It is also a supplier to new power plants equipped with technologies that significantly reduce CO2 emissions.
Major Drilling Group provides contract drilling services to mining companies. The balance sheet is strong, and while a shortage of skilled workers is preventing a portion of rigs from deploying, management should soon rectify the situation.
Now that commodity prices have increased, miners will want to catch up on years of deferred exploration and mine development. Indeed, Major Drilling’s past two quarterly reports disclosed that inquiries for its services were increasing.
Valaris, Calfrac, Thungela and Major Drilling are still buys, in Mr. Kupperman’s opinion. They were already cheap because of their depressed sectors – then they got cheaper and/or better fundamentals because of recent corporate events.
The oil and gas sector has been out of favour since OPEC flooded the market with supply and drove prices down to put fracking firms out of business. COVID-19 and the growing influence of ESG investing handed out more setbacks. Yet demand is now on the upswing as governments stimulate economies and vaccines work on taming COVID-19. And with the price war won, OPEC can now be more disciplined in holding back supply to support prices.
As for the mining industry, it has underspent on existing mines and exploration for more than a decade, Mr. Kupperman pointed out. Mine depletion exceeded reserve growth in almost every year since 2008. In short, valuations were quite low to begin with.
Want more from Mr. Kupperman? A believer in Francis Bacon’s observation that “writing makes an exact man,” he spins off ideas and data into his Kuppy’s Event Driven Monitor and blog at adventuresincapitalism.com.
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