CLNE: Sell; Q315 Update

CLNE reported its third quarter earnings on November 5.  Including a $2.4 million gain related to the previous sale of a biomethane plant, CLNE reported a positive adjusted EBITDA of $3.1 million.  This was the first quarter that CLNE reported a positive adjusted EBITDA - a major milestone for sure.  Revenue for the quarter reached $92.3 million, which was less than the $103.4 million value reported in the year-ago third quarter.  The decrease in revenue was attributed to decreased pricing for fuel and lower station construction proceeds.

CLNE delivered 80.6 million gallons of fuel, which was 17% more gallons than the year-ago quarter.  The overall fuel growth was driven by 29% growth in refuse, 13% growth in trucking, and 186% (from 3.5 million gallons to 10 million gallons) growth in industrial.  While the gallons delivered increased impressively, the gross margin per gallon delivered decreased by 2 cents, or 7%, from the year ago quarter.  The growth in industrial gallons, and the growth in Redeem gallons from 13 million to 36 million, are two bright spots in CLNE's revenue picture.

On the expense side, CLNE reduced capital expenditures by $35 million and SG&A expenses by 20% relative to the year-ago quarter.  Due to these reductions and other factors, CLNE generated
-$1.01 million of operating cash flow over the first three quarters.  Not impressed?  This is an improvement of $55 million compared to the same point last year.  I'm being slightly facetious, negative operating cash flow is unhealthy for a company regardless of how much it has improved.

CLNE continues to putter along.  However, it has reached a critical point in terms of its debt.  CLNE has $150 million of debt due by August of 2016.  With a negative cash flow, it is not likely that CLNE will be able to generate enough cash to pay this debt off without dipping into its current cash or using other options.  CLNE management stated the following during the recent conference call:

"We remain focused on our 2016 convertible notes which are due at the end of August next year.  We are in regular communication with note holders and we expect to repay these notes with a combination of cash and stock ahead of the maturity date."

Let's analyze this situation.  CLNE has $166 million in cash and short-term investments on its balance sheet.  Let's assume that CLNE needs to keep $50 million of cash on its balance sheet for working capital (cash needed to run the company while it waits to receive cash it is owed).  In that case, CLNE can use $116 million of its cash (for discussion purposes, assume cash includes short-term investments as well) and can issue $44 million in new stock to pay the $150 million debt.  The $44 million of new shares would be issued in exchange for cash, which would dilute the current shareholders (If you own 1 share out of 10 available, you own 10%.  If the company issues 5 new shares, then your new ownership stake is 1/15 of the company, or 6.7%).

CLNE has a current market capitalization (number of total shares x current stock price) of $346 million.  If CLNE issues $44 million in new shares, each shareholder will be diluted by 11%.  This is the better-case scenario.  The worst-case scenario is that CLNE would use 100% equity (stock) to repay the debt.  In this case, current shareholders would be diluted by 30%.  In summary, current shareholders are likely looking at a range of 11% to 30% dilution before August of next year at CLNE's current share price.

Okay, so one big dilution, and then in the clear going forward?  Nope.  CLNE also has $250 million debt due in October 2018 and $50 million per year due from 2018 to 2020.  When considering these debts, CLNE either has to make drastic improvements to its operating cash flow, issue more debt, or issue more equity.

To reiterate, CLNE continues to putter along.  However, a drastic acceleration in revenue growth is going to be required to turn this company into an investable stock.  As such, Common Cents is looking to sell its shares of CLNE.

While CLNE can fall even further from where it is now, there is likely a lower bound at some point due to the potential for CLNE to be acquired.  The business rationale is still intact for CLNE, as the long-term desire for cheaper, cleaner energy still exists.  In fact, companies are increasingly interested in their global footprints to the point that they may pay more to obtain an eco-friendly image to clients and the public.  CLNE is simply in a race against time to repay its debt.

Common Cents will look to sell its shares on a rebound in oil prices.  CLNE has been highly correlated with oil prices over the recent history, and any increase in oil prices will provide a much more attractive exit point than current levels.

