Flags for shortselling

As value investor, it is also important to know the other side and how short sellers select their targets. Several are related to fundamental business analysis as below.

  1. Competition – When a strong threat appears and take away market share
  2. Commodity Trap – When the product of the business becomes a commodity with little differentiation other than price. Short sellers often look for premium products to eventually become commodities. When this happens, profit collapses and the stock price
  3. Loss of major customer – This happens when a business has a few key customers and it lost one of these.
  4. FADs – the product is a fad. Technology companies can fall under these such as Atari.
  5. Regulatory actions – When a bill is passed that is unfavorable to the business
  6. Delayed Financials – When a company has to delay their reporting. Shows problems with internal controls and sometimes accounting frauds.
  7. Unexpected loss
  8. Dividend cuts
  9. Reverse split
  10. The end of growth
  11. Failed business model
  12. Declaring war on shorts – Short sellers are often encouraged by these
  13. Resignations of key management
  14. Hype
  15. Aggressive mergers that might up the risks and debts
  16. Family ties – when many different family members are running key management positions
  17. Significant insider selling
  18. Unfavorable Auditor’s Report
  19. Unreasonable management pay
  20. Management not able to achieve stated plans
  21. Quarterly deterioration in cash balance

A common idea is to short sell before the 4th quarter as the first 3 can be unaudited.

Typical type of stocks to short

  • Blue chips
  • Growth stocks
  • Cyclical
  • Speculative

Flags to look out for in financial statements

  1. Cash Per Share = (Cash + Marketable Securities) / Share Outstanding
    • A short seller will calculate the burn rate which is the average quarterly reduction in the cash balance.
  2. Accounts Receivable
    • Check allowance for doubtful amounts. A low ball account will boost receivables as well as profits
    • An increasing trend of accounts receivable might be a red flag.
    • Another metric is day sales outstanding = (Ending Receivables / Credit Revenue) x Number of Days in the Period. A good gauge is comparing with the industry and competitors.
    • Short sellers will also look at the discrepancies between sales growth and accounts receivable. An example is when sales growth is lesser than accounts receivable growth.
  3. Inventory
    • Change in accounting for inventory that might increase the gross profit. Eg. if a company changed its accounting valuation method from FIFO to LIFO. Basically, if inventory costs increases and a company wants to understate this, it can move toward FIFO. This means that the first items purchased will be the first ones included in determining the value of inventory.
    • Discounts and write-offs are major red flags especially in retail
    • Inventory turnover ratio = Costs of Goods Sold / Average Inventory. Red flag if ratio increases over time.
    • Days sales of inventory = Ending Inventory / COGS x Days in the Period. Red flag if there is rising over time and is 20 percent longer than industry peers.
    • Growth trends in raw materials that might eat into margins if the finished product price trend is slower than that of raw materials.
  4. Soft assets
    • Check is there current expenses that are accounted into assets.
  5. Goodwill
    • Large amount of goodwill might indicate aggressive acquisitions that might lead to higher risks
  6. Long Term Assets
    • Reasonable depreciation
    • Change of depreciation method from acceleration to straight line.
    • Did company lengthens the term of depreciation
  7. Liabilities
    • Liquidity ratios – Current Ratio (Current Assets / Current Liabilities) should have a 2:1 ratio. Quick Ratio (Current Assets – Inventory) / Current Liabilities should not be below 1.
    • Debt Ratios – D/E should not be more than 70 percent in general except for certain industries. Times interest earned ratio (EBIT/ Interest Expense) which give a sense of a company’s ability to pay off debt is often used by banks in making loans. If the ratio falls below the specified level, the company will be in default and the bank has the right to require the repayment of the loan.
    • Watch out for special liabilities such as the corporate pension. A short seller might get concerned if a company increases the average return which will understate the overall pension liability.
    • Another note is off-balance sheet liability often in the form of a new venture known as special purpose entity which companies like Enron used to cover their tracks. A special ratio (Balance Sheet Debt + Off-balance Sheet debt)/ Equity. Short sellers will look at the growth of this ratio over time as well as a comparison to industry peers to look out for companies doing aggressive accounting.
    • Look out for warranties which can be a potential liability if their product fails.
  8. Company Bond Prices
    • A lower bond price of 90 percent and below might indicate some problems. Below 80, means investors are concerned.
  9. Z-Score
    • Z-Score = 1.2a + 1.4b + 3.3c + 0.6d +1.0e, where
      • a = Working  capital / total assets
      • b = retained earnings / total assets
      • c = earnings before interest and taxes (EBIT) / total assets
      • d = equity market capitialization / total assets
      • e = annual sales / total assets
    • The higher the Z-score the better it is. If the Z-score hits 1.8 or lower, then the company is in trouble and there may be a short-sale opportunity.
  10. Equity
    • Large and growing negative retain earnings
    • Growth Rates higher than ROE which might suggest that the company has not enough cash flow to finance its growth
    • Toxic Private Investment in Public Equity (PIPE). Can refer to 8-K which can dilute shareholders.
  11. Common-size financials
    • A frame of reference in analyzing financial statements. Eg. Accounts receivable percentage as of total assets.
  12. Income Statement
    • Recognized future contracts upfront causing inflated income
    • High bill-and-hold policy where company will invoice a customer but retain the goods in the warehouse
    • Broker recognizing the whole sales amount as revenue
    • Key metrics for retail/restaurants
      • Same-store sales or comparable store sales
      • Average revenue per store
    • Aggressive vendor financing
    • Spike in revenue without new product launches or major customer contracts
    • Low gross margins compared to competitors.
    • Honey-pot accounting
    • One-time charges (recurring “restructuring” costs, write-downs)
    • PEG > 1.7
    • Current PE / Forward PE > 1 = bullish. If it’s too much above 1, it can be too optimistic and a sell-down can occur if the business condition changes.
  13. Cash flow statement (Net income + Depreciation = Cash Flow)
    • Risky large cap-ex
    • Decreasing Operating cash flow margin: Operating Cash Flows/Sales
    • Factoring (Selling accounts receivables for less than the full amount)
    • Consistent negative cash flow after acquisitions
    • Unhealthy Day’s Sales of Payables: Accounts Payable / (Cost of Goods sold X Number of days in the period)
    • High volatility in operating cash flows
    • Low Quality of Earning (QE) ratio (less than 0.5): Operating Cash Flows / Net Income
    • Low Cash Flow Efficiency (less than 1): (Current Assets – Cash and Cash Alternatives) / (Current Liabilities – Short-Term Debt)
    • High valuation based on high growth for DCF valuation

