A Small-Cap Driller Boosts Its Volume

 | Nov 25, 2013 | 6:07 PM EST  | Comments
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Miller Energy Resources (MILL) had been quiet in the last month in terms of news flow, although its shares had been gyrating wildly in recent trading days, as is typical. But Miller made some noise today. 

The company announced an initial production rate from its Sword No. 1 well of 883 barrels of oil per day. Coming on the heels of management's announcement of October that results from the company's RU-5B well were a disappointing 250 bbls/day (the initial estimate was 400 bbls/day), this has truly changed the discussion on Miller, and the stock is reflecting that today. Net net, Miller predicted 1,150 bbls/day IP combined from the two wells, and they are producing at the level, and that is reassuring.

But there is a bigger point here. Miller bought the Redoubt Unit and the Osprey platform in 2009 out of bankruptcy, and the company's Cook Inlet Energy unit, led by local veteran David Hall, has done an admirable job of reworking (sidetracking) old wells from the platform (RU-1A, RU-2A, RU-7, etc.). But that's not the growth story. The growth story is onshore, in the form of the Sword prospect, the Sabre prospect and to a lesser extent the legacy West McArthur River Unit assets and the Olson assets up the Inlet, which are mainly gas.

Just when you think it is moving up the west side of the inlet and is going to focus solely on that approach, management today announced a deal to buy natural gas assets on the east side of the inlet, down the Kenai Peninsula, closer to the sea.

The deal for Armstrong's North Fork Unit includes six natural gas wells, with the prospect for 24 more, and crucially nine miles of nat-gas transmission pipeline. I've noted with Magnum Hunter (MHR) the importance of access to midstream assets to an emerging gas play, and it's a potentially saleable asset for Miller. Importantly, the deal also comes with a multi-year commitment from the gas utility Enstar at a contracted price of $7.00/ MCF. Nat gas prices in Alaska, unlike those in the Lower 48, have been notoriously volatile in the last few years, especially during the winter, so that takeaway agreement lowers Miller's commodity risk profile.

So our nice little one-platform sidetracking play is now into two more plays, and a third is coming (the North Fork deal should close in early 2014). At Portfolio Guru, we don't do empire building, and in a world where commodity prices are depressed (nat gas) and are in a bit of a funk (oil), we are only buying companies that can move the needle on production. Miller announced today that total production is now in excess of management's year-end target of 4,000 bbls/day, and now the focus will shift to its fiscal year-end (April 30) target of 6,000 bbls.day. A 50% increase in four months certainly qualifies as moving the needle.

Sword No. 1 is a transformational well for Miller, but remember that adjacent to the Sword prospect is the Sabre prospect, which is three times as large. It doesn't border existing West McArthur River Unit assets as Sword does, but it's not too distant, and Sabre No. 1 is included in Miller's fiscal 2014 (April) production plans. So we will find out soon enough.

How does Miller pay for all this growth? That is the key question. The North Fork Unit nat gas acquisition will cost $60 million in cash plus $5 million in the Series D stock. Miller has an agreement to sell up to $75 million worth of that Series D stock in at-the-market offerings, and I would assume that it is doing some of that now. But that still leaves the bigger question of how Miller is going to finance its growth while at the same time "buying out" private-equity partner Apollo (and its 18% financing), which is management's stated goal for calendar 2014. Miller management will be presenting at the LD Micro conference in Los Angeles next week, and I expect to have many more details on Miller's 2014 financing plans -- this is crucial for us, as MILL-C preferreds are an important holding for Portfolio Guru.

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