When a stock has performed poorly, as Miller Energy (MILL) has done over the past three months, my first instinct is always to do more research: Has the market missed something?
In that vein, I was fortunate enough to attend Miller's analyst day in Alaska last week. When it comes to due diligence, I am not sure there is anything more valuable than helicoptering out to an offshore oil platform of the company in question. Seeing Miller's assets up close was indispensable -- and two things jumped out at me.
1. Scalability: Miller's processing facilities at Kustatan and West McArthur River have excess capacity in terms of production and power. Also, Miller's Cook Inlet platform, the Osprey, showed spaces for future well infrastructure in its "leg rooms" -- and, as the platform outputs all oil to Kustatan via pipeline, takeaway is never a problem. Obviously drilling wells to depths approaching 19,000 feet is riskier than drilling 6,500-foot shale wells. Not surprisingly, given all-in costs as much as $30 million, it is also considerably more expensive.
But unlike many other shale players, Miller is truly good to go. For other firms, the strategy seems to be, "Drill now, worry about takeaway later" -- something that leads to higher rates of capital expenditure as oil is being produced. At Miller, the capital needed to build the infrastructure has been spent, and the incremental costs for an incremental barrel of oil produced will be tiny. That's Miller's competitive advantage.
2. Local Knowledge: Spending a day and a half with Miller's chief operating officer, David Hall, has reinforced my opinion that the company's assets require specialized knowledge. It was also heartening to see that a key member of Mr. Hall's team had worked for Alaska's Department of Natural Resources. The energy business in Alaska is truly a mutually beneficial public-private partnership, unlike the adversarial relationship that exists in many parts of the Lower 48.
In addition, Alaska has a tax-friendly approach to energy production -- under the Alaska Clear and Equitable Share (ACES) program, the state pays Miller in cash for up to 65% of production costs. Ultimately this, and Miller's local knowledge, make these assets very, very rare. Hilcorp is next-door and Apache (APA) produces nearby, but Miller's Cook Inlet Energy subsidiary is indeed a jewel.
I believe the ultimate endgame here is that Miller's new management, led by CEO Carl Giesler, will maximize the value of assets through a sale. Mr. Giesler's background includes a successful master-limited-partnership (MLP) transaction, and if Miller were to drop its assets into an MLP structure, I'd consider that a sale. But I also wouldn't rule out partial sales of assets via joint ventures (JVs) with larger players, or even a sale of Miller in its entirety.
Based on my on-site visit, I can confirm that Miller is not some wildcatting operation roughing it in Alaska. This is a viable operation that has already achieved critical mass -- and one that has the potential for so much more. Miller produced an average of 3,313 barrels of oil equivalent per day in the quarter ended July 31. Thanks to recent acquisitions, Miller's asset portfolio now sports high-priced gas (at $7 per Mcf) that produces a high rate of British thermal units (BTU) -- and the company's moves have only firmed its production base.
In addition to Miller's base of producing assets, its balance sheet has been cleaned up immensely in the last 12 months. This was achieved through new credit facilities from both new and old lenders. There has been a lot of due diligence on Miller over the last year, and lenders base credit decisions on reserves and production -- not on the occasionally weird factors that can hit stocks, especially those with low levels of market capitalizations (under $200 million) such as Miller.
Simply put, the concept works.
There are ample supplies of oil and natural gas in Alaska's Cook Inlet, and it's an environment favorable to producing and selling those hydrocarbons. But investors have been dumping energy stocks with extreme prejudice in the last month and -- for me, anyway -- calling a bottom on Miller common shares would be difficult.
What do I do when I want to invest in a business without assuming risks in markets -- in this case, world oil and U.S. equity -- that I cannot control, as much as I would like to do so? I go in as a creditor. Miller's Series D preferred shares have offered a fantastic return thus far in 2014, with a total return of 20.2% year to date, and I will continue to buy that issue for my clients.
Please note that due to factors including low market capitalization and/or insufficient public float, we consider MILL to be a small-cap stock. You should be aware that such stocks are subject to more risk than stocks of larger companies, including greater volatility, lower liquidity and less publicly available information, and that postings such as this one can have an effect on their stock prices.