Suitable Variables to identify candidates for short-selling

  • High D/E > 0.5
  • Days Sales in Receivable Index (Annual Change in the day’s sales in receivables)
  • Gross Margin Index > 1 (ratio of gross margin over the past year)
  • Asset Quality Index > 1 (ratio of non-current assets over the past year), company could be deferring costs to inflate earnings
  • Sales Growth Index > 1 (ratio of sales over the past year), company may be subject to accounting manipulation
  • Depreciation Index <1 (ratio of depreciation over the past year), company many be aggressively changing its depreciation policy and assumptions to improve profits
  • M score above -2.22

Possible S&P stocks in bargain territory

Just saw a recent report highlighting the underperformers in S&P


Personally, I think some companies are worth researching more ->AAP, AZO, KR, TSCO, LB, APA, MAT, AKAM, SLB
Some reasons why I am interested in these few
AAP – just went through acquisitions that might see margins improving, positive insider transactions
AZO – Best margins among competitors
KR – unusual bullish call options at strike 25
TSCO – Recommended across different analysts and its business model sounds good to fend away Amazon
LB – Strong brand
APA – Some reports indicate possible turnaround in their assets in the later half of the year
AKAM, MAT – positive insider transactions
SLB – Market leader

Which one do you think is the best value?


Cheat Sheet Metric

The following highlights the important metrics for the various sub-sectors

  • Cruise lines – Net Yield
  • Defense – Backlog
  • Consumer goods such as shoes – Product order and growth
  • Gold – extraction costs
  • Drugs – Pipeline (patent starts during pipeline)
  • Restaurant – Same stores sales, Food costs
  • REITs – Occupancy rate, forward rental yield
  • Tech – Book to bill yield
  • Banks – Return on Assets, Non-Performing Loan, Loan ratios, P/B
  • Telco – Subscriber Retention Rate
  • Media – Advertising Dollar
  • Hotels – Occupancy rate, Room rates

Company Conference Calls to note for global economic health

Federal Express just announced its conference call and FedEx is known as the bellwether of the global economy. In its latest quarterly announcement, it was forecast of above 2% growth in the global economy and there was also a rise in packages and volume sent in the last quarter. So far so good and it looks like the bull still has some room to run.

