There aren't many energy stocks that have risen more than Magnum Hunter Resources (NYSE: MHR) since last summer, surprising even the most optimistic investor of the energy patch. What is the secret behind Magnum's success? What has pushed Magnum to new highs for 2013? Does this rally have legs? To find the answers, let's dig deeper into this company.
What?
The company faced a bumpy road in the first half of 2013. First, it had to restructure its business in order to pay down its hefty long-term debt, which hit $1 billion back in March. In April, it sold its oil-weighted Eagle Ford acreage in South Texas to Penn Virginia Corporation (NYSE: PVA) for a total purchase price of $401 million. This asset was the perfect fit for Penn Virginia's existing asset base, which is located adjacent to these properties. After this transaction, Penn Virginia's Eagle Ford pro forma production rose approximately 40%, and Penn Virginia currently has 420 net drilling locations in the Eagle Ford play and an eight-year drilling inventory, based on its ongoing six-rig program.
The company faced a bumpy road in the first half of 2013. First, it had to restructure its business in order to pay down its hefty long-term debt, which hit $1 billion back in March. In April, it sold its oil-weighted Eagle Ford acreage in South Texas to Penn Virginia Corporation (NYSE: PVA) for a total purchase price of $401 million. This asset was the perfect fit for Penn Virginia's existing asset base, which is located adjacent to these properties. After this transaction, Penn Virginia's Eagle Ford pro forma production rose approximately 40%, and Penn Virginia currently has 420 net drilling locations in the Eagle Ford play and an eight-year drilling inventory, based on its ongoing six-rig program.
Due to this transaction, Magnum's acreage shrank significantly, and the company had to focus on its producing Bakken and Marcellus properties along with its new core area, the Utica shale. Its remaining acreage in Texas was just 7,000 net acres and was obviously too small to attract the company's interest.
On top of that material asset sale, Magnum fired PricewaterhouseCoopers in April 2013. That auditor discovered information that "may have a material impact on the fairness or reliability of the company's consolidated financial statements," according to the company. That red flag pushed the stock down to its 2013 lows, making many investors throw in the towel and switch to greener pastures.
Things started to improve last summer when the new auditor helped Magnum become current with its annual and quarterly SEC reporting requirements, and regain compliance with the NYSE's continued listing standards. Production also jumped to 16,500 boepd (51% liquids), and Magnum now guides for a production exit rate of approximately 24,000 boepd for year end 2013.
After all, Magnum's stock has risen exponentially, climbing from $2.5 in May 2013 to approximately $7.3 as of today.
So what?
Magnum's valuation has skyrocketed. Excluding the company's midstream asset, the Eureka Hunter pipeline, which will be monetized by 2014 and has a net value of approximately $500 million, Magnum's current enterprise value stands at approximately $1.8 billion. Let's check out its peers below:
Magnum's valuation has skyrocketed. Excluding the company's midstream asset, the Eureka Hunter pipeline, which will be monetized by 2014 and has a net value of approximately $500 million, Magnum's current enterprise value stands at approximately $1.8 billion. Let's check out its peers below:
|
Company |
EV ($million) |
Prod. (boepd) (Est. Q4 13) |
EBITDA ($million) |
Proved Reserves (MMboe) |
EV/EBITDA |
EV/Prod. ($/boepd) |
EV/1P ($/boe) |
|
Magnum Hunter |
1,800 |
24,000 |
150 |
57.8 |
12 |
75,000 |
31.14 |
|
Enerplus |
4,600 |
88,000 |
850 |
227.3 |
5.41 |
52,273 |
20.24 |
|
SM Energy |
7,550 |
142,000 |
1,500 |
293 |
5.03 |
53,169 |
25.77 |
|
Penn Virginia |
1,700 |
21,000 |
330 |
125.5 |
5.15 |
80,952 |
13.55 |
As illustrated above, Magnum's key metrics have a huge premium compared to its peers' with a balanced commodity mix, even if the best case scenario happens and Magnum achieves its production exit target for 2013.
Now what?
Thanks to "pad" related drilling and given the successful drilling results of other operators in the vicinity of its leasehold acreage, Magnum believes that its Utica properties will drive its production growth in the coming quarters and a substantial portion of its Utica Shale acreage will be added to proved reserves over time as more wells are drilled and delineated in this region.
Thanks to "pad" related drilling and given the successful drilling results of other operators in the vicinity of its leasehold acreage, Magnum believes that its Utica properties will drive its production growth in the coming quarters and a substantial portion of its Utica Shale acreage will be added to proved reserves over time as more wells are drilled and delineated in this region.
However, the picture from Magnum's acreage in Utica is fuzzy currently because these properties aren't de-risked. Magnum has not announced any drilling results from its Utica acreage, leaving its shareholders literally in the dark.
Setting also high expectations from Utica seems to be optimistic because many wells have finally yielded far less oil than initially expected. According to Donald Templin, Marathon's vice president and CFO: "I would say the growth has been slower than we originally anticipated". Marathon Petroleum, the Midwest's largest refiner recently made changes at its 78,000 barrels-per-day refinery in Canton, Ohio, anticipating increased Utica crude output. So far it only processes 1,500 bpd of Utica oil and condensates.
According to Wood Mackenzie, the Utica will only be producing an average of about 200,000 barrels of oil by 2017, which is a fraction of the 1.15 million barrels of oil a day the Eagle Ford will be producing, according to the consultancy's projections.
Additionally, Magnum's valuation has already risen to outrageously high levels, and its premium relative to its peers is apparent. To me, a prudent investor has to lock in gains and switch to Magnum's peers.
For instance, Penn Virginia has a diversified portfolio that extends from the Mid-continent to the Marcellus and Eagle Ford formations. It has grown its production significantly in 2013, and projects full year 2014 crude oil production to be between 65% and 85% higher than the midpoint of 2013 production guidance.
Enerplus (ERF 0.45%) is another company that continues to see strong performance from its core areas in both Canada and the U.S. Its Bakken and Marcellus assets in particular keep delivering ahead of expectations. Meanwhile, shareholders are collecting a hefty dividend of 6.3% annually while waiting for the stock to rise.
Bottom line
Stepping away from the pack, I am making a contrarian forecast. Magnum's stock is close to a turning point, while its peers have compelling valuations and strong growth prospects. So if I owned shares of Magnum, I would switch to cheaper plays before it is too late. Some might think that this time will be different. I believe this time won't be different: Magnum's stock won't rise indefinitely.
Stepping away from the pack, I am making a contrarian forecast. Magnum's stock is close to a turning point, while its peers have compelling valuations and strong growth prospects. So if I owned shares of Magnum, I would switch to cheaper plays before it is too late. Some might think that this time will be different. I believe this time won't be different: Magnum's stock won't rise indefinitely.
