UPDATE: This post is wrong. Please see the updated post.
I am not short this stock because it may go up several times in the future. It may also take several years for it to reach the short seller’s dream price ($0). But here are the problems I see with the stock.
- Negative cash flow. Cash from operating activities alone is negative every year. (It’s bad when free cash flow is negative, but even worse if cash from operating activities is negative.) The reason why this company reports GAAP profits is because inventory is going up every year.
They could be hoarding inventory of drilling supplies. Year after year after year. But in my cynical opinion, it is highly likely that questionable accounting is going on. They may be using up drilling supplies but pretending that these supplies weren’t used up. Therefore drilling costs don’t get expensed and profits are inflated on their books. THIS IS JUST MY SPECULATION. I HAVE NO IDEA IF FRAUD IS OCCURRING. Please do your own due diligence. They are profitable everywhere except for Canada. This doesn’t make sense. They should be profitable in their home jurisdiction. In my cynical opinion, they aren’t profitable in Canada because that is where their auditors reside. There is a good chance that their auditors will verify their Canadian inventories. It is unlikely that the auditors will fly all over the world and check inventories everywhere. (EDIT: They don’t generate any revenue in Canada but have corporate expenses there from head offices and such.)
- They are a serial issuer of equity. This is a pattern that I am extremely negative on. Companies with negative cash flow that are always raising capital usually end badly for investors. Real growth companies like Apple have positive cash flow and do not issue equity (*let’s ignore stock-based compensation ok?). They should be able to fund their growth from their own cash flows.
- They are making an unusual amount of money in a commodity-esque business. Are their profits too good to be true? (I am not very well versed in drilling services / oil services stocks so don’t take this comment seriously. It is possible that their product really does have a hard-to-duplicate competitive advantage.)
Disclaimer: I have no position in this stock.
I have no idea if it is a fraud. Please don’t sue me.
Other people think that it is a good long.
Recap of investing heuristics that I subscribe to:
- You should probably avoid companies that are always issuing equity. (*Though I guess I am really breaking this rule right now because most of my portfolio is in junior exploration companies. What I am doing may be a bad idea.)
- If free cash flow is much lower than reported profits, you should really look at the accounting.
- If free cash flow is much lower than reported profits, free cash flow is probably a better indicator of the company’s actual profitability. More often than not, people are smart and promotional.
- Don’t short crazy stocks… unless you’re really sure that the collapse is near (unless you can buy put options). Otherwise these stocks may go up several times on you (at the very least eating up margin) and take several years to collapse…. giving you an awful rate of return on your short position.