Sticking With Magnum Hunter

 | Feb 28, 2014 | 2:00 PM EST
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In 1976, the Tampa Bay Buccaneers' coach, John McKay, was asked during his team's infamous 0-14 campaign, "What do you think of your team's execution?" His reply: "I'm in favor of it."

Execution becomes key after a stock has had a run, not in anticipation of it. While the U.S. stock market is at an all-time high, one could look at execution on a meta-level, and next week, I'll write more about the earnings outlook for the S&P 500.

But my remit as a Real Money columnist and, more importantly, as an asset manager, is to focus on individual stocks. At Portfolio Guru, we had much success with oil-patch names (common and preferred) last year, and I believe that will continue into 2014.

2013 was the year the market finally figured out that unconventional drilling was for real. The strong performances of such unconventional plays as Gastar Exploration (GST), Miller Energy Resources (MILL) and Magnum Hunter Resources (MHR) powered returns for my clients. In 2014, I believe that the market will cast a more critical eye on results from the drillers and that we'll see a separation between the more-efficient and less-efficient producers.

So Magnum Hunter's results, released Monday, were an important step toward establishing the company's true valuation. The results were mixed: The company's production level wasn't as high as some had expected, and the impact of divestitures make the ongoing production level hard to predict.

Magnum Hunter's conference call was kind of "blah" as well, as it included many references to weather-related delays in drilling, especially in Appalachia. I would note that this is very different from a retailer blaming the weather for poor sales growth. If the diesel in the generators freezes, then drilling is difficult, and Magnum Hunter has had some delays.

But it is possible to focus too much on the details, and, as a former sell-side analyst, I can attest that sweating the minutiae is what pays the bills. On the buy side, dealing with an uninspiring conference call is really a much simpler process.

It involves three questions:

  1. Has management made any comments that change my view on its ability to execute its business strategy?

  2. Has anything in the numbers (and, more importantly, management's explanation thereof) changed my fair-value calculation for the stock?

  3. Is management giving any clues that industry conditions will be tougher in the near term?

In Magnum Hunter's case, the answer to all three questions is "no."

  1. The two most important developments for Magnum Hunter occurred in February and thus weren't included in the fourth-quarter 2013 results. The superb results from Magnum Hunter's first Utica well on the Stalder Pad (32.5 MMCF/D) and American Energy Partners' huge acreage purchase (at a valuation of over $12,500 per acre) from Hess were ex-post items. Management didn't say anything on the call to dampen enthusiasm for its prospects in the Utica and, by implication, the value of that acreage.

  2. I'm in print with a fair-value estimate for Magnum Hunter of $12.25, and there wasn't a single number either in the 10-K or mentioned on the call that makes me adjust that estimate. It's my story, I'm sticking to it, and while space constraints limit my ability to derive the valuation here, if you would like a full explanation, please send me a message.

  3. There certainly wasn't anything in Magnum's results to make an outside observer less bullish on the Utica shale play. Also, remember that the Marcellus, the hot play of 2011-2012, is a geological formation that is basically adjacent to the Utica, and different wells on the same pad can exploit both strata. This is exactly what Magnum Hunter is doing on the Stalder pad, with a Marcellus well now be drilled near the existing Utica well.

The Marcellus was sort of forgotten with all the ebullience over the Utica in 2013, but I believe 2014 will see renewed interest on those plays that are east of the Ohio River. As a polar vortex refugee (at times, anyway), I can attest that the Northeast needs more natural gas, and adding more wells to existing acreage in the Marcellus is one way the industry is going to make that happen.

So, I still like Magnum's story, and I still believe it's worth about 50% more than the current price. Simply put, it's a buy. 



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