HOLDINGS (In no particular order)
Jones Energy (JONE):
JONE released a reserve report and guidance on Feb 24 that was disappointing. It was disappointing in the sense that the new completion design might not be worth it. I wouldn’t necessarily call the PR ugly, but the market reaction sure was given the illiquidity in the shares.
The disappointment stemmed from a production rate for FY 2013 that was a little light of the guided midpoint (17k boe/d vs range of 16.6k-17.9k boe/d) and from what appears to be the company “abandoning” the new completion design.
The following section is the most important part of the PR in my opinion:
“Update on Completion Techniques in the Cleveland
Jones Energy has completed 20 test wells in the Cleveland using a new completion technique, which has an average of 20 stages (3 clusters/stage resulting in approximately 70 foot spacing between clusters) compared to the prior design of 20 stages (210 foot spacing). The new technique uses a cased-hole design as compared to an open-hole completion in the prior design. The average cost per well of the new design is approximately $4.0 million, compared to $3.1 million using the historical design. All of the 20 wells in the first phase of the test program have been completed and are currently producing hydrocarbons.
Of the 14 wells with 30 or more days of production, 12 have produced at or above historical type curve. Over the next two quarters, the Company will monitor production data on the test wells and undertake additional optimization techniques, prior to making a decision on whether the level of production is significant enough to justify the incremental capital investment per well, and which design to utilize going forward. In the interim, Jones Energy will be employing its traditional open-hole completion technique in the Cleveland, which is the basis for its guidance for the balance of 2014. Going forward, the Company expects its average Cleveland AFE to remain at a best-in-class $3.1 million, which we expect will allow us to continue to generate compelling rates of return in our core play.“
The new completion design is showing production above the historical type curve, but obviously not at rates that would imply a superior rate of return and the company has decided to wait to see if results improve. In the meantime, they will go back to their play-leading open hole completion design. Perhaps the results over 2 quarters will show increase EURs or lower decline rates from the wells => That would be a positive. Perhaps the company will find that the completion design at almost $1M incremental cost is just too restrictive => That would be a negative.
Frankly I am not concerned about the report or the new completion methodology. As I have said before, the worst case scenario is the company reverts back to its industry leading open-hole design that costs $3.1M and produces IRRs in some cases over 100%.
I think the market reaction was overdone and that the impact of the new completion design experiment was limited. Let’s think about it this way: The company drilled 20 wells with the new design. Presumably the company spent $20M more than it otherwise would have to case and frack the wells according to the design ($1M incremental cost per well). Let’s assume the new design is just an abject failure (which is unclear at this point, maybe it is ultimately a success), then the company essentially torched $20M. What’s that per share? With 49M shares outstanding, it’s only about 40 cents per share. On the day of the announcement, the shares were down almost $3/share!
The company risked $20M for a chance to increase its already large lead as an operator in the Cleveland. And it’s not like the $20M is gone! This capital will still produce a return, just not as large a return as it otherwise would have.
There’s always the chance that costs come down and/or EURs (and therefore IRRs) go up in the future. You never know. It’ll become a problem if the company stubbornly tries and tries again to make a new design work.
In light of the disappointing results, the company is doing the right thing – it is going to utilize the old completion method going forward. That is, unless the new design is perfected and shown to produce superior returns.
Backing up to the 10,000 ft view: Using the old design through the first half of 2013, JONE was to my knowledge the only small or mid cap E&P company that was growing at 25% top line and spending within its cash flow. I don’t see any reason why that cannot continue being the case (unless of course mgmt acts stubbornly and throws good money after bad).
Magnum Hunter (MHR): MHR had year end results last week. The company missed horribly on its 2013 exit rate guidance of 23-25k boepd. The actual exit rate came in at 11,298 boepd – or 15,386 boepd adjusted for divestitures and shut-ins. Given the horrible weather up here in SW PA, I understand the difficulties facing the company. There were days I had trouble starting my car this winter. I can only imagine what it is like trying to orchestrate a drilling effort in sub-zero temperatures.
According to Jim Denny (EVP of the Appalchia Ops), the company would have been right at 22k boepd if it weren’t for the weather delays. Here are his exact words:
“We’ve had extreme temperatures as all of you might realize living — most of you living in the Northeast, it’s been very difficult to operate in these conditions when we get down below 10 degrees on a wind chill or at absolute temperature. The diesel in our engines and vehicles begins to gel and will not flow without heat [Dedwards – Yeah, I experienced this in my driveway several times]. But — and a further complicating it is the hydraulic oil, which we — hard for me to get my arms — head around — actually becomes a sludge. So we’ve had a very, very difficult time continuing drilling and completion operations when we can’t test our BOP’s properly. … So I would say that we are a good 50 days behind where we anticipated being even in the third quarter, or early fourth quarter of last year. So if we — just to summarize, with what we have tested and are shut-in and what we are now completing, all of which what I anticipated being in 2013, we would have been right at 22,000 Boe a day.”
=> According to the call, MHR will be drilling 5 Utica wells in 2014. Assuming these are 30 million cubic feet a day monsters, the company shouldn’t have a problem getting to its 35k exit rate. Add in shut-in production and wells waiting to be completed in the Marcellus, the production story here could change rapidly. (Fingers crossed that it finally does!)
Fortunately for MHR, Eureka Hunter appears to be doing well. The company just barely missed its YE throughput target of 200 MMbtu/d, but demand for the pipe looks strong as new wells from 3rd parties come online. This demand should only get stronger as the company builds out its Ormet lateral in Monroe County OH (a hot spot).
