Energy, Industrials, and Consumer Discretionary: Opportunities in Chapter 11 Bankrupcties Among Deflated Sectors

The rate of chapter 11 bankruptcy filings increased by approximately 43% since December 2019 as of June 3 this year and persists to rise with ostensibly no end in sight. Industrial, energy, and consumer discretionary companies constitute the vast majority, or collectively 83% of bankruptcies this year. This manifested as an unprecedented oil price war between Saudi Arabia and Russia in conjunction with travel restrictions and lockdowns in many states and provinces across the world, a lack of industrial equipment, materials, and machinery demand by manufacturers that supply consumer discretionary companies whose annualized revenues plummeted 26.3% by Q2 of 2020 following a growing consumer preference for online shopping and the commencement of quarantine which ultimately exacerbated this trend.

Consequently, innumerable opportunities now exist where one can acquire shares in NCAV companies at a significant discount by purchasing their second lien notes which rank highest in the capital structure and convert to often an excess of 95% of the restructured company's equity. Concurrently, the selection of distressed companies prone to bankruptcy in this process must be limited to those whose total assets exceed total liabilities and confer a high tangible book value. Debt-laden and negative tangible book value companies cannot ensure creditors remuneration as the cost of their bonds will exceed the asset value of their position in the newly restructured company, (e.g., CHK 7.8 Billion Asset - 11.7 Billion Liabilities = 3.9 Billion Excess Liabilities, OAS 2.8 Billion Assets - 3.5 Billion Liabilities = 0.7 Billion Excess Liabilities). 
   The vast majority of companies including those whose assets exceed their liabilities pursue the deflation of assets listed on their balance sheet so as to satisfy creditors of whom managements frequently collude with, often preceding the chapter 11 filing when establishing a prepackaged deal and during the restructuring process. For example, Whiting Petroleum reported a net property and equipment value of $7.3 billion in Q3 of 2019. This asset valuation was later reduced to $3.4 billion in Q1 of 2020 due to impairment incurred from lower oil prices. Whiting's disclosure statement assumed a $1.55 billion enterprise value, an approximately 48% decline from the previous year when it was $2.96 billion. This implies that the Whiting's NCAV or liquidation value of property and equipment was less than $900 million, given its now substantial credit facility. Therefore, Whiting Petroleum's assets were deflated by nearly 65%, a stifling contrast from the valuations suggested by the balance sheet. A second example is Breitburn which filed for chapter 11 bankruptcy in May 2016 and whose assets exceeded liabilities by $1.3 billion on its Q1 balance sheet only months prior. Breitburn's bankruptcy asset valuations were more than 50% less than those presented in its balance sheet. Denbury Resources which was previously expounded upon in a recent post exemplifies a high asset value company whose tangible book value exceeds its current share price. Denbury's management recently filed for chapter 11 bankruptcy and intends to apportion the equity of the restructured company primarily among its second lien noteholders. The company's current asset values postulated within its balance sheet will presumably undergo significant deflation comparable to Whiting's, ranging from potentially 50% - 70% in the restructuring process to provide second lien noteholders with additional equity and account for low oil prices. As a result, Denbury Resources' second lien notes may be acquired for approximately 0.45 cents on the dollar, or potentially much less if oil demand sees a resurgence preceding the distribution of equity in the new company. Information regarding Denbury's Second lien notes which comprise 76% of the company debt can be found at the following link: https://finra-markets.morningstar.com/BondCenter/BondDetail.jsp?ticker=C610055&symbol=DNR4117942