Does Magnum Hunter Resources Have Too Much Debt?

With a staggering debt ratio and questionable insider practices, Magnum Hunter Resources is as risky as they come, but how much risk is too much?

Jul 1, 2014 at 10:21AM

Bloomberg had a really great article last week detailing some of the risks investors face when owning shares of Magnum Hunter Resources (NYSE:MHR). One of the issues that the article pointed out is that the company has amassed a staggering amount of debt to take advantage of the shale boom. It's enough to make any investor wonder if Magnum Hunter Resources is in over its head as we've seen larger peers like Chesapeake Energy (NYSE:CHK) really struggled to get out from under the weight of debt. 

Debt is in the eye of the beholder
The Bloomberg article noted that Magnum Hunter Resources has amassed $891 million in debt. That number represents an unfathomable 70 times EBITDA, which is exceedingly above the industry average of 4.3 times. But that number alone doesn't necessarily mean Magnum Hunter Resources is at risk for bankruptcy.

This is a company that just received a $150 million cash infusion from a very reputable energy investor to become its largest shareholder. Further, as the following slide from a recent investor presentation points out, the company has aggressively sold off noncore assets to enhance its liquidity.

Magnum Hunter Resoruces Asset Sales

Source: Magnum Hunter Resources Investor Presentation (link opens a PDF) 

As that slide notes the company has sold off or is in the process of selling upward of $741.3 million in noncore assets. Add in the company's recent cash infusion and Magnum Hunter Resources could have paid back every single penny it owned.

But that's not what it's doing with the money. Instead, the company is reinvesting it into its high growth shale business and earning a strong double digit internal rate of return. Those investments have slowly boosted the company's net asset value to as much as $2.47 billion according to an internal valuation by the company as seen on the next slide.

Mhr Net Asset Value

Source: Magnum Hunter Resources 

As noted on the above slide, most of Magnum Hunter Resources' value is tied up in the company's undeveloped acreage position, which Magnum Hunter Resources sees being valued between $1.6-$2.1 billion. Needless to say, that undeveloped acreage is quite the land bank that could be sold off if a liquidity crisis ever hit. Selling off undeveloped acreage had become the basic blueprint followed by nearly every major shale driller as it was the plan that was pioneered by Chesapeake Energy. On top of that the company's interest in its midstream subsidiary is worth between $438-$608 million, which again could be monetized if debt repayment became an issue as that's what Chesapeake Energy chose to do with its midstream business a few years ago. So, while Magnum Hunter Resources does have a lot of debt, it also has more than enough assets to maintain its debt. 

The question is if this is the best path for the company to take. We've seen Chesapeake Energy dramatically change its plans over the past few years. In fact, Chesapeake Energy is now focused on simplifying its balance sheet and investing within its cash flow to grow. Only time will tell if Magnum Hunter Resources will hit the point where its debt becomes too big of a hurdle to growth.

Investor takeaway
Just the fact that Magnum Hunter Resources is engaged in the exploration and production of oil and gas makes it a risky company. Add to that risk a huge pile of debt and it's enough to push some investors away from the stock. That being said, even though its debt level is high, its not unmanageable at this point as the company's assets are worth far more than it owes. But there will inevitably come a day of reckoning as even Chesapeake Energy couldn't continue to live on debt and needed to change its free spending ways.  

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Matt DiLallo has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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