So what other companies earning is important to note for global economic health?

A simple check will be the top constituents in the MSCI Index. As of this writing, it’s as below

  • General Electric (In particular the sales in China to estimate the growth in second largest economy)
  • 3M Co
  • Siemens
  • Honeywell International
  • United Technologies Corp
  • Union Pacific Corp
  • Lockheed Martin Corp (Would exclude this as it’s in the defense sector)
  • United Parcel Service
  • Caterpillar (This is a good gauge as the items are big ticket items and does reflect corporate optimism in the industry)


Industrial Industry


  • Diverse – Both in where the companies are and in the end markets served
  • Tends to be economically sensitive
  • Highly correlated to broad markets
  • Tends to have lower profit margins

Sector Drivers

  • Corporate Spending – Economic strength, Corporate financial health, access to cheap capital
  • Construction spending in turn driven by
    • available market supply,
    • real estate prices,
    • vacancy rates,
    • consumer spending,
    • financing conditions and tax incentives,
    • regional economic and population growth and demographics,
    • input availability
  • Beneficiaries of increased construction spending
    • Aerospace and Defense (heating systems, air con, elevators, security systems)
    • Building Products
    • Construction and Engineering
    • Commercial services such as waste management services
    • Industrial Conglomerates
    • Machinery
    • Transportation Industries
  • Beneficiaries of increased manufacturing
    • Electrical Equipment
    • Industrial Conglomerates
    • Machinery
    • Trading companies & Distributors
    • Transportation Industries
  • Transportation Equipment demand is primarily driven by an overall growing economy and industry profitability. Major industry beneficiaries are:
    • Aerospace & Defense
    • Industrial Conglomerates
    • Machinery
  • Industrials exposed to commodities
    • Construction and engineering
    • Industrial Conglomerates
    • Machinery
    • Marine
    • Road & Rail
    • Trading Companies & Distributors
  • Government Spending
    • Defense Spending (Aerospace & Defense, Construction & Engineering, Machinery, Industrial Conglomerates)
    • Infrastructure Spending (Machinery, Construction & Engineering, Industrial Conglomerates, and Electrical Equipment)
  • Capital Goods’ industries make up the bulk
    • Wide sector weights deviations can occur from country to country
    • Concentrated in relatively few large players
      • Market values of the largest firms outweigh global peers by far
      • Barriers to entry in some industries
      • Government involvement in some


Industrial Classification

based on https://www.msci.com/gics

Capital Goods Aerospace & Defense Aerospace & Defense

Manufacturers of civil or military aerospace and defense equipment, parts or products. Includes defense electronics and space equipment.

Defense companies mainly found in US and dependent on the size of US defense budget. Defense backlog often include

  • Fixed price contracts
  • time-and-materials (fixed hourly wage)
  • cost-reimbursable contracts (fixed fee and reimbursement for allowable costs)

Aerospace companies manufacture non-defense related commercial airplanes and other industrial goods. Mainly duopoly of large aircrafts but extremely competitive with emerging countries designing new planes.

Building Products Building Products

Manufacturers of building components and home improvement products and equipment. Excludes lumber and plywood classified under Forest Products and cement and other materials classified in the Construction Materials Sub-Industry. Competition is a major issue due to limited barriers to entry. Demand is driven primarily by residential and commercial construction and remodeling activity.

Construction & Engineering Construction & Engineering

Companies engaged in primarily non-residential construction. Includes civil engineering companies and large-scale contractors. Excludes companies classified in the Homebuilding Sub-Industry. Projects usually take years and awarded based on their technical expertise, prior track record, and bid competitiveness.

Electrical Equipment Electrical Components & Equipment

Companies that produce electric cables and wires, electrical components or equipment not classified in the Heavy Electrical Equipment Sub-Industry.

Demand for both mainly driven by global industrial production and capacity utilization levels, corporate capital expenditures and manufacturing capacity investments (upgrades, expansions, new facilities, etc).

Heavy Electrical Equipment

Manufacturers of power-generating equipment and other heavy electrical equipment, including power turbines, heavy electrical machinery intended for fixed-use and large electrical systems. Excludes cables and wires, classified in the Electrical Components & Equipment Sub-Industry.

