It's been nearly a decade since the shale revolution began.
Suddenly, the U.S. was being referred to as the "Saudi Arabia of
natural gas," and hundreds of companies decided to spend massive
sums of money to explore shale formations.
#-ad_banner-#It was a heady time, with dreams of future
riches. Yet, as they'll tell you in business school, you should
only invest money in your business to the extent that future cash
flows will benefit. Otherwise, you'll go bankrupt.
That's the sad lesson now being learned by executives at
Forest Oil (NYSE:
. The company has been on a spending bender for quite some time
-- with little to show for it.
Blame goes a series of once-promising wells that never really
produced the oil and gas as expected. As a result, Forest Oil's
cash flow statement can make you wince.
If you are wondering how a company that already carried nearly
$3 billion in net debt at the end of 2008 has managed to stay
afloat despite massive annual negative free cash flow, the answer
lies in asset sales -- many of them. Forest Oil has sold off many
of its most promising oil fields to pay off bonds that have come
due at various intervals.
Forest's long-term debt has fallen to $800 million (as of the
end of 2013), but that is still too much for its lenders, and as
a result, the company
recently cut a new deal to avoid an imminent
breach in debt covenants
As noted by Bloomberg, Forest can now hold a level of debt
that is less than 5.75 times annual operating cash flow. Analysts
at Goldman Sachs calculate that Forest will generate $128 million
in operating cash flow this year, meaning debt must remain below
$736 million. Presumably, recent asset sales will reveal a drop
in debt from the $800 million figure seen at the end of 2013.
(Forest will report first-quarter results on May 6.)
That mandated debt-to-cash flow restriction eventually
tightens to 4.5. Luckily for the company, operating cash flow
might eventually rise to $200 million, according to Goldman
Sachs. More troubling, this is still a company that is addicted
to living beyond its means. Let's look at the numbers again,
though this time with a forward view.
According to Goldman Sachs' forecasts, Forest Oil is likely to
generate negative free cash flow for the next three years. It
would be nice to think that the company can just make more asset
sales to raise fresh cash and stave off creditors. But the
current cash flow targets that the lenders are anticipating will
be hard to meet if there aren't enough assets to produce them.
The best thing that could happen to Forest Oil would be a massive
spike in oil or gas prices -- but that is no way to run a
Moody's which downgraded Forest's bonds to B3 (Negative) in
early March, before the debt covenants were loosened, noted that
"Drilling results in Forest's Eagle Ford Shale are short of
expectations, which we previously stated could be a catalyst for
a downgrade," adding that "the reallocation of capital away from
the Eagle Ford will result in lower oil production than we had
leading to reduced cash flow and higher
When Forest announced some relief from lenders in the form of
looser debt covenants on March 31, you would have expected shares
to stage some sort of relief rally. Yet shares remain stuck below
$2 anyway. Investors clearly understand that this company, which
has a litany of missed cash flow targets under its belt, may once
again fail to deliver enough cash flow to satisfy lender
Risks to Consider: As an upside risk, yet another asset sale,
at an impressively high price, could loosen the noose around this
company's neck just a little.
Action to Take -->
Forest Oil is selling off the furniture to pay off the mortgage,
yet the ongoing robust capital spending plans (which are leading
to further free cash flow losses) is akin to buying a new TV set,
even though there's no couch to sit on. This stock has
potentially 100% downside if management decides to seek
bankruptcy protection, or the bank grows tired of loosening the
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