Today's markets presented a rare buying opportunity in energy-sector preferreds, which form the heart of my Portfolio Guru, LLC Model Portfolio and the guts of my income-based clients' Classic accounts.
At one point, Magnum Hunter Series D