Centre Street Cambridge Corporation

Private Investment Counsel


April 1993

I have on previous occasions noted the important role that the price paid for an investment plays in achieving satisfactory results.  By limiting our purchases to reasonably priced securities we reduce our reliance on highly uncertain predictions of future events, protect against the possibility of unforeseen adverse circumstances causing severe and permanent losses and improve the odds that our operations will be successful.  In my opinion, our purchase of Oryx Energy Co. (ORX) is a good example of this approach at work.

At our purchase price some important valuation measures indicated that ORX was very reasonably priced.  Page 3 is a copy of a report outlining the reasons for my interest in this company.  Item #2 refers to the table on page 4.

ORX explores for and produces oil and gas which it then sells to refiners and distributors.  The investor in a company such as ORX in effect owns a portion of the reserves of these crude products that the company has discovered and developed.  The amount of these reserves, therefore, provides a way of valuing the company and comparing it with other companies in the same industry.  Our table represents an exercise in attempting to determine, on a per share basis, how much investors are paying--at current stock prices--per unit of reserves (the unit is the "barrel of oil equivalent" by which natural gas reserves are expressed in terms of a volume of oil containing the same amount of energy.).  Although the figures require some interpretation, ORX did appear to be inexpensive at $18.

Item 8 on page 3 refers to another method commonly used on Wall St. to value reserves.  It involves making estimates of future cash flows and then discounting them to a "present value".  This calculation suffers from the usual problems associated with forecasting, but it tends to reinforce the conclusion reached through our favored approach.  By this measure ORX was valued at only about 85% of the average valuation for similar companies.  Finally, the price to cash flow valuation mentioned in Item 3 also indicated that the shares were attractively priced.

Why was this company so cheap?  There were some good reasons.  ORX was highly leveraged (lots of debt) and had owned interests in some unattractive oil fields.  However, if one's time horizon extends beyond a few weeks or months (which to Wall St. thinking is "long term investment"), one could see that developments were under way which seemed to indicate a brighter future was in store for ORX.  Management had become more focused and was concentrating company resources on more promising exploration projects while selling off less productive tracts.  The company's exploration record was good and had established a portfolio of assets that would lead to higher levels of production and cash flow over the next few years.  Finally, significant amounts of debt had been paid down.  One could conclude, without being a wild-eyed speculator, that ORX would probably do OK operationally and that the company could attain a valuation closer to the industry average, implying a significantly higher share price.  A commitment at the prevailing price, therefore, seemed to offer the possibility of a meaningful return within a 2-3 year period.

Note that considerations of future energy prices have yet to enter the picture and given their unpredictable nature we don't want this factor to play a major role in our investment decision.  Expectations regarding energy prices do have a significant impact on the market for energy stocks, however, and excitement or depression about the price outlook can either push the stocks to unrealistic levels (ORX, for example, sold for $40-50 per share only a few years ago) or create opportunities by causing sell-offs.  In fact, some interest in energy prices developed immediately after our purchase and drove the stock price above our buy levels.  But, as with any business related to a commodity, the chances of the price returning to more reasonable levels are quite good, at which point we would fill our position.  We bought ORX because it was attractively priced, because factors were already in place which indicated the company would do OK and because the odds of the company reaching a better valuation seemed good.  With all of these things operating in our favor, oil price increases and excitement about energy stocks would be icing on the cake.

By way of comparison I thought I would show you a more forward-looking kind of analysis.  Page 5 is a copy of a brief brokerage report (from Wertheim) dealing with the outlook for natural gas companies.  I've highlighted a few passages which illustrate the predictive quality of the argument.  This type of analysis does not necessarily lead to bad results--some people are very adept at investing in this manner.  It's just that I am not one of them.  It's worth noting, perhaps, that this strong emphasis on future prospects dominates the investment world of our era, as it has, really, since the late 1920s.  In an earlier age investors sought to secure income and safeguard capital while appreciation was considered an incidental benefit.  Nowadays, as the saying on Wall St. goes, you are lucky to "get paid while you wait".  I admit to being somewhat old-fashioned.

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Looking back at the first Commentary it's heartening to see that my predictions for 1993 have been right on the mark so far:  the stock market rose, interest rates fell and the economy grew!

Stock prices in general remain at uninteresting levels; therefore, I can't be optimistic about the availability of good investments any time soon.  But these things are unpredictable, so you never know when something might turn up.


Dennis Butler, MBA, CFA