Common Cents Take: CLNE is in a race against time to repay its debt.  It does not, and likely will not, generate enough cash to repay its debt without using current cash reserves, additional debt, or new stock.  Therefore, Common Cents will look to sell its shares of CLNE when/if oil prices rebound.

BP: Hold; 3Q15 Update

BP reported its earnings for the third quarter on October 27.  BP's profit declined by 40% year-over-year (y-o-y) to $1.8 billion; however, this profit was 39% higher than the second quarter.  Operating cash flow was reported as $5.2 billion.  In the case of BP, determining the dividend sustainability is Common Cents' primary valuation objective.  

In the third quarter, BP's capital expenditures (capex) totaled $4.4 billion, and asset sales during the quarter totaled $208 million.  To find the cash available to finance the dividend, we subtract the operating cash flow ($5.2b) by the capex ($4.4b) and add the proceeds from asset sales ($208m). This results in $1 billion available to finance the quarterly dividend.  BP's quarterly dividend approximates $1.7 billion each quarter.  Uh oh! $1 billion - $1.7 billion = -$0.7 billion!  That doesn't look good for us as investors.  BP is having trouble generating enough cash to sustain its dividend.

That's all in the past though.  Let's look forward.  BP plans to limit capex to between $17 billion an $19 billion annually, or $4.25 billion to $4.75 billion a quarter.  Asset sales are projected to total $3 billion to $5 billion in 2016, or $0.75 billion to $1.25 billion a quarter (asset sales are projected to decrease to $2 billion to $3 billion after 2016).  With the $1.7 billion quarterly dividend, BP will need to generate about $5 billion in quarterly operating cash flow to sustain the dividend in 2016.  Based on the decrease in oil prices, which directly affects BP's operating cash flow, BP will have to fire on all cylinders to meet this number.

There are multiple other moving parts to the operating cash flow number.  For one, BP is increasing production in some segments; however, oil prices are drastically decreasing the yield per a unit produced.  The elevated stress in the oil industry does not come without its benefits, though.  BP has been able to substantially decrease its cost of production due to the lowered demand for production services in the industry.  While this won't help the lower yield of production, it will help BP's operating income through lowered cost and, therefore, higher profit.

When BP can't sustain its dividend organically, it has to rely on a dividend cut or an increase in debt to fund the dividend.  BP reached its projected maximum gearing of 20% during the previous quarter.  While the concept of gearing may warrant a complex discussion, generally speaking, this means that BP has reached the maximum level of debt that it intends to take on.  However, the following excerpt was taken from BP's third quarter conference call:

"At the end of the third quarter, gearing stands at 20%, including the impact of the Consent Decree and agreements with the Gulf States.  This compares to the 10% to 20% target boundary we established in 2010 to allow greater flexibility for uncertainties, of which Deepwater Horizon was the most significant.  As mentioned, with the recent filings in the United States, we have moved a step closer to finalizing these agreements, which provide for payments over an extended period.  With that context, we will manage gearing going forward, allowing some flexibility around a 20% level while volatile market conditions remain."

In summary, BP will waiver a bit on its 20% maximum gearing.  This will help to sustain the dividend while BP's operations are in a stressed state; however, it's not exactly a good sign that management is proposing to take on more debt due to the current stressed state of the oil industry.  BP's management indicated that they expect to be able to support the dividend without extra leverage by 2017 if oil prices increase to $60.  From there, operating cash flow will continue to grow and allow for increases in the dividend.

Current estimates of oil prices in 2016 include decreases to the $20's and increases to the $60's.  Who is right and who is wrong?  Who is biased and who isn't?  Who can tell the future?  Not I.  I'll wait for further developments to confirm what the appropriate action is for my energy positions.  Until then, Common Cents feels that BP should be Held until further clarity exists on the direction of oil prices.

Common Sense Take: BP will struggle to maintain its dividend through 2016 if oil prices remain deflated, but BP has created some wiggle room for that year.  If oil prices do not increase to the $60 level by late 2016 or 2017, BP will likely have to reduce its dividend.  The trajectory of oil prices is unclear at the current time; therefore, a wait-and-see approach is warranted.