“We’re also try to increase marketing exposure for Triad and other producers, getting 2 additional pipelines, new interconnections with companies such as REX, TETCO, Dominion and TICO. As Gary mentioned in the opening statements, we — Eureka touched just under 200 million — of 200,000 MMBtus a day, the other day. That was a record for us. Our volumes swing widely with freeze-offs and producers doing various operations at various wells. Our volumes do continue to ramp very nicely though on average through the fourth quarter and into the first quarter of ’14. Over the next 90 days, we’re expecting additional volumes from new production from naturally Triad, but also Eclipse, JB, Stone, and into the summertime, Noble and CONSOL.”
After the report came out, MHR shares slid pretty hard because of the production miss and also because the company’s precarious financial situation became clearer. As of January 31, the company had $55M of liquidity ($48M cash, $7M on the revolver), versus a capital budget of $400M. The budget implies a cash burn of $33M per month. This means the MHR had roughly a 7 week runway as of January 31 before it would encounter a liquidity crisis. Fortunately, MHR has a solid asset base and appears to be involved in negotiations to raise cash. It will be interesting to see how this plays out, but the company has a lot of options including:
- JV unproven Washington County acreage
- Sell Tableland Field/Saskatchewan acreage
- Sell dry gas Huron/Weir Shale acreage in Kentucky
- Sell the pipeline (they won’t do this yet unless the price is ridiculous)
Whatever management decides to do, it will have to be done soon as the cash is probably running thin at The Hunter.
Gastar (GST): Gastar came out with 2014 guidance in February that the market thought was no Bueno. The company exited 2013 with 9.2 Mboe/d production and guided for only 9.7-11.0 Mboe/d production over 2014, while spending $192M in the capital budget.
The company plans to drill 17.1 net wells in Oklahoma (9.7 net non-op and 7.4 net operated with 2 in WEHLU). Assuming each of these Oklahoma wells IPs with 400 bbl/d, you’re looking at almost 7,000 boepd of initial production right there. Obviously these rates will decline and not all the wells will come online at the same time, but it looks pretty clear the company will beat its 10.3 Mboe/d midpoint 2014 guidance (or at least the exit rate will be impressive).
The company’s finances are strained, but not horrible. They have a $192M budget for 2014 – $32M cash as of year-end + $100M available on a revolver. The balance – $60M – should easily be made up through operating activities (street has them doing $75M EBITDA in 2014).
The next batch of catalysts are Hunton well results that should be out soon. What we have found with the Hunton wells is that it takes 60-90 days for the wells to de-water before hydrocarbons start to flow. We are waiting on the Burton 1H and the Townsend 1H, which must be flowing back at this point.
Antares Energy (AZZ.AU/AZZEF): Antares was a nightmare, sale cancelled and company will attempt to drill its own horizontal program in the Permian. Management continues to play games with the shares. I feel stupid for being involved here. I will be exiting on any and all pops.
Emerald Oil (EOX): EOX has a new investor presentation here. The company has shown a strong ability to execute on its operated drilling program. You can see on slide 6 that the company’s results in the Low Rider area have been quite strong. 90 day rates are over 600 bbl/d on average and the company is outperforming its 550 Mboe type curve.
The company maintains solid liquidity – $145M ($105M cash, remainder available on revolver) vs a capital budget of $307M for the year ($182M for drilling, $125M for leasing activities). I can see the company covering drilling capex via current liquidity and cash from operations, but see them struggling to meet the $307M bogey when leasing activities are thrown in. The company will undergo a borrowing base redetermination in April, which given the strong drilling results should mean an increase in the revolver. I am still unsure the borrowing base bump the company expects will get them to this $307M mark. I assume they will be selling more non-operated acreage in the near term.
The third rig is due to come online in Q2.
Alaska Communications (ALSK): We will get FY results from them on March 6.
Black Diamond (BDE): This is my newest position and surprisingly is not an E&P company (not that I am exclusively an E&P investor… I have just been content riding that wave for some time now). Black Diamond is a brand manager that has a portfolio of interesting outdoor brands. You can see the latest investor presentation here.
BDE’s products – from the website:
“From carabiners, skis, headlamps and harnesses, to freeride ski boots and trekking poles, we design and manufacture an exceptionally wide range of superior products for climbing, skiing and hiking. This diverse collection of products is united by excellence in quality, true innovation, and inspired details and features. This is partly the result of desire and diligence by an extraordinary team of people, as well as the fact that we are climbers and skiers ourselves.”
I first came across this company when someone on Twitter mentioned it (in freefall from 52-week highs following a holiday-time slaughter in retail names). Then, I happened to be watching a really cool snowboard documentary on Netflix called The Art of Flight, which was sponsored in part by BDE. I mention this in order to bring up an important aspect of investing in retail names or brand managers – trends and popularity.
One trend I have taken note of is the recent and growing prominence of outdoor sports and outdoor apparel. REI appears to be a successful outdoor retailer that appears to have a new store everywhere I go these days. L.L. Bean is cut out of the same mold (or I should say cut the mold that REI is now exploring in retail brick & mortar). Judging by Cabela’s stock price and financial performance, outdoor sales are doing pretty well.
Long story short, outdoor retail is hot right now. BDE is a good way to play that trend in my opinion. As the company makes a push into apparel from accessories, I think there are significant growth prospects – apparel market is much bigger than outdoor accessories. BDE has hired impressive talent away from competitors Patagonia and The North Face (slide 13 of presentation) and has seen recent success in apparel. BDE targets getting to $250M of apparel sales by 2020. That would more than double company revenue in 6 years.
The company has a history of successful acquisitions and $212M of NOLs available. I expect it to make accretive acquisitions and to fully utilize these NOLs.
Value: Not a value stock, instead a trend stock. $380M EV ($345M mkt cap + $35M net debt) vs. 2012 EBITDA @ $14M.
2013 FY numbers are out as of tonight. BDE missed its revenue guidance of $205-210M, with FY 2013 revenue at $203M.