In my book, “Choose Stocks Wisely, I present my balance sheet method for investing which includes tests for balance sheet quality. A balance sheet needs to be amply liquid in terms of working capital and not overly leveraged (indebted), and ideally have assets largely tangible in composition. This week, I want to share some recent news articles concerning bankruptcies in the oil and gas sector.
Below, I’ll provide links to several articles from this past week:
There is a good bit of repetition across the articles above. The number of bankruptcies in the energy sector has been escalating and the amount of indebtedness involved increasing. The numbers are pretty staggering.
Energy companies are capital intensive meaning a lot of the asset base is comprised of the property, plant and equipment asset class. It takes a lot of money to finance these non-current assets so it’s not unusual for a significant amount of long-term debt to be involved. While these companies can generate a lot of cash flow from operations when the underlying commodity (oil and gas) is priced high enough for success, the leverage can become an albatross when the commodity price drops precipitously. As these articles say, even though oil has climbed well into the $40s/barrel from its low in the mid $20s just recently, for many companies, it has been too little too late.
I’ve written before about commodity companies and mentioned them in my book when I wrote about my hard lesson experiences with dry-bulk shipping companies several years ago. These companies can become dirt cheap relative to their net asset position but they can also become very illiquid if the subject commodity faces a steep decline in demand. So, the balance sheet has to reveal more than a cheap stock price; it must also reveal substantive liquidity to ride out a bad storm since the greatest risk faced with stock investments is that of a company default.
Have a great weekend and may God bless you.
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