Sunday, 18 November 2018

ARE MALAYSIAN OIL AND GAS COUNTERS WORTH TRADING? WE DECIDED TO FIND OUT

A few things in life are inevitable. Among them are death, taxes, and Bursa Malaysia's oil and gas stocks simultaneously going up (and later, down). It's hard to anticipate, but you will see it when it occurs. It can be driven by something totally sentiment related, or it can be based on underlying fundamentals of the companies. But they are cyclical, and many of us do not truly understand what this means.



The most popular oil and gas counters on Bursa Malaysia currently are the downtrodden, money losing companies who were kings in the glory days of US$100 oil but are now burdened by onerous debts. In some cases, they are unfairly valued due to sentiment. In others, their operating models are fatal in the long run; too much leverage, but too little cash flow to show for it. They are doomed to issuing ever larger rights issues to fill their cash deficits, resulting in ever larger dilution of shares.


This is the fate faced by these companies, specifically firms with exposure in the upstream oil and gas segment.


But a cyclical sector such as oil and gas always provides new opportunities. There are moments when you can buy any counter indiscriminately to capitalise on the catalyst. Alternatively, there are instances where an internal catalyst in the firm's business turns it into a value investing opportunity. And there are  also those crazy times when you can just buy DIALOG without thinking of these trading and short termist angles. Seriously, just buy DIALOG.

 How can you disagree with a doctor? Check out his slides.


But in this post we will focus on a few of these upstream firms and how their stocks react to external, or internal, stimuli.


But first, a brief digression on global crude oil prices.


BRENT/WTI : SHOULD YOU CARE?


The short, uninformed answer is yes: you must always pay attention to crude oil prices. But they are only effective as indicators up to a point. That's the thing about catalysts; they are temporary.


The oil market is notoriously cyclical, and are fundamentally dictated by the supply and demand situation. They are also influenced by real secular trends; cycles can take as many as 20 years to complete the boom and bust phases. The most recent ones? Six years (2008 to 2014) and close to three years now from trough to recovery (2014 to the second quarter of 2018).


Business planners and budgeting managers at the oil and gas companies you know and love so much do not look at absolute prices of crude oil on any given day. They look at the quarterly or (if they are smart) annual average prices for crude oil.


The upstream segment is an inherently risky business; you're basically forced to guesstimate / anticipate the long term price trajectory of crude oil. You then commit to invest vast sums of money on assets that you hope will generate enough cash flow to pay off existing debts.


For companies with oil and gas vessels (ships, drilling rigs, tender rigs, floating storage offshore production rigs, and other exotica), they will go into debt to finance these rigs, and then generate cash from these assets to pay off long term debts. Residual income will be counted as profits, if any, after excluding operating expenses.


In an environment of steadily rising oil prices, this business strategy works wonders. Higher demand for upstream services brings charter rates for these ships through the roof. As crude oil becomes more expensive, companies can make a lot of money from fees gained for their services. This is the upcycle.


Guess how it's been from March 2016 onwards? Source.

But then the obvious happens (you do realise what cyclical means, right?). In an environment of steadily falling oil prices, the business model is turned on its head. Now your debt load and repayment obligations are rising faster than cash flow generated from the assets you have. Your interest payment on the debt for this quarter is RM50 mil, but your company doesn't earn enough to repay this amount.


The debt load keeps mounting, and you're hurt at the same time from lower demand, hence lower charter rates. If it gets bad enough you may have to essentially go bust, or perhaps find drastic solutions to raise equity. (Editor's Note : Or if you're in Singapore, your company will go into a bankruptcy-but-almost-not-really stage).


In other words, assuming the debt level and asset value is the same,


Oil price upcycle: High debt and leverage + High demand for assets financed with those high debts   = value creation

Oil price downcycle: High debt and leverage + Low demand for assets financed with those high debts = value destruction


Which brings us to the present day and the state of these once loved oil and gas stocks. Just to give you a clue as to the impact that it has had on Malaysian upstream firms: one was unceremoniously dumped by its parent company, another lost billions in market cap but still rewarded its founders richly, yet another had to drastically reinvent itself by acquiring oil fields, and another was caught in a two-year turmoil with shareholders before finally establishing itself as a serious oil and gas firm.


As a group, Malaysian upstream oil and gas counters most definitely have lost at least 70% of their collective market cap over the past three years (Editor's Note : DIALOG and YINSON being the clear exceptions) ; we're talking about tens and tens of billions of ringgit in value lost. But just recently we were finding ourselves in a rising oil environment. Each day brings news about crude oil being the highest since such and such (highest since the big fall in 2014, to be precise).