October 27profit in the third quarter was $1.8 billion, down 40% on the same period a year ago and 39% higher than the second quarter of 2015Operating cash flow was 5.2 billionContinuing to take costs out of the system2.6 billion divestment in first 9 months, 3-5 divest in 16, 2-3 thereafter, new assets have a mid teens to 20 return at oil price of 60
1.1 billion fcf first nine months

Brent oil has averaged around $50 per barrel this quarter, down from $62 a barrel in the second quarter. Although global demand has been stronger and U.S. production has begun to decline, OPEC production is running higher than the 2014 average and inventories continue to increase. As we have mentioned before, there is also the prospect of Iranian production coming onto the market in 2016. Saw sustained lower oil prices early last year, have been adjusting since
Around 80% of investments break even below $60, expect to move lower as costs decrease, reduction of 15% over the last year

we expect to rebalance organic sources and uses of cash by 2017 at an average Brent oil price of around $60 per barrel. Organic free cash flow is expected to grow thereafter at constant prices. This underpins our ongoing commitment to sustaining the dividend as the first priority within our financial framework and restoring growth in distributions to shareholders over the long term

In this environment and based on our planning assumptions, we would expect free cash flow growth from 2018 restoring our capacity to grow distributions to shareholders

at gearing of 20%, using debt to sustain dividend

LUV: Purchase @ $44

Common Cents purchased shares of LUV on December 11 as the share price declined on a market-wide decline and concerns over PRASM metrics.  It appears that Southwest's discounting of fares to increase market share has resulted in an unfavorable competitive environment...surprise, surprise.  The sustained competitive environment, however, will be buffered by lower fuel prices.  While lower fare prices brings in lower revenue, the profit may not change much due to the fuel prices (remember: profit = revenue - cost).

Common Cents believes that the competition will not sustain over the long term.  Airlines are in a period of profitability (finally) and, I believe, have an implicit agreement to sustain profitability through lack of intense competition.  The short-term period of competition is related to Southwest's expansion in certain markets and, according to management, is not intended to be sustained.

Going forward, Common Cents will look to add on to this position at a near 10% decline in share price or sell a portion of the position at a near 10% increase.

YTD Performance Update: December 2015

YTD performance (as of 11/30/15): -1.11%

S&P performance (as of 11/30/15): +3.01%

Common Cents Portfolio is down by 4.12%!!

Portfolio Composition by Position:

AAPL:  11%

RH: 11% 

V:  8% 

BP:  7% 

HZNP: 5% 

LUV: 5% 

T: 5% 

CLNE:  4% 

HD:  3% 

GLD:  3% 

CASH:  39% 

Portfolio Composition by Sector/Industry (excluding cash):

Retail:  23% 

Energy: 19% 

Technology:  19%

Financial Services:  14%

Healthcare: 9% 

Industrials:  8%

Communication Services:  8%

RH: Purchase @ "92.5"

On Wednesday, Common Cents purchased a January 15 $85 call option for $7.5.  The option was purchased a few days prior to RH's earnings call last night.  Going forward, Common Cents will look to sell this option on a rise in share price after RH's earnings results.

RH: Sale @ "94"

Common Cents sold its January 15 $85 call option on Friday, December 4.  The option was purchased for $7.5 and sold for $9, yielding a return of 20% off of an approximate 3.5% increase in the share price of the common stock.  The volatility in RH's share price was related to widespread volatility in the market; no news specifically pertaining to RH was released during this period.

RH: Purchase @ "92.5"

Common Cents purchased a January 15 $85 call option for $7.5 as RH's share price decreased during a market-wide selloff.  No pertinent news was released that warranted the magnitude of intraday decline in RH's share price.  Going forward, Common Cents will look to sell the option above $8.  The earnings release on December 9 will likely serve as a catalyst for rapid growth in RH's share price, as has been the case over the last several quarters.

