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<DAILY TROUBLE>
Friday, January 8, 1999
Union Pacific Resources
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Phone: 817-321-6000
Website: http://www.uprg.com
Price (1/7/99): $9 3/4
HOW DID IT FIND TROUBLE?
As the price of oil has been nearly drilled in half over the past two years, going from roughly $21 a barrel to near the $12 level, many companies in the oil and gas industry have found their stock prices running on empty. A screen I ran for stocks to highlight in this column showed 39 stocks with market capitalizations of $1 billion or more with declines of at least 50% in the last year. Over half of those, 19 to be exact, were oil and gas related stocks. In other words, one could almost randomly pick a company from the oil industry and come up with a candidate for this troubling column.
One that has found trouble is the largest driller in the country, Union Pacific Resources <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: UPR)") else Response.Write("(NYSE: UPR)") end if %>. A spin-off from railroad titan Union Pacific <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: UNP)") else Response.Write("(NYSE: UNP)") end if %>, the stock has been a real train wreck over the past two years, falling from above $31 a share in early 1997 to around $9 a share as of this writing.
While not nearly as exposed to the crude oil industry as others, the price of the company's primary asset, natural gas, also had an acute case of gravity, falling from an average selling price of $2 per Mcf in 1997 to $1.65 in the most recent quarter. The primary driver behind a commodity company's stock is the market price of the commodity it produces, and Union Pacific Resources is no exception. Union Pacific's stock price headed the same direction as that of its commodity -- down.
BUSINESS DESCRIPTION
To stimulate railroad growth in the West, the Pacific Railroad Act of 1862 granted large chunks of western land for those attempting to lay railroad tracks across the continent. Union Pacific, the Goliath of railroading west of the Mississippi, was given 7.9 million acres in Colorado, Utah, and Wyoming. It wasn't until a good 50 years later that Union Pacific started to mine this land for oil, gas, and coal in earnest.
After growing the business both organically and through several acquisitions, Union Pacific found itself a major player in the natural resources market. In 1995, the railroad packaged together and spun off to shareholders all of its assets in gas and natural resources as Union Pacific Resources.
After Union Pacific Resources found itself independent of the railroad, it went about looking for acquisitions. Its first major deal, a hostile offer for Pennzoil <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: PZL)") else Response.Write("(NYSE: PZL)") end if %> at more than double today's prices, was derailed at the last moment in 1997. Still hungry for mergers and acquisitions, the company successfully bought Canada-based Norcen for $3.5 billion last year. Late in 1998, Union Pacific Resources decided to sell its midstream gas processing operations to Duke Energy <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: DUK)") else Response.Write("(NYSE: DUK)") end if %> for $1.35 billion to pare down debt and concentrate on upstream gas exploration. The company is now one of the largest gas exploration companies on the continent.
Union Pacific Resources is a member of the S&P 500 index.
FINANCIAL FACTS
Income Statement
12-month sales: $2,261.5 million
12-month income: $70.8 million
12-month EPS: $0.29
Profit Margin: 3.1%
Market Cap: $2447.3 million
Balance Sheet
Cash: $44.0 million
Current Assets: $648.8 million
Current Liabilities: $954.6 million
Long-term Debt: $4,585.7 million
Ratios
Price-to-earnings: 33.6
Price-to-sales: 1.1
Dividend Yield: 2.1%
HOW COULD YOU HAVE SEEN IT COMING?
Predicting commodity prices is as tough -- if not tougher -- than trying to predict where the stock market as a whole is headed. So unless you are clairvoyant and were able to predict the meltdown in the oil and gas market, finding this trouble would have been rather difficult. Even so, there were a few signs ahead of time that prices were headed for some weakness. Namely, the Asian economic crisis, which started in late 1997, caused a drop-off in demand for oil that didn't really get felt in the market until mid-1998. Mix in this reduced demand with supply gushing in at record highs both domestically and from OPEC, and it only makes sense that prices have fallen across the board.
One warning sign with Union Pacific Resources that maybe should not have been overlooked was the company's excessively high level of debt (long-term debt to equity stands at a tall 2.8x). While the exploration activities can be shaved and operational costs trimmed during times of weak prices, debt represents a large fixed cost that has to be paid no matter what the market conditions. Debt alone is no reason to sell a company that has as many hard assets as Union Pacific Resources, but it does reduce the margin of error for equity investors.
WHERE TO FROM HERE?
The company's fortunes are tied intimately to oil and gas prices and, to truly know where Union Pacific Resources is headed, one has to know where the commodity markets are going. Just as the company's profits and margins have shrunk with the gas market, they are likely to rebound sharply if the price of gas bounces. Three links to bookmark to keep an eye on the oil and gas commodity market are:
http://www.cnnfn.com/markets/commodities.html
http://headlines.yahoo.com/Full_Coverage/Business/Oil_Prices
http://www.cook-inlet.com/comments.htm
Union Pacific Resources is also in the midst of deleveraging itself by selling off non-core assets. The sale of the company's gas processing businesses to Duke Energy is in sync with this strategy, and more sales are expected to close in the near future. What should emerge is a company with greater financial flexibility that is concentrated in the business it knows best -- finding and drilling for natural gas.
At 1.3 times book value (industry average is 1.7x), it is tough to call the stock expensive. Likewise, on an earnings, cash flow, and return on invested capital basis, the company currently barks like a dog, but that is because natural gas prices stink at the moment. While still a slave to the commodity markets, Union Pacific Resources is nevertheless a company to keep an eye on, especially if the price of natural gas starts to improve.
Those interested in learning more about the oil and gas industry are invited to stop by The Fool's Drip Portfolio area. The portfolio managers are researching diligently and scribing nightly columns about the oil industry to find the most suitable investment in the sector for the long-term investor. Union Pacific Resources is likely to be one of the companies covered in the review.
� Paul Larson
([email protected])
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