July 29, 2002; Be Careful Speculating in El Paso Corporation


Some energy infrastructure stocks are so beaten up that it is tempting to take a flier on a turnaround in a company like El Paso (EP).  Though the turn could possibly be here, we have low confidence that is the case and in the McDep Ratio framework, the bet is not worth it. 


El Paso’s current McDep Ratio appears to be a low 0.76 with a ratio of Debt/Present Value of 0.61.  Contrast that with ChevronTexaco at 0.69/0.16 and Royal Dutch at 0.74/0.12.  Thus even at $10.34 a share, the fundamental value in EP is not as good as that of CVX and RD. 


Thus if one took those McDep Ratios and ratios of debt at face value, only a capital constrained speculator would choose EP.  Because of the high ratio of debt, EP stock would normally go up faster and down faster than that of CVX and RD.  A normal, thoughtful investor, if he desired to do so, could achieve the same risk adjusted effect by borrowing money to buy CVX and RD or simply buying more CVX and RD and holding less cash. 


At the same time, we have low confidence in our estimates for EP and high confidence in our judgment on CVX and RD though, in a commodity business, numbers are always changing.  For sure our debt for EP is understated as we have included only one level of the pyramid of debt.


Recent experience with other infrastructure stocks implies high risk of further bad news ahead for El Paso.  For example our estimates for AES, Calpine, Dynegy and Williams are now at bankruptcy levels with nominal Net Present Value of just $1.00 per share in each case.  Those stocks are just bundles of debt with no meaningful equity.   We have watched the progression.  Investors raise questions.  Negative articles get written.  The CEO resigns. The debt is downgraded.  The SEC investigates. The debt is downgraded to junk.  The stock collapses.  The Justice Department investigates…………….

July 29, 2002; Meter Reader: Move Up to Quality