HZNP: Buy; PT $37.9; 3Q15 Update

HZNP: 12/1/15; $21.30

From Thomson Reuters I/B/E/S Estimates:

Forward Earnings: 2.16

Forward PE: 9.86

5-yr Estimated Earnings Growth Rate (EGR): ~20%

PEG Ratio: .493

S&P Forward PE: 17.55
S&P EGR: 5.58%

Horizon Pharma reported its third quarter earnings on November 6.  After reporting a 200% year-over-year (y-o-y) increase in revenue and a 500% increase in EBITDA, HZNP raised its 2015 revenue guidance by 13% and 2015 EBITDA guidance by 30%.  These numbers come in large part due to acquisitions made by Horizon; however, they are still impressive.

Horizon is currently in a high-growth phase, which is fueled by HZNP's acquisitions of other small drug companies.  HZNP added $100 million in cash during the quarter and now has $684.3 million of cash on the balance sheet.  HZNP also has $1.274 billion of debt on the balance sheet; however, the first debt payable is due in 2021.  Until then, HZNP is only required to make "coupon" or interest payments.

Horizon has issued a plan to get to $2 billion in revenue by 2020.  Very little of this will come from organic growth.  According to HZNP management, the current environment presents several opportunities for cheap acquisitions due to the widespread decline in share price of the biopharmaceutical sector.  The decline in the sector is related to recent unfavorable headlines pertaining to multiple related companies.

HZNP has suffered a significant decline in its shares over the past 2+ months as a result of the news headlines.  HZNP specifically refuted recent negative allegations of price gouging through commentary similar to the following (taken from the recent earnings call):

"There has been a tremendous amount of noise in the marketplace and media recently about pharmaceutical companies, biopharmaceutical companies, and so-called specialty pharmaceutical companies, how they operate and do business, the cost of their medicine, and so on.  There has been a lot of misinformation and misleading commentary provided by many incented to do so."

"First and foremost, it is important to understand that at our very core, we do put patients first.  Patient access and affordability is at the heart of everything we do.  It is the cornerstone of our company culture and something that we talk with each of our employees.  In fact, I believe there's not a single company in our industry that has done a better job than Horizon in providing free medicines or medicines at greatly reduced costs to our end customers, the thousands of patients we serve."

This commentary directly addressed the criticism that caused shares of HZNP to drop to absurdly undervalued levels.  The CEO continued in the call to describe how a particular medicine that was critiqued for being a simple, higher priced combination of two generic drugs was actually helping to save lives, as people did not take the drugs separately when prescribed.  In fact, the CEO said that he suffered from stomach ulcers related to not taking both the two drugs when prescribed separately, and HZNP's combination drug helped to treat subdue the ulcers.  I have little doubt after this conference call that HZNP is a semi-reputable biopharmaceutical company that is not as ultra-risky as the recent headlines would indicate.

Being convinced of that, HZNP is severely undervalued at current levels.  Using a PEG ratio of 2, HZNP would be valued at $86.4 [ = 2 (PEG) x 20 (EGR) x 2.16 (forward earnings) ].  Due to the method that HZNP uses to achieve growth (i.e., acquisitions), the potential limitations of this method related to the availability of targets and stress on the balance sheet, Common Cents feels that it is conservative to value HZNP with an equivalent PE to that of the S&P.  Therefore, Common Cents feels that HZNP would be fairly valued @ $37.9 [ = 2.16 (forward earnings) x 17.55 (S&P PE) ].  Therefore, Common Cents feels that HZNP is an attractive buy at these levels.

Common Cents Take: Management dispelled the recent negative allegations that have caused a significant decline in HZNP's share price.  The remaining headwinds for HZNP are finding attractive acquisition targets to fuel growth, which should not be a problem in the near future due to the widespread decline in share prices of biopharmaceutical companies.

RH: Purchase @ "91.7"; Sale @ "93.2"

Common Cents purchased and sold a December 18 $85 dollar call option today.  After purchasing the option for $6.7 and selling it for $8.2, Common Cents netted a profit of 22%.  The purchase was made as RH's share price declined to the high $88's on no pertinent new information.  Going forward, Common Cents will look to repeat similar trades prior to RH's earnings release on December 10.  However, with the recent Goldman Sachs downgrade, caution is warranted in these trades, as sentiment for RH seems to be wavering a bit.