Industrial Conglomerates Industrial Conglomerates

Diversified industrial companies with business activities in three or more sectors, none of which contributes a majority of revenues. Stakes held are predominantly of a controlling nature and stakeholders maintain an operational interest in the running of the subsidiaries.

Machinery Construction Machinery & Heavy Trucks

Manufacturers of heavy duty trucks, rolling machinery, earth-moving and construction equipment, and manufacturers of related parts. Includes non-military shipbuilding.

Agricultural & Farm Machinery

Companies manufacturing agricultural machinery, farm machinery, and their related parts. Includes machinery used for the production of crops and agricultural livestock, agricultural tractors, planting and fertilizing machinery, fertilizer and chemical application equipment, and grain dryers and blowers.

Industrial Machinery

Manufacturers of industrial machinery and industrial components. Includes companies that manufacture presses, machine tools, compressors, pollution control equipment, elevators, escalators, insulators, pumps, roller bearings and other metal fabrications.

Trading Companies & Distributors Trading Companies & Distributors

Trading companies and other distributors of industrial equipment and products.

Commercial  & Professional Services Commercial Services & Supplies Commercial Printing

Companies providing commercial printing services. Includes printers primarily serving the media industry.

Environmental & Facilities Services

Companies providing environmental and facilities maintenance services. Includes waste management, facilities management, and pollution control services.  Excludes large-scale water treatment systems classified in the Water Utilities Sub-Industry.

Office Services & Supplies

Providers of office services and manufacturers of office supplies and equipment not classified elsewhere.

Diversified Support Services

Companies primarily providing labor oriented support services to businesses and governments.  Includes commercial cleaning services, dining & catering services, equipment repair services, industrial maintenance services, industrial auctioneers, storage & warehousing, transaction services, uniform rental services, and other business support services.

Security & Alarm Services

Companies providing security and protection services to business and governments. Includes companies providing services such as correctional facilities, security & alarm services, armored transportation & guarding.  Excludes companies providing security software classified under the Systems Software Sub-Industry and home security services classified under the Specialized Consumer Services Sub-Industry. Also excludes companies manufacturing security system equipment classified under the Electronic Equipment & Instruments Sub-Industry.

Commercial  & Professional Services Professional Services Human Resource & Employment Services

Companies providing business support services relating to human capital management. Includes employment agencies, employee training, payroll & benefit support services, retirement support services and temporary agencies.

Research & Consulting Services

Companies primarily providing research and consulting services to businesses and governments not classified elsewhere.  Includes companies involved in management consulting services, architectural design, business information or scientific research, marketing, and testing & certification services. Excludes companies providing information technology consulting services classified in the IT Consulting & Other Services Sub-Industry.

Transportation Air Freight & Logistics Air Freight & Logistics

Companies providing air freight transportation, courier and logistics services, including package and mail delivery and customs agents. Excludes those companies classified in the Airlines, Marine or Trucking Sub-Industries.

Airlines Airlines

Companies providing primarily passenger air transportation.

Mainly three types of airlines – the major airlines, the regional airlines and the low-cost airlines.

Marine Marine

Companies providing goods or passenger maritime transportation. Excludes cruise-ships classified in the Hotels, Resorts & Cruise Lines Sub-Industry.

Shipping generally is broken down into wet and dry bulk. Dry bulk shipping is the transportation of bulky raw materials such as coal, iron ore that react badly to water.

Demand is driven by the strength of the global economy and demand for food and commodities. Industry profitability is driven by freight rates, which are most commonly linked to the Baltic Dry Freight Index.

Wet bulk shipping is the transportation of wet goods, primarily oil and petrochemicals. The industry is very cyclical.

Road & Rail Railroads

Companies providing primarily goods and passenger rail transportation.

4 types of railroads in US:

  1. Class I railroads (1 percent of railroads but make up of 67 percent of mileage and main revenue)
  2. Regional railroads
  3. Local line haul
  4. Switching & Terminal Carriers

Companies providing primarily goods and passenger land transportation. Includes vehicle rental and taxi companies.

Transportation Infrastructure Airport Services

Operators of airports and companies providing related services.

Highways & Railtracks

Owners and operators of roads, tunnels, and rail tracks.