PART I : OCTOBER 2018


Just to give one example, indiscriminate buying of oil and gas counters tends to happen when this type of news comes out:


This is what indiscriminate buying looks like. This is a list of top traded stocks by volume from 2 October at 12:30PM, or the midday break. More than half of the companies you see here are upstream oil and gas counters (and their company warrants).



We're sorry to say that this is not a post about trading oil and gas stocks profitably. Consider this a handy reminder that the boom and bust cycles are fleeting. One month everybody's cherishing oil and gas counters; the next month investor sentiment is totally destroyed. And we mean this literally, as you can see below.



The definition of volatility, wild sentiment, and boom-bust: Brent Crude Oil price per barrel chart, mid-August to 17 November, 2018. Source.





GET TO KNOW THE CYCLE

Indiscriminate buying is temporary, and in case you don't already realise this, they will be followed by indiscriminate selling in the short term. There will have been a large number of speculations and uninformed investors chasing this easy angle. If you're one of these people, here's our message: if you want to chase the latest and hippest trends, go open your Pinterest account, not your Bursa Malaysia trading account.


We have found that any extensive buying activity in oil and gas stock, specifically as a reaction towards oil prices reaching new highs, is extremely short lived. The average timespan is less than two weeks (10 trading days), or the typical contra period for speculative capital to flow in the market.


At the same time, those holding these counters are exposed to the volatility in crude oil prices. If you bought these stocks simply as a proxy for crude oil prices, you will be king for a day, but a pauper for the rest of your life. You're exposed to the volatility in the stock, as well as volatility in the commodity. And unless you're a wizard at predicting the movement of crude oil prices - you're not - you're exposed on both sides (the volatility of the stock as well as the commodity).


In other words, don't simply buy oil and gas counters as proxy to current oil prices. We think it's a dumb move, and we're also referring to ourselves as we've made the same mistake before.


PART II : THINGS GO SOUTH QUICKLY


Remember Part I? Well here are the headlines barely a month and a half after the whole world was rejoicing the new dawn of constantly higher crude prices.





To get back to our original point, this is a lousy cycle to trade. Although it's fairly well-known that HIBISCUS and REACH are the stocks most susceptible to movements in crude oil, due to their oil-producing asset owner status, we thought it's worth putting a selection of oil and gas counters into a comparison chart.


Black is Brent Crude (ICE prices), with HIBISCUS and REACH represented in orange and blue respectively. The two stocks closely follow the trajectory of Brent, with a similar decline of around 15% over the past month.


Note that DIALOG's movement is fairly benign, while SAPRNG started from a low base due to its already low stock price due to other issues. PETRON, another downstream player, is largely influenced by their earnings performance, it seems.





The point is this : it's not worth buying HIBISCUS and REACH if you consider them proxies to crude oil price. Whether in an upcycle or downcycle, speculative capital flows means that their upward movement is not sustainable in an environment of weak oil prices. Even if you buy them to express a long term bullish viewpoint on crude oil prices, your timeframe may be as long as two years.


To know how bad the impact of the recent bust in crude prices has been, check out the following closing prices for selected upstream oil and gas counters on 16 November 2018. These are the ones you can compare with the 1 October prices.


You can see here that the one-and-a-half month decline is between 20% and a devastating 50% or more (look at BARAKAH in particular).  There is little earnings-related sentiment here; we believe that these purely reflect the shift in crude prices for the most part. And for the majority of the companies listed here, in the long term it hardly matters if oil prices go up; they are encumbered by huge debt loads and assets that are not really performing.





So when is actually a right time to buy into oil and gas counters? To put it simply, there are two options.

1) Buy when the stock is experiencing a price shock. We traded this angle profitably with SAPNRG.

2) Buy when crude oil itself is experiencing a price shock. If and when this happens (like in late 2014, or some say, right now), there is still downside to the oil and gas stocks that you see above. If bad enough, even solid companies like DIALOG can come under pressure. The shock must be bad enough that fear overwhelms reason. And when that happens, it is time to buy into fear.










Thursday, 1 November 2018

MARKET SIGNAL : HOW WE ANTICIPATED SEACERA'S 50% PRICE INCREASE IN 4 DAYS





We're going to share with you one of our market signals for buying into a stock that has the potential for double-digit percentage gains. Within about... four days, as we will demonstrate. There's a catch though; the market signal is just a fraction of what makes a profitable trade. Other things you'll have to learn on your own; trading execution, gumption (the courage to deal with extreme price movements), how to manage your bladder, et cetera.


To us, the market signal (or a trigger to start trading a stock) was blindingly obvious. But the market may not be operating on logic sometimes. Investors may be late in processing important market moving information. Or market conditions may be so bad that nobody cares how good the news flow is. The lesson is this : signals are just that. They may never be 100% accurate, but they can lead to excellent returns on investment, if wisely applied.


