Magnum Hunter: Clearing the Pipes

 | Jul 12, 2013 | 11:30 AM EDT  | Comments
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I've  written before about Magnum Hunter Resources (MHR), and this has been an eventful week for the company. MHR finally filed its first quarter 10-Q on Tuesday, as well as issuing an operational update and hosting management conference call. They also hired a new CFO today.

The "public company" issues clearly are done, and the fact that MHR's new CFO has more than 20 years of experience in audit/reporting is a reassuring sign that the company's reporting issues will not recur.

As for operations, CEO Gary Evans noted that the Eureka Hunter pipeline will be marketed, beginning in September. Evans is still ascribing a value of $750 million to $1 billion on that asset (MHR owns 60 %.) The company is on target for $300 million in capital expenditures in 2013, split evenly between Appalachia and the Dakotas. They also project a production exit rate for 2013 of 23,000 to 25,000 barrels of oil equivalent per day.

Natural gas prices remain stubbornly low, however, despite the rise in crude oil prices. With the pipeline divestiture likely not to occur until 2014, we think MHR common shares will be "on pause."

As always at Portfolio Guru, LLC, our angle is an income-generating one, and we continue to focus on MHR's preferred securities. The company has been unable to pay preferred dividends while its financial statements were in arrears, but those dividends are cumulative -- meaning they will be paid out of arrears when the company is current with its reporting.

On its conference call with analysts, MHR management noted "we'll be filing...other 8-Ks later in the week...that are pro forma 8-Ks related to the Penn Virginia sale. And once those were filed, we will be clear to bring all cumulative dividends current on the 3 series of preferred..."

We are nearing the end of the saga, and the shareholders who stood by MHR will likely receive four months' worth of dividends (the cumulative dividends from April, May and June, plus July's dividend) at the end of this month. The Series C preferreds are currently callable and are trading at a premium (see table.) That is not a good combination, as the premium (albeit a slight one at 2.2%) would at redemption become a capital loss for an investor who bought the Series C today. Evans noted on the call that the Series C preferreds would likely be redeemed before the end of the year.

That leaves the Series D and Series E preferreds. The main difference is that the Series E preferred is convertible into MHR common shares at $8.50. If you are massively bullish on MHR and want to lock in an 8.2% yield until November 2015, then the "E kind" is for you.  While I do believe that MHR's reserve valuation equates to a share price in the high-single digits, that is a theoretical valuation, and I am not going to predict that MHR shares will more than double in 27 months.

I'd rather lock in the 8.7% yield on the D kind, which is trading at a discount to face value. If you bought at today's closing price and MHR called at first opportunity, you would realize MHR-D's current 7.5% discount to face as a capital gain. And you would have the monthly coupon payments for 9 months.

Adding the 7.5% discount and the 6.5% yield (nine months' of dividends) gives a 14% return in nine months. That's healthy, and it is obvious that if the Series D preferreds are not called, then your total return increases each month. With $220 million outstanding of Series D vs. $100 million of Series C, the D is less likely to be called at first opportunity.

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