Marine Ports & Services

Owners and operators of marine ports and related services.


Bullish and Bearish Industrial Fundamentals

Bullish Drivers Bearish Drivers
Increasing GDP Decreasing GDP
Increasing Industrial production Decreasing Industrial production
Increasing Durable goods orders Decreasing Durable goods orders
Improving ISM Manufacturing numbers Decreasing ISM Manufacturing numbers
Increasing Construction spending Decreasing Construction spending
Increasing Defense spending Decreasing Defense spending
Increasing Commodity prices Decreasing Commodity prices
Improving Corporate financial health Worsening Corporate financial health
Easy Access to capital Difficult Access to capital
Increasing Monthly sales orders Decreasing Monthly sales orders
Increasing Rail volumes Decreasing Rail volumes
Increasing Cargo volumes Decreasing Cargo volumes
Increasing Truck tonnage Decreasing Truck tonnage

Ways to evaluate economic health

Measuring corporate health

  • Company Earnings Announcements
  • SEC Filings
  • News Sources
  • Corporate Profit reports (www.bea.gov)
  • Interest Rates
  • Equipment Leasing and Finance Association’s monthly leasing and finance index (http://www.elfaonline.org/)
    • New Business Volume
    • Aging of Receivables
    • Average losses as a percentage of net receivables
    • Credit approval ratios as percentage of all decisions submitted
    • Total number orf employees
  • Loan Survey  (www.federalreserve.gov)

Industry Specific Indicators


Infrastructure Market

Infrastructure can be broken to

  1. Energy – Electric power generation, transmission, and distribution, and natural gas transmission and distribution.
  2. Social – Schools, Hospitals, Stadiums, public housing, community facilities and prisons.
  3. Telecommunications – Fixed and mobile phone lines, the internet, cable networks, satellite, television and radio towers.
  4. Transport – Airport runways and terminals, railways, toll roads, bridges, highways, tunnels, ports, logistics centers, and other transit systems.
  5. Water and Sanitation – Potable water generation and distribution and sewage collection and treatment.

Infrastructure Investment Drivers

  • Supporting Economic Growth
  • Overusing aging infrastructure
  • Growing Urbanization
  • Encouraging Foreign Direct Investment
  • Ensuring Public Safety

Risks to Infrastructure Growth

  • Economic and government – bureaucracy, corruption, budget, lack of public support. Delays are common.
  • Execution – Labor shortages, commodity and machinery shortages, and cost overrides and increases
  • Financial Market – Difficulty raising funds.

Participating in Infrastructure Boom

  • Public Private Partnerships
  • ETFs and mutual funds
    • Broad-based – IGF, GII, MGU, FGIAX, CSUAX, KGIAX
    • Water exposure – PHO, FIW, CGW, PIO
    • Energy exposure – NLR, MFD, TYG
    • Other – PKB, EVX
  • Buying infrastructure-related stocks
    • Construction & Engineering
    • Electrical Products
    • Industrial Conglomerates
    • Machinery
    • Transportation Infrastructure

Industry Summary

Aerospace & Defense

  • Defense companies tend to do well when expectations for future defense spending and military modernization efforts are rising
  • Defense companies have historically outperformed in bear markets and recessions because product demand is less variable compared to more economically sensitive industries
  • Aerospace companies tend to do well when air travel fundamentals are favorable, including sustained economic growth, increased air traffic, and airline profitability.
  • Market acceptance of a new design is crucial given production and design costs and the number of years the planes remain in service
  • A number of the larger US Aerospace & Defense companies reach a diversified set of markets, linking them to the broad economy as a result

Air Freight & Logistics

  • Package delivery demand tends to correlate with economic strength and do well when economic growth expectations are increasing.
  • Weak economic conditions and oil high prices can limit profits and industry success.


  • Driven by consumers wealth and travel demand.
  • Both discretionary and elastic. Hence airline pricing can affect demand, profitability, and share prices.
  • Rising oil prices can have a detrimental effect on profits and share prices.

Building Products

  • Tend to do well when residential and non-residential construction is strong and remodeling activity is elevated.

