Why Did Robert Rodriguez Buys Cimarex Energy , St. Mary Land & Exploration Company, and Atwood Oceanics, and Sells Foot Locker

We added several new names, with a majority in the energy sector. We continue to view energy as a strategic area for investing and have communicated this idea to you over the last several years. The rapid decline in energy share prices affords us the opportunity to deploy capital into very attractively valued companies. We also added to some of our existing holdings while in the initial stages of establishing new positions in other industries. The companies selected have very strong balance sheets and are market leaders; therefore, we believe they will be survivors and thus, they will improve their competitive positions in this down cycle. After this round of purchases, we will slow the rate of acquisition for a period of time to assess how the stock market responds to recent governmental policy actions as well as what other policies might be implemented. We are not disclosing our purchases at this time since we do not want to inform our competition of exactly what we are doing. We will discuss these new holdings in greater detail in our next shareholder letter.

……

We believe the long-term fundamentals for the oil and gas exploration and the oil service sectors are favorable, which is why combined they constitute our largest investment area of significant improvements in technology and understanding of where oil is. Over the last four decades, worldwide oil consumption has virtually doubled from 45 million barrels per day in 1970 to 86 million barrels today. Discoveries have been going the opposite direction. Despite continually improving discovery techniques, including 2D seismic, 3D seismic, and diamond bore technologies, global discoveries have declined from 60 billion barrels per year, during the peak years of the 1960s, to around 10 billion today. Thus, after five decades we are now finding a fraction of what we found five decades ago. The easy and large finds were discovered first, leaving the smaller, less prolific producers to be discovered later.

……

Because of this outlook, we recently began adding to several existing oil service positions, and started purchasing several new oil service companies at what we believe are depressed valuations. The oil service companies we are purchasing are selling at 25-40% of our estimated replacement values, at 4-6x trailing earnings, and at 3-4x trailing cash flows. Their balance sheets are strong with low debt to capital ratios and, in several cases, net cash on the balance sheets. The price to replacement value for these companies today is similar to when oil prices traded down to $10/barrel in 1999, and below the price to replacement values we saw in 2001, when oil prices went to $18/barrel. For the reasons discussed, we think it is a low probability that we’ll see future oil prices at their levels of 1999 and 2001. If oil prices drop to the levels experienced in 1999 or 2001, cutbacks in spending by exploration and production companies, combined with the natural reduction in production due to high decline rates in existing fields, should act as a natural balancing mechanism and bring prices back up. We believe we have a large margin of safety built in at the valuations we are purchasing these companies, and that they are discounting a large decline in oil prices from the current level of $60/barrel.

An investment that has performed well this year and over the last quarter is Foot Locker (FL). Through the end of September, FL is up over 18% for the year and appreciated nearly 30% in the third quarter. Foot Locker is the largest U.S. athletic footwear retailer and it also has a large presence in Europe. FL has performed well this year because it is taking a much more aggressive stance on its net inventory owned position and, thus, is generating more free cash flow this year than last year. For example, through the end of the company’s most


recent second quarter, ending in July, the company generated $80 million of cash flow after capital expenditures versus a negative $30 million for the same period a year ago.


Nonetheless, we believe that FL and other consumer discretionary stocks will be challenged to produce good profitability over the near term and, hence, at the right valuation we would look to reduce our position.