Revisiting a Drill-Down

 | Aug 13, 2013 | 1:00 PM EDT  | Comments
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mhr

I'm attending the EnerCom Oil & Gas Conference in Denver, where the presentations are packed, lunch is on overflow, and the interest level is generally high. Market action has recently appeared to show energy stocks falling out of favor at the expense of technology, but there is no evidence of that here. Here are my notes on two companies I have written about previously.

GreenHunter Resources (GRH)

The company is turning away business. GRH management noted that in the last few weeks they have had to turn away customers in Appalachia because demand for its saltwater disposal wells (GRH operates eight in the Marcellus Shale) is so strong. It is looking to expand capacity but constrained because capital is tight: The single greatest issue facing GRH remains lack of capital to fund growth. Management appeared laser-focused on this issue, and I believe that they are close to finalizing a source of private equity financing. While working capital deficit is an issue for GRH, management once again noted that the company's $2 million line of credit with largest shareholder Gary Evans (CEO of Magnum Hunter) remains undrawn.

New product introductions proceeding apace. GRH has its first modular above-ground tank (MAG tank) installed and running for a customer, and the company's Frac-Cycle oilfield water recycling/reuse technology has already been taken up by a couple large producers. Every bullet point in the "growth opportunities" area of the company's presentation is coming to life, while the core SWD business continues to see demand from oil producers.

Exploiting the water side of the fracking business is still a great idea, but for GreenHunter Resources to be a great company, they need to raise capital, and the urgency to realize that was quite evident in management's demeanor. A capital raise would give time to attain the internal cash flow needed to self-fund, and would also "de-risk" the company's Series C preferred shares. It's the silver bullet here, and since the Series C is currently trading at a 26% discount to face and a yield of 13.6%, my firm continues to buy it -- while eagerly awaiting news from GRH's boardroom.

Magnum Hunter Resources (MHR)

Infrastructure is Magnum's greatest challenge, but also its greatest opportunity. Magnum's first half was marked by operational issues in the Williston Shale and MHR is still flaring gas that it could be selling as it waits for ONEOK (OKE) to complete gas infrastructure in North Dakota. Also, MHR and was victimized in the second quarter by pipeline-related production shut-ins in the Marcellus.

Across the U.S., the infrastructure for shale drilling is lagging the drilling itself, thus raising the value of that infrastructure. MHR's Eureka Hunter pipeline thus becomes crucial asset, and Evans noted that marketing would begin soon with a sale likely in early 2014. He's sticking to previously estimated value of $750 million to $1 billion, so in that scenario, MHR's 60% interest would be worth $450 million to $600 million. Given the current market cap of MHR is $694 million, one can see the value-unlocking potential from a sale of the pipeline assets.

Preferred shares not likely to be redeemed soon. As I have written previously, MHR's hiatus in preferred dividend payments has ended; the shares will trade ex-dividend Tuesday morning. Nonetheless, I still believe the prefs (MHR-C, MHR-D, MHR-E) offer great value here. Thus, I was pleased when Evans told me that the Series C (currently callable) would not be redeemed without divestitures and the Series D -- callable next March and a much larger tranche than the Series C -- would not be redeemed until there is a transaction with Eureka Hunter. The preferreds offer a great way to play a company with a massively improved balance sheet and strong growth prospects, and I am happy to see them "live" as long as possible.

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