It’s still earnings season, and while many prominent companies have reported, there are a number of notable companies still reporting. One of today’s biggest movers on an earnings miss is Vertex Energy (NASDAQ:VTNR). Earlier today, VTNR stock sunk more than 50%, before making up some of its losses this afternoon.
A mid-cap player in the energy sector, Vertex’s earnings miss certainly received no pardon from investors today. The company’s Q2 loss widened to $67 million from less than $20 million a year ago. What’s worse, analysts had a consensus estimate of $92.9 million in earnings for the company. Oof.
This earnings miss appears to be driven by losses tied to various commodity derivatives. In layman’s terms, the company hedged its refining production, locking in prices at unfavorable levels. Thus, Vertex is paying a hefty price for this insurance on their production.
This past quarter, the company reported an unrealized commodity derivative loss of $46.9 million, along with a realized commodity loss of $46.1 million. An additional intermediation agreement tied to backwardation (when near-term energy futures are worth more than long-term futures) led to an additional $23.2 million loss.
Let’s dive into what investors should make of these earnings.
VTNR Stock Sinks on Upside Down Hedges
There are many reasons oil companies, including refiners, choose to lock in prices. Like an insurance contract, derivatives allow a company who expects to produce a certain amount of oil or refined petroleum products to lock in a specific margin on their production. When prices are volatile, this can be a good thing.
However, derivatives contracts are generally priced so that the insurance is unlikely to pay out. Additionally, in a rising input cost environment, refiners can get hit harder than many oil companies locking in a price per barrel of oil. It’s important to remember that crude oil is an input for refiners. And we’ve seen what’s happened to the price of oil of late. If a company limits their upside on how much they can charge for finished product, but the price of their raw materials increases, it’s a recipe for losses.
Today’s incredible 50% decline in Vertex appears to reflect concern investors may have with the company’s hedging strategy. That said, should these hedges get removed, on a forward-looking basis, VTNR stock may be attractive. This is likely to be a special situations stock various investors and traders are likely to play from here. Personally, I have this company on my watchlist right now.
On the date of publication, Chris MacDonald did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.