The market signal is this :


When a stock falls due to extreme selling pressure by major shareholders, it's time to buy into it. The selldown is temporary, and a price recovery is almost assured within a limited timespan. The buying opportunity is especially attractive if the stock fell steeply and hit new lows.


That's it; we just laid it out on a platter for you. All the best and go make your millions.


Do you trust us or this guy? Link to buy his book.



OK, there's actually a lot more to it than that. To elaborate, we will use as an example a recent trade that capitalised on this angle. For the record, we have established a fairly successful track record on trading this very opportunity, just to prove that this was not a one-time lucky break.


Which companies, how successful they are, or which sectors do not matter at all with this market signal. Profits that can be derived are arguably lower-risk, and possibly has a higher profit potential, than the bad news-driven volatility trades that we occasionally throw ourselves into.



THE BLINDINGLY OBVIOUS PART 


If there's one concept that forms the bedrock of Pelham Blue Fund's strategies, it is the notion of artificial mispricing. Over the years, we have repeatedly committed large sums to trading this theme in our investment activities. We have thrived from the really successful trades, and suffered from losses that were necessary for us to constantly refine our understanding of it.


To simplify, we'll divide artificial mispricing into two columns. The focus for this post is on the second type.



To identify the blindingly obvious trigger to trade the stock, we will walk you through our recent trade in SEACERA from the very beginning with limited information, to the very end when we were managing our profitable exit points.


PHASE 1 : IDENTIFICATION

As a trader, you must always have an eye for weird or interesting movements in the stock market. Some people binge watch Netflix; we watch the movement in the stock markets and chill.



On 26 October, 2018 SEACERA caught our eye with its monumental price decline and heavy trading volume. The stock fell from 24 sen to 18 sen within hours, or a 25% loss. And this was the day after it had already fallen by 20%!

 Notice the timestamp.


We know (as should you) that such a thing almost always happens in reaction to really, really bad news. But there was nothing to speak of in SEACERA. There was no major scandal. It still has tangible assets. There was nobody being accused of fraud or 1MDB type things. It was loss making and has a heavy short term debt load, but those would not necessarily explain the big move downwards.


At this time, we were left with uneducated guesses. We considered two possibilities:


1) Some loss of major contracts, given the company's closeness to the previous government and government-related contracts.

2) Share sales by major stockholders for one reason or another.


We have experience in trading stocks which possessed the characteristics of either (1) or (2). On the morning of 26 October, we have no inkling on which is which, and there was zero news report or speculation on the company itself.


So to start with, we decided to trade the stock based on pure technicals. The stock had fallen 48% in two days. It easily broke through the 20 sen mark; typically a support point with normally heavy buying interest, but the selling pressure drove the stock further downwards.


We actually built up a position at around the 17 to 18.5 sen mark, with a view towards short term profit taking when the stock recovers. We believe that a stock that falls steeply (by 48%) has the potential of at least making back 10% of the loss; it's similar to our '5% down 1.5% up' rule. The risk profile of such trade is moderate, with what we assumed to be limited downside.


Yet our position moved south quickly, causing us to be somewhat concerned. By this point, perhaps Netflix and chill was the better option. We made the sensible decision to cut our losses and exit the trade as SEACERA closed at its lowest point that day (15.5 sen). We also knew that this outcome would not deter us from re-entering at some point, perhaps when there is more clarity in this situation.


We couldn't bear assuming the position and the risk over the weekend; if some really negative announcement comes out, none of our rules or trading signals matter. It would mean that the extreme selling was justified, and as private information becomes public, another avalanche of selling would have commenced. We stood to lose our capital, our shirts, and the chance to start life anew on the curbsides of downtown Kuala Lumpur.


Daily price chart in SEACERA, 26 October 2018. That's a new NINE-year low. 


But this did not happen. So the following Monday, our diligent and always curious stock exchange operator decided to ask the company outright, "what the hell is going on?". We did not anticipate the query; we have seen many stocks fall steeply without inviting as much as a flying kiss from Bursa Malaysia. 


We are fallible and not very thorough sometimes, but earlier that morning we had a cursory examination of the Bursa Malaysia filings by SEACERA. It appeared that their major shareholders have been selling shares actively since the beginning of the month, not just in recent days. We thought, "Hmm... maybe that's the reason?" (Editor's Note : If we were smarter and more diligent, we would have checked this last week).