Construction & Engineering

  • Tend to do well when corporate and government spending on infrastructure and commercial construction is strong
  • Pay attention to major project delays and escalating project costs as it will affect profits.
  • Global shortages of qualified engineers can cap the growth of individual firms

Commercial Services & Supplies

  • Very diverse and generally do well when corporate spending is high and the economy is strong.
  • Environmental & Facilities Services tend to do well during periods of economic growth and strong construction levels.
  • Tend to be more defensive than other industrial industries.

Electrical Equipment

  • Demand historically follows economic conditions and sensitive to activity in the construction market, industrial production levels, electronic component production and spending by utilities for replacements, expansions, and efficiency improvements.
  • Do well when pricing increases can stay above input cost pressures.
  • A slowdown in corporate profitability and a decrease in manufacturing levels can slow electrical equipment demand.

Industrial Conglomerates

  • Do well when the global economy is strong.
  • Strong infrastructure spending helps drive the larger industrial conglomerates that manufacture large fixed assets.
  • Global diversification helps drive relative outperformance when the global economy performs better than the domestic economy.


  • Demand for machinery has historically followed general economic conditions and sensitive to construction market activity, industrial production levels, commodity prices, and corporate capital expenditure trends.


  • Dry bulk shipping demand is generally driven by the strength of the global economy and demand for food and commodities. Shipping rates are also driven by dry bulk demand, as well as available ship supply and port capacity, both of which are expected to increase moving forward.
  • Wet bulk shipping demand is driven by demand for oil and oil derivatives like petrochemicals.
  • Container ship firms are driven by global trade and available supply ships.

Professional Services

  • Driven by corporate activity and consulting and legal service needs.
  • Human Resource & Employment Services companies tend to be driven by employment demand and corporate profitability

Road & Rail

  • Trucking and Rail companies are driven by global economic growth and consumer and corporate spending levels.
  • Historically highly sensitive to oil prices and corporate success will be likely be driven by how well it can pass on higher costs to its customers.
  • Operational improvements play heavily on stock prices and profitability

Trading Companies & Distributors

  • US trading companies tend to be leveraged to US economic growth and industrial production and manufacturing levels, while foreign firms tend to be driven by global economic growth and commodity prices.
  • Sales are driven by both corporate and government spending levels

Transportation Infrastructure

  • Historically considered the defensive industry as toll-road demand is usually fairly stable.
  • Decrease in road traffic primarily driven by the macro environment and oil prices
  • Port operators tend to do well when global trade is strong. Limited global capacity magnifies the industry’s sensitivity to elevated product demand.

Examples of falling demand:

  • Recession – regional or global; perceived or real
  • Reduction in corporate capital expenditures
  • Weakening corporate profitability
  • Difficulty accessing credit to purchase new equipment
  • Falling construction activity
  • Commodity pressures – high prices drive commodity producer expansions but hurt manufacturers who have the commodity as an input cost
  • Reduction in government infrastructure and defense spending
  • Removal of government tax incentives for equipment purchases and alternative energy spending
  • Inability to source necessary parts and supplies

Industrial Websites and Data Sources

Forecasts/Annual Reports

Aerospace Industries Association Forecast http://www.aia-aerospace.org
AIA Construction Forecast https://www.aia.org
Annual Construction Equipment Business Outlook https://www.aem.org/
Current Market Outlook (Commercial Boeing) http://www.boeing.com/commercial/market/
FAA Aerospace Forecast https://www.faa.gov/data_research/aviation/
International Air Traffic Association Industry Outlook www.iata.org
ISM Manufacturing Report on Business https://www.instituteforsupplymanagement.org
USDA Agricultural Projections https://www.ers.usda.gov/


Air Cargo World http://aircargoworld.com/
Air Transport Association http://airlines.org/
Association of Equipment Manufacturers https://www.aem.org/news/
Aviation Week http://aviationweek.com/
Construction Equipment https://www.agc.org/agc-news
Defense News http://www.defensenews.com/
Industrial Market Trends http://news.thomasnet.com/
Industry Week http://www.industryweek.com/
Logistics Management http://www.logisticsmgmt.com/
Manufacturing Economy Daily http://www.nam.org/
MAPI Manufacturing https://www.mapi.net/
McGraw Hill Construction https://www.construction.com/
Quadrennial Defense Report https://www.defense.gov/News/Special-Reports/QDR/
Supply Chain Brain http://www.supplychainbrain.com
Journal of Commerce http://www.joc.com/
Transport Topics http://www.ttnews.com


