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Oil Market’s Dumpster Fire Claims New Casualty

Louis BaseneseAfter last week’s descent for oil stocks, investors are licking their chops for these cheap issues.

If you’re one of these folks, I urge you to reconsider…

As I indicated last week, there will be much more pain before the gain here.

But that doesn’t mean we can’t profit on the downside.

In fact, senior analyst Jonathan Rodriguez serves up what could be one of sexiest energy shorts of the year below.

Ahead of the tape,

Louis Basenese
Chief Investment Strategist, Wall Street Daily

Black Times for Black Gold

Jonathan RodriguezTo say that energy stocks have given investors a bumpy ride over the last few years would be major understatement.

And just when things were starting to look good for oil this year, the floor gave way…

As you may know, after two years of record-high oil production intended to force out U.S. shale drillers, OPEC agreed to decrease their efforts last November — hoping to boost the flagging price.

But the opposite actually occurred…

On rising U.S. production and stubbornly high inventory levels, front-month crude has fallen 15% since the start of the year — and right into a fresh bear market.

In fact, this is the sixth bear market for oil in the last four years.

And as a result, energy stocks have taken a nose dive in the last month.

But as my colleague Louis pointed out last week, unless you’ve got an iron stomach, loading up on oil names now isn’t the best move.

Yes, many of these stocks are cheap relative to the broader market. However, barring a major event overseas that disrupts production, oil will likely hover between $40 and $60 for the next several years.

True, oil producers have gotten more efficient about getting the stuff out of the ground. Still, most of them won’t see much of a profit at these prices.

Even shale drillers, some of which can break even with oil at $45, will struggle under the weight of heavy debt loads.

Add it all up and we’re looking at some of the most compelling short plays on the market.

Here’s one such downside play to whet your appetite…

A Race to the Bottom

Cimarex Energy Co. (NYSE: XEC) is a Denver-based oil and gas producer operating in the Southwest U.S.

The company currently sports a market capitalization of $8.6 billion — down more than 30% from its all-time high in December.

Over the last five years, Cimarex sales have fallen 6%, while the oil and gas industry grew 3% on average over the same period.

While the company’s sales are expected to rise 20% next year, its growth trails the industry’s forecast top-line increase (29%) by 31%.

Since 2012, the company has posted a 24% decline in earnings per share. That’s nearly three times worse than the industry, which posted a 9% drop in that time.

The company trades at 5.9 times trailing sales — twice the industry average (2.9).

Cimarex also trades at four times its book value. That’s a 76% premium to its five-year average (2.1) and more than double the industry average (1.7).

Even more damning, shares trade at 17.9 times forward earnings — a whopping seven times the energy sector’s P/E (2.6) and a 28% premium to the oil and gas industry (14).

Let’s put the downside into perspective here…

Analysts expect Cimarex to earn $5.30 per share in fiscal 2017. Using the industry’s forward earnings multiple (14), shares could fall by 20% in the next year.

To capture a downward move, investors could simply short the shares. But to really ramp up returns, speculators might consider purchasing the December $95 puts, trading around $9.20.

The put doubles in value with a drop in shares to $76.50, and would break even at $85.80 — a mere 7% below the stock’s current price.

Bottom line: Oil prices won’t stay low forever, but they will challenge the profitability of producers for years to come. And Cimarex represents one of the most compelling short-term plays on the downside action.

On the hunt,

Jonathan Rodriguez
Senior Analyst, The Wall Street Daily