2012 Turkey of the Year

In Which we Pile on to some weak picks from the past year.

By Travis Johnson, Stock Gumshoe, November 21, 2012

Every year, as Thanksgiving comes around, the President calls up a turkey to the Rose Garden to be ceremonially pardoned … and your friendly neighborhood Gumshoe calls up a turkey of a stock pick from the annals of the teaserdom to be ceremonially pilloried, as a reminder to all of us about just what stinkers we can sometimes be talked into buying because of a compelling story.

The rules are simple: It has to be a stock that was teased by a newsletter ad over the past year and covered in this space, which usually narrows it down to about 200 stocks; it has to have had terrible performance, which usually cuts that number in half or so (there’s a lot of mediocrity to sift through); and the promise has to have been outsized and ridiculous. That almost always still leaves me with a tough choice at the end, since pretty much every year has had its share of teaser picks that lost at least 80% of their value and were overpromised and overhyped … so which one wins the coveted Turkey of the Year this time around?

Well, I gotta tell you, I was sorely tempted by a handful of “this will change the world” junior resource-type stocks — everything from IBC Advanced Alloys (IB.V IAALF) to DNI Metals (DNI.V DMNKF) to the several Graphite/Graphene stocks, particularly Flinders Resources (FDR.V FLNXF), Northern Graphite (NGC.V NGPHV), and Focus Graphite (FMS.V FCSMF), has ended up taking a harsh pounding this year and been pitched by several different newsletters. But at its heart, you kind of had to expect that — these are stories without sales, explorers or folks who are trying to develop new markets or new techniques or technologies or rebuild mines, and though the world was promised we had to know it was a bit overblown… especially as newsletter attention was a big part of the fuel behind their big price spikes in the first place. All of those are at least back to where they were before the hype began, most have fallen further than that.

And there’s usually a biotech pick in the running, too — this time I was sorely tempted to tag Star Scientific (STSI) with the Turkey label … but heck, it’s hardly fair, that one’s only down 50% or so from his recent recommendations, and we’ve got a couple dozen stocks that have done that badly or quite a bit worse. And we already end up talking about that one a lot, our last piece on STSI back in August has more than 70 comments, many from Anatabloc users, and is still going strong.

So what it really came down to in the final determination was two oil services stocks — both of whom played off of the same theme (fracking uses a lot of water), and both of whom had great stories: Poseidon Concepts (PSN.TO POOSF) and GasFrac (GFS.TO GSFVF). And of the two, I give Gasfrac the edge because it was recommended by a couple different newsletters and pushed more aggressively, even as the business was deteriorating, and because even I thought there was something to the story the first time I heard about it and thought it might be worth a nibble at a couple points as it fell, so I get to aim the Turkey baster at myself, too.

If you’d like to browse through the lists of past picks yourself, by the way, you can always do so in our tracking spreadsheets — we’ve got the original price for each of the thousand+ teaser picks we’ve covered since 2007, a few are probably in need of updating for splits and such, but the data is mostly accurate. And sobering.

I don’t want to understate how close this call was, and it’s really just personal sentiment that swayed the balance — so Keith Schaefer can rest assured the he came within a drumstick of winning this year. Poseidon Concepts’ edge in this argument was that it was clearly a business that would get more competitive in the long run — how can you keep paying a massive yield by just building gigantic heated swimming pools for storing fracking water? Can’t someone else get into that business pretty quick and charge less and cut into your margins dramatically? (The answers is “yes” on that, apparently).

Yes, they are evolving and offering more advanced services to differentiate themselves and get stickier relationships with their customers, and yes, for now they’re still paying out that dividend, but it was a gravy train that looked a little rickety even way back when we wrote about the teaser in February, just before the shares topped out around $16. I couldn’t have predicted that they’d have this particularly steep kind of collapse, going from $13 to $5 in two days, I thought they’d deteriorate more slowly as competitors came into their space, but that overnight fall that didn’t even give folks a chance to trigger some stop losses really caught the attention of a lot of investors, and earned a lot of Turkey points.