Bureau of Economic Analysis https://www.bea.gov/
Bureau of Transportation Statistics https://www.bts.gov/
Cass Information Systems Freight Index http://www.cassinfo.com/transportation-expense-management/supply-chain-analysis/cass-freight-index.aspx
Census Bureau https://www.census.gov/
Department of Defense https://www.defense.gov/
Electroindustry Business Confidence Indices https://www.nema.org/Intelligence/Pages/Electroindustry-Business-Conditions-Index.aspx
Equipment Leasing and Finance Association https://www.elfaonline.org/
Federal Reserve https://www.federalreserve.gov/
IMF http://www.imf.org
OECD http://www.oecd.org/
Robotics Industries Association https://www.robotics.org/
United Nations http://www.un.org
World Bank http://www.worldbank.org/
World Trade Organization https://www.wto.org/

Atwood Oceanics – Value Play or Value Trap?

Extract from its latest filing on industry conditions in May 2017

The offshore drilling industry remains in the midst of a very severe downturn that began in the second half of calendar year 2014. Since that time, the industry has experienced declining demand for drilling rigs that has been exacerbated by a sharp decline in oil prices. E&P companies generally reduced their offshore capital spending in 2015 and 2016 by canceling or deferring planned drilling programs, and this trend is expected to continue into the second half of calendar year 2017. Since declining to multi-year lows below $30 per barrel in early 2016, Brent oil prices recovered modestly during the latter part of 2016 and ranged between $50 and $55 per barrel in April 2017. However, we expect offshore rig demand to continue declining during the first half of calendar year 2017 and potentially beyond, as offshore rigs complete existing contracts at a faster rate than new drilling programs are initiated. Declines in offshore drilling demand and the associated reductions in rig utilization and day rates could materially and adversely affect our financial position, results of operation or cash flows. See “Our business depends on the level of activity in the oil and natural gas industry, which is significantly impacted by the volatility in oil and natural gas prices” under “Risk Factors” Item 1A of our Annual Report on Form 10-K for the fiscal year ended September 30, 2016.
Even as offshore rig demand declined from the peak levels in calendar year 2014, some drilling contractors continued to take delivery of new, more capable rigs that were ordered prior to the industry downturn. However, over the past year drilling contractors have generally delayed further rig deliveries, especially for uncontracted rigs, through renegotiation of terms with the shipyards that are constructing these rigs. Due to the confluence of an oversupply of offshore rigs and declining rig demand, a lower percentage of marketed rigs are being re-contracted, and day rates and utilization have declined sharply across all offshore rig classes. While clients generally prefer newer, high specification rigs over older, less capable rigs, many newer floaters and jackups have been idled or cold-stacked as drilling demand has declined across all regions, water depths and rig classes. The bifurcation trend of higher utilization rates for newer, more capable rigs has been generally muted, but has been maintained more consistently for floaters than for jackups.
Due to the uncertain duration of the current industry downturn, a growing number of older, less capable rigs have been permanently removed from the marketed supply of rigs by virtue of being scrapped, announced for scrapping, or cold stacked.
There are a few key risks highlighted as below:
  • Offshore drilling industry severe downturn. Even though there are less floaters and jackups, the supply still exceeds demand
  • Reduction in rig utilization
  • Decrease in day rates

In the latest reports, Atwood has

  • Negative operating income
  • Issue new shares to raise capital ( jump from 64M to 80M)
  • Issue new debt to finance
  • Considerable depreciation expenses

In its May 17 Fleet status:

  • The day rate for well in progress is lower than the contract day rate and is not disclosed.
  • Deep water semisubmersible scraped
  • 4 out 5 jackups are idling
  • One out of two ultra deep water semi-submersible is idling in the period Sep 17 to Mar 18
  • Current fleet utilization is about 50 percent

Metrics based on gurufocus:

  • Net cash value:  -11.93
  • Net current asset value: -9.46
  • Tangible book value 42.24
  • Days inventory increased from 104 to 140 from 2016 to 2017

For value play, most look at the tangible book value. But from above, we can see many risks involved and I have doubts about the tangible book value as many of the company assets can’t be sold at the market price with the current downturn and that might look like it will stay for a couple of years with the depressed crude price.

Hence, ATW is a value trap and I would short it if it reaches above $12.

Disclosure: I do not hold any positions on ATW.