Life after death in the oil patch

Why Eric Mollenhauer invested in several energy firms that recently emerged from bankruptcy.

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More than 100 oil & gas companies went bankrupt in 2020, although Fidelity’s Eric Mollenhauer notes that a handful re-emerged from the pandemic this year, led by new management teams and a renewed focus on containing costs.

“The drop in oil and gas prices in 2020 caused many of our loans to become distressed, forcing many companies to restructure,” says Mollenhauer, who, alongside Kevin Nielson, co-manages Fidelity® Floating Rate High Income Fund (FFRHX). “While we sold out of some positions, we decided that some of these names had declined to unreasonable levels and potentially offered upside with a new capital structure.”

By being active in the workout process, with help from a dedicated special situations team, Mollenhauer and Nielsen equitized previous debt, ending up with ownership stakes in a few companies with clean balance sheets.

“By and large, they have not disappointed so far this year,” he notes.

In Mollenhauer’s view, this highlights the investment strategy that he and Nielsen pursue: They look for ideas in market segments and individual securities that aren’t necessarily popular and ignore short-term market noise when their research points to high-conviction, long-term investment opportunities.

The managers invest at least 80% of fund assets in floating-rate loans, which often are low-quality debt securities. They sometimes receive equity stakes in return for their investments, and they hold on to them if they see upside potential.

Such was the case for Chesapeake Energy (CHK), Denbury Resources (DEN), and California Resources (CRC), all equity positions that have added value in 2021.

Chesapeake, once the second-largest natural-gas producer in the U.S., made its return to Nasdaq trading in February. It no longer boasts the same market valuation it once carried. Yet the managers invested in the company because of its attractive longer-term oil and shale assets, believing that those assets covered the value of the debt.

While the loan did trade much lower through the restructuring, the fund has returned its original investment and more, as the equity the fund received has gained post-bankruptcy. The company’s financial leverage is now among the lowest in its peer group, and the company has much improved liquidity and flexibility to ride out volatile energy prices, Mollenhauer contends.

“While this firm still could face operational hiccups and swings in performance due to increasing gasoline prices, this company is clearly on much more solid financial ground than it was a year ago,” he says.

Denbury, which is focused on assets in the Gulf Coast and the Rockies, also had to restructure to improve its balance sheet. While the existing business of using carbon dioxide to extract oil from mature wells remains intact, longer term, Mollenhauer thinks the company has potential to profit by storing carbon dioxide for commercial customers, potentially making this one of the few true environmentally friendly plays in the oil patch.

Lastly, California Resources, an independent oil & gas producer focused exclusively on The Golden State, shed $4.4 billion of debt through its bankruptcy, and boosted its production in the second quarter. The managers are optimistic that the firm’s new management team will continue to focus on cost reduction and more efficient production.

“Not every one of our investments in the oil & gas industry has worked out, but we’ve done well recently by taking advantage of our in-house research and special situations team’s expertise in striving to maximize value for our shareholders,” Mollenhauer says.

Securities mentioned were owned in the fund as of August 31, its most recent holdings disclosure. For specific fund information, including full holdings, please click on the fund trading symbol above.

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