Bad Small-Cap Stocks: Warning: Avoid This Small Energy Company
Jan 10th, 2006 | By Greg Guenthner | Category: International, Investing StrategiesGreg Guenthner tells us about a Bad Small-Cap Stock, and then one maybe to look into.
Publisher’s Note: In today’s Sleuth, our small-cap newshound, Greg “Gunner” Guenthner shares two very important insights with you. The first is about a small-cap energy stock that screams BUY on the outside. But after spending two days reading all the “fine print” in recent annual and quarterly reports, Gunner determined this stock is not what it seems. In fact, if you own it, you should sell immediately.
The second is about a small-cap company we featured here in Sleuth last year. It has outpaced Google by 306% in the last 12 months. And Gunner explains why…
The energy sector is booming right now. The XLE — a proxy for the energy sector — is up 54% in the last 12 months. And with the war in Iraq, diminishing supplies and increased demand from emerging economies like China, the energy boom will likely continue on in 2006.
If you are a Penny Stock Fortunes reader, you know that booming energy prices can lead to some nice small-cap gains. Last month, James and I recommended you buy shares of VAALCO Energy (EGY:AMEX) for just over $4 a share. The tiny oil producer — with a large majority of its operations in the small African nation of Gabon — is already up over 11% in four weeks. If it kept up this pace, you would make 143% this year alone. Impressive. And we are constantly looking for other fundamentally sound small-cap energy stocks to add to the portfolio. In fact…
Last week, we came across another potential buy candidate, Harvest Natural Resources (HNR:NYSE). Harvest explores, develops and manages oil and gas properties. The company has a high earnings yield, high return on invested capital and no debt — just like VAALCO. But after doing our due diligence, there is no way we could recommend HNR.
Bad Small-Cap Stocks: What’s Wrong with This Small Energy Company?
The Houston-based company is going through some tough times. Its net income has dropped over the past three quarters — from $18 million to $8 million. Sales have been flat. And the company is losing money every day from its operations in the United States and Russia. But worse yet, its main business in Venezuela (the only profitable sector of Harvest’s operations) is in jeopardy of losing $85 million — more than double its total net income from a year ago.
Here’s the deal…
Harvest makes money in Venezuela by drilling oil and selling it to Petroleos de Venezuela S.A., a Venezuelan oil exporter. As long as Harvest finds oil and Petroleos de Venezuela buys it, Harvest is a solid little company. But when that dynamic breaks down, there is trouble.
For two straight quarters, Petroleos has failed to pay Harvest on time for its oil. As a result, its income from Venezuelan operations is down almost $1 million from the same quarter last year.
Strike one.
In Sept. 2005, Petroleos de Venezuela S.A. violated its agreement with Harvest, offering 25% of its payment in Venezuelan bolivars instead of U.S. dollars. Harvest mentioned in its most recent quarterly report that it has little need for bolivars in the conduct of its business. Harvest has limited means to convert the bolivars into U.S. dollars or other foreign currencies, and there would be a loss on the currency conversion where the exchange rate is above the official rate of 2,150 bolivars to the dollar.
Strike two.
Bad Small-Cap Stocks: Retroactive Tax Concerns
On top of this, Venezuela’s tax authority is also attempting to retroactively raise taxes on Harvest from 34% to 67% for 2001 and from 34% to 50% for all years thereafter. After auditing Harvest’s books last year, the Venezuelan tax authority wants $85 million. For Harvest — which recorded only an $8.1 million net income last quarter — this would spell disaster.
Harvest is protesting the tax hike, and noted in its most recent quarterly report that an increase in tax rates above 34% could cause some of its planned future investments to become uneconomic.
This does not bode well for HNR, since its two other operations are both losing money (wells in Russia lost $433,000 in the third quarter, and operations in theUnited States and other smaller operations posted losses of $5.16 million for the same period).
The energy sector’s future looks bright, but Harvest has too much to deal with to buoy its price. Even though two strong indicators like earnings yield and return on invested capital scream “buy,” Harvest’s underlying problems will at best stall the company’s growth…or a crippling retroactive tax increase could sink HNR’s ship altogether. This makes the company not worth owning, regardless of what the share price is.
If you were thinking about taking the plunge with Harvest, think again.
Bad Small-Cap Stocks: Chasing Google? Try Leading the Pack…
I’m a bit of a newshound. As usual, I keep the small-cap world at the front of my mind, just in case I come across anything that might interest you or help your investments.
I don’t mess around reading blogs, but I’m sure some of you Sleuths are familiar with The Corner and Jim Geraghty, as well as some of the other conservative blogs out there at the National Review Online. However, I did see something in NR that I thought I should share with you.
In a Jan. 5 article for National Review Online, Tom Nugent writes:
“The irony in the world of professional investing is that the big guys with all the marketing muscle and slick sales forces cannot overcome the fact that big stocks, the only game in town for big money, haven’t been performing well relative to smaller stocks. For example, the S&P 500 is essentially flat, rising only 0.64% per year for the five years ended Nov. 30, 2005, while the S&P MidCap 400 and the S&P SmallCap 600 are up 10.07% per year and 13.57% per year, respectively, over the same time period.”
Hmmm… That grabbed my attention.
Nugent goes on to write about what he calls one of his favorite stocks: Hansen’s (HANS:NASDAQ), a natural beverage company that makes juice, sodas and energy drinks. One of these energy drinks is called “Rumba Energy Juice” (not to be confused with the Roomba — the popular robot vacuum cleaner that looks like a giant Frisbee on wheels).
Hansen’s is in good graces here in Sleuth Country. We featured the company way back in November 2004.
Bad Small-Cap Stocks: Since We Profiled Hansen…
Last November, we featured Hansen’s here in Sleuth because of its tremendous growth numbers. Hansen’s gross sales surged 59.9%, to $68.1 million, from $42.6 million in the previous quarter. Net sales rose 58.1%, to $52.6 million, up from $33.3 million a year ago. On top of all this, operating income for the third quarter was up 182.9%, to $9.9 million, up from $3.5 million a year earlier.
At $17 a share, we knew this was a great small-cap stock to own. It was fundamentally sound, growing and gaining market share on the big boys — like Coca-Cola and PepsiCo.
Since we first wrote about Hansen’s over a year ago, the stock is up more than 400% — far more than even Google — the darling of Wall Street over the past 17 months.
Now with a market cap of $1.8 billion and a share price north of $90, Hansen’s isn’t a baby anymore. And for the first time, the media is starting to realize what we knew all along.
Nugent commented in his Jan. 5 article:
“When I compared the performance between Google and Hansen’s, I found the results interesting. Since Hansen’s has been around a lot longer than Google, I compared the performance of these two stocks from the time of Google’s IPO to the present, and I was surprised to see that Google rose 309% since inception while Hansen’s climbed 615% over the same time period.”
Google, although trading at an outrageously high price (its P/E ratio today is 91.6, while the rest of the industry averages around 55), couldn’t even keep pace with Hansen’s, a company that went public many years before the search engine giant. And all the mainstream media seems to want to talk about is how high Google will go. If they only knew…
Until next time,
Gunner
January 10, 2006
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