Investors Put Denbury in the Bargain Bin

 | Nov 27, 2013 | 12:00 PM EST  | Comments
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This month has been a tough one for those in Denbury Resources (DNR). While many names in the oil space have sold off, few have done so like Denbury. It dropped from $19.50 to $17, a decline of nearly 13% in three short weeks.

Denbury, a domestic pure-play in CO2 injection-aided oil production in mature fields, has sold off because investors are disappointed the company decided not to become a Master Limited Partnership, or MLP. As partnerships, MLPs pay no corporate taxes, and most excess cash flow is usually distributed back to unit holders. As a holder of mature acreage, with perhaps the highest margins of all its peers, Denbury seemed an ideal candidate for the MLP structure.

But alas, management saw "no long-term shareholder benefit," in converting to an MLP. This is because management wanted to keep its balance sheet clean and simple. In a conversion, the balance sheet, in their words, would become "at least a little messy."

Denbury also pays all of its dividends through operating cash flow. While most upstream MLPs do indeed pay distributions through cash from production, the balance sheets and cash flow statements of these partnerships can be confusing. Management has decided to keep things simple and straightforward.

But here's the problem. Many investors were expecting to get substantial income from Denbury, hence the selloff. It seems like the market currently only likes energy companies of two kinds: Those which are growing production rapidly such as deep water players, shale players or servicers from either respective industry -- or those which pay a big dividend, such as the super majors or MLPs.

Denbury's dilemma is that it is neither one of those. The company is a slow-and-steady grower, using enhanced recovery methods in traditional basins which tend to get overlooked in favor of the shale. While Denbury will raise its yield to 1.35% in 2014 and 2.8% in 2015 by today's prices, that really isn't enough to entice dividend investors today.

Denbury, in summary, provides mid single-digit production growth, yet has a small dividend which will increase over the long term. Having no room for in-betweeners, investors have placed Denbury in the bargain bin. The stock now trades at just 1.18x book and 14.6x forward earnings. The market just doesn't have the patience to wait for Denbury.

This is exactly why I believe Denbury deserves your contrarian consideration. No matter how you look at it, Denbury is trading at a friendly valuation. The company has a simple, clean balance sheet. Denbury will provide income growth, which is increasingly hard to find these days. Perhaps most importantly, Denbury is the most efficient, highest margin producer of its peer group -- it is quite possibly the most efficient player in all of North America's oil patches.

         

The chart above shows Denbury ahead of all its peers in both margin per barrel and capital efficiency. How is Denbury able to do this? In fact, Denbury's tremendous efficiency is inherent to the company's business model. While CO2 injection into mature fields won't beget the stellar growth rates of the shale, these fields' economics are much better, with significantly lower extraction costs.

Conclusion         

Right now there are no catalysts which will propel Denbury shares out from the discount bin it now occupies. This is a "slow money" pick which should be held for multiple years. However, if it's sustained, outsized dividend growth you are looking for, Denbury is a great pick. Not only that, Denbury's high margin production and simple balance sheet make the company about as low risk as it gets for oil production.

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