In my June 27 column, I discussed meetings I had recently held with managements from Miller Energy Resources (MILL) and Torchlight Energy Resources (TRCH), two companies in my Mad Money Model Portfolio. Since then both stocks have declined (MILL down 12.5% and TRCH down 1.5%) in a rising market. Why? They missed their numbers.
Miller's fourth-quarter average production (fiscal year ended April 30) was 3,070 barrels of oil equivalent per day vs. management's forecasts at the beginning of the fiscal year that implied production of about 6,000 boepd. Similarly, TRCH's June 30 production rate was 387 boepd vs, their target of 500. Both companies hosted conference calls this week and both have shown progress with current production rates (5,100 boepd for MILL and 460 boepd for TRCH) approaching the targeted rates, albeit belatedly.
But a miss is a miss and market punishment is swift. But it would be foolish to ignore another factor affecting both MILL and TRCH: short-sellers. In both cases shorts have taken to other websites to publish columns about TRCH and MILL that are inane, factually inaccurate and quite simply not worth rebutting in the precious few column inches I am granted by Real Money.
Drilling for oil and gas is the definition of a risky business. Things don't always go to plan and yet the planning/budgeting process is so much more rigorous than in other industries I have followed. So, the measurement of return on capital is so much more transparent. But sometimes the rock doesn't cooperate. Hitting a dry hole or two doesn't make management "incompetent" or "frauds"(words used in articles I have read online about TRCH and MILL).
But both stocks have fallen. So, how do you decide between a buy-on-the-dip opportunity (the stock will rebound as production does) and a the-market-is-right (production shortfalls show the company's assets are worth less than you had calculated) moment?
That is such a hard decision with regard to a stock and, honestly, there is no easy formula. The non-answer answer to that question is that knowledge is power and I have seen Miller and Torchlight present a combined 12 times in 2014. I talk to both managements online and off line and I believe the knowledge gained from these conversations is invaluable in analyzing Miller and Torchlight. It's not about liking or trusting management (although I do in both cases). It's about understanding the risks of drilling in their respective plays.
But that's still not an answer to the question "should I buy on weakness?" The other non-answer is that you don't have to. My preferred (sorry) method of investing in E&P companies is via preferred shares. Given the statistically unpredictable nature of drilling, the volatility in well results can lead to volatility in share prices (as seen with both MILL and TRCH). But cash flow never lies and with some basic analysis, measuring an E&P company's creditworthiness is quite simple.
The strong performance of Miller's two preferred series (MILL-C and MILL-D) have powered my Portfolio Guru Model Portfolio's 15% year-to-date gain, along with contributions from the preferreds I own in other energy companies: Gastar Exploration (GST-A, GST-B) Magnum Hunter Resources (MHR-C, MHR-D, MHR-E) GreenHunter Resources (GRH-C) and Evolution Petroleum (EPM-A).
These preferreds all carry coupon yields above 8% (yes, E&P is risky), which should make the prefs less volatile than the common and that has been the case this year.
I own Miller's preferreds and will continue to do so and Torchlight management has noted in their last few presentations that they are raising mezzanine capital of their own via private placements. My firm's mandate prevents me from buying non-publicly-traded securities, but, given my analysis of their numbers, I would LOVE to have a chance to add a TRCH pref to our collection.
So, despite my rant about not wasting column inches, that is exactly what I have done. If you want further information on the specific situations at Miller and/or Torchlight please send me a message in the comments section and I'd be happy to go through their stories in detail with you.