A disclaimer : We neither know or care about the reasons behind the selling, only that it was happening. Major shareholders sell their shares for many reasons; cashing out, margin calls, etc. What we care about is whether this would fully explain the stock price's steep. If it does.... we smell opportunity (Editor's Note : In general, it is very unlikely that major shareholders would ever sell stock ahead of bad news, given our strict securities laws on insider trading. Nobody really wants to go to jail).


THE TRIGGER 

By this point, when the query was made - lunchtime, 29 October - we had an idea of where this is going. We only had to anticipate two crucial things that will determine whether we should re-enter this trade:


1) SEACERA's reply to Bursa Malaysia (which typically has to be made within the same day the regulator's query is made).

2) How the stock reacts to the reply.


Of course, we had no idea of knowing when the reply would be made. Most of the time it would be made after market hours. But SEACERA decided to have its stock suspended from trading from 3:03PM to 4:03PM on that day. It was going to reply during market hours. (Editor's Note : an easy explanation is that when a company's stock declines rapidly and receives a regulator's query, it is incentivised to reply as soon as possible, in the hopes of halting the decline and provide clarity to concerned investors)


The reply was sort of what we expected and was very revealing. This is the trigger for us to determine our next move.


This was an admission, and confirmation, of that we seek the most: the stock is merely down due to selling activity. Artificial mispricing confirmed.


We then retraced the steps taken by the stock earlier that day. From a close of 15.5 sen last Friday, it actually opened strongly at 17 sen and never really looked back. During the morning trading session on Monday, it hit an intraday high of 19.5 sen before retreating to close at 17.5 sen at 12:30PM. Opportunity smelled.


We formulated a basic plan to re-enter the stock. We would prepare for the resumption of trading in SEACERA by 4:03PM. We wanted to observe the price activity of the stock in reaction to this disclosure. We suspected that this will positively propel the stock upwards, but we needed that confirmation. So, first things first: we will see how the stock behaves during the first 15 minutes of trading after it resumed.

5-minute chart in SEACERA, 12:25PM to 4:50PM, 29 October 2018.

Turns out we didn't have to wait 15 minutes. Notice that long green candle right after the stock resumed trading? That was enough for us to go in decisively. We bought 200,000 shares at the 18.5 sen and 19 sen mark. By doing this, our position is hedged by a 'profit buffer' once it reaches 20 sen, again supposedly the support point. That one sen-per share profit is a crucial element in determining our longevity in this trade.




At the same time, we strongly suspected that the stock would go much further. The realisation that the stock is artificially mispriced merely allowed us to go into the stock sooner. The market may be slower in realising this, but once it does, there will be strong buying and sustained support in SEACERA, assuring us of profits. (Editor's Note : No prizes for guessing whether this outcome turned out exactly as we anticipated or not)


... this outcome turned out exactly as we anticipated.


BUILDING UP THE POSITION + WEATHERING VOLATILITY

To stay invested in a momentum stock - especially one that moves fast with extra volatility - you have to be able to handle the fluctuations.


Our simple philosophy is : once a market trigger is identified, it's  OK to stay invested in the stock. (Upward) momentum is assured as long as buying interest (high volume) is sustained.


On 30 October, SEACERA, which closed at 20.5 sen the day before, dipped to an intraday low of 18 sen before quickly recovering. Such deviations are normal for momentum stocks. The recovery itself is an additional market signal; the market is buying, and buying big.


The next signal to confirm our anticipations : the stock staged a late rally to close at its intraday high of 21 sen. We had earlier purchased an additional 50,000 shares amid these fluctuations.

Since we tweeted this, the stock has gained.... 47%.


Over the next two days, the stock continued to rise. On 1 November, we conservatively sold our positions at 24 and 24.5 sen for a 20% return on investment - solid work for four days, if you can find them (Editor's Note : Yes, we know it went all the way to 28 sen. We got our profit targets met; we never try to guess the peaks).


Yup.


This trade turned out to be a best-case scenario trade for us; a strong rally during a contra (T+4) period where we did not have to pick these shares up, as it turned out. This following chart pattern demonstrates what we mean.

 Perfect momentum. As of 12:30PM, 1 November 2018.


We have to point out that the stock was on everybody's radar; we sure many profited from this trade over the past four days (it was the top traded stock on the exchange pretty much every day of this week), with little else but intuition and an appetite for a good bet.


But we do think it's better to have a plan. Without a step-by-step process to capitalise on a market signal, we would not have had the opportunity to buy into the stock at a good price. Without the conviction that the signals are real, we would not have been able to accumulate such a large block of shares. And without understanding momentum and volatility, we would not have been able to hold on to the position.


By mastering the three main building blocks of trading - identification, execution, and trade management - it is much easier to replicate the same strategy for future trades. These are the kind of trades we live for, and they're worth the trouble.


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