And yes, I know, I’ve picked lots of lousy investments, too. There are two kinds of stock market pundits, commentators and newsletter editors: Those who will tell you that they’ve made at least a handful of bad choices; and those who will lie to you. I don’t do this to pick on any one newsletter stock picker, and I’ve had a few of these “Turkeys” over the years where I’ve been able to single out a true turkey of a pick at the same time that I can point to a huge winner teased by the same newsletter. This is about the stocks and the crazy “story stock” promises that are flung around like feces in the monkey pen — not necessarily about the editors whose newsletters are being advertised.

And we can emphasize that doubly so by singling out our Turkey of the Year for 2012 as Gasfrac … but also telling you that the award is still shared, by the two newsletter guys who aggressively teased the stock this year, Sean Broderick and Keith Kohl. And we could even throw in a few honorary mentions in the long and sad history (so far) of Gasfrac, including Keith Schaefer and Brian Hicks for teasing it earlier on at even higher prices, in 2011 and 2010, and, if we’re being fair (dammit), to your friendly neighborhood Stock Gumshoe, who owned it for a few months in 2011 before taking a lovely tax loss on the sale and said some relatively optimistic things about it back when it was at the seemingly low price of four bucks a few month ago. It’s at about $1.30 now.

So what happened to the company?

Well, the short version is that Gasfrac was a story stock that happened to have a management team that maybe believed their own story too much and overbuilt and oversold the story, sharing that optimism with shareholders whenever they got the chance. That’s not unique to this company, of course, but it so happened that they’re in a capital-intensive industry … and they probably invested heavily in their expansion before they had enough committed customers.

If you’ve been fortunate enough not to have been exposed to this company before today, I should probably explain that they are a fracking firm — they do the pressure pumping to fracture shale and tight rock formations to release trapped gas and oil. But unique among pressure pumpers they’re not a hydraulic fracturing firm, they’re a LPG fracturing firm. Instead of pumping pressurized water and additives (proppants and chemicals) down wells to fracture rock formations and release oil and gas, they pump gelled propane down those same wells, which they say allows them to produce more oil and gas than the water does. Because that propane can then be recovered along with all the rest of the petroleum products they produce from the well, they’re not offering any new pollution to the water table or using millions of gallons of water (and contaminating that water with chemicals) during the fracturing process — their process is apparently waterless. Sounds perfect, right? That’s a dream “story stock” — more production, more environmentally friendly, no water problems, la di da.

The technology worked, we kept hearing, and the production was great and results were strong … but there just weren’t all that many customers, and the customers they have haven’t been ramping up their usage of the GasFrac system. Which doesn’t make sense if the story is accurate, right? Why wouldn’t customers keep signing up for more and more wells to be “gasfracked” if the system works as well as the company says in their presentations.

Well, part of it is probably that it’s never that simple — different wells and different formations respond differently to different technologies and strategies, so sometimes the LPG fracturing doesn’t work better than hydrofracking … or at least, not better enough to justify the higher cost. Water, though not always cheap and plentiful, is certainly a lot cheaper than gelled propane. Even if you recover a good portion of that propane, you don’t recover it immediately and the up-front capital costs are still significant. And change is hard — if a company is doing something that works, asking them to pay more and commit to a new system that might work better is a tough sell. Particularly if a lot of your customers are natural gas drillers, and they’re having trouble enough with their margins and the profitability of pressure pumping and fracturing as it is. Propane is a natural gas liquid (NGL), and is often produced with natural gas, but it’s far more expensive than “dry” gas — so using propane to produce dry gas is perhaps a tough sell. Not that it doesn’t still make sense — if the LPG produces more and is mostly recovered, it ought still to be a good economic argument, and it can be used by oil producers as well as dry gas and NGL producers — but up front costs may be a deterrent anyway.

Perfect stories don’t always lead to great businesses, or great stocks. Unfortunately. GasFrac still has a chance, I expect, because they do have a couple customers still using their technology on at least a testing scale, and they’ve just pulled back from the brink to enter “survival mode” — a mode where they mothball half of their equipment sets and fire a bunch of employees and scale back to just running what’s already been ordered. The CEO has left, he had come over from Halliburton to spearhead Gasfrac’s expected glorious growth transformation as