Wednesday, October 19, 2011

Chanos Chims In


The famed short-seller, Jim Chanos, recently spoke at the Value Investors Congress in New York. As the largest short fund (bets on the stock price of a company going down) in the world with assets of 6.7 billion, he is the king of the bears. Chanos, is worth listening to. He has been "pounding" the table on several areas where he sees problems. He spoke about "value traps" in Chinese banks (and most other things China related), commodity companies dependant on one large consumer - like China, Brazil, large integrated oil companies like Exxon (XOM) and digital distribution of media (blockbuster gone bust, with more to follow) and lastly, for profit education companies.

His mention of oil companies is very interesting considering I have just taken a position in a large integrated oil (Total SA at $45-$46) which I wrote about here. The crux of his arguement is that the finding and development cost of a barrel of oil has increased from $5 in 2000 to $22. Also, the cost of production has tripled from $5 to $15/barrel. Not to mention increased SG&A. This has squeezed the oils into "paying up" for reserve replacements. He cited, XOM's huge purchase of XTO for $31B in 2009. Exxon is betting on the future of natural gas and paid a hefty price for that bet. XOM's balance sheet has suffered going from $25B in net cash in 2007 to net debt of $6B now.

I don't know if Chanos is bearish on all integrated oils (or talking his book - he could be short XOM) but I'd agree that many of the North American oils are expensive, with some like XOM trading at 2.5x book value and 1x NAV. However, at the risk of opposing Chanos - not all the oils are expensive. The European oils (TOT, BP, RDS.A, STO) are much cheaper with more "bad" news priced and therefore provide a greater margin of safety. You can buy some the Euro oils for 6x's earnings with hefty dividend yields and 0.75 of NAV (based on $80 oil). If history is any indicator, then if the cost for oil has risen that significantly, then commodity prices should only trade at a small premium to that marginal cost of production. So that means, $140 oil (2007) is not likely to return soon nor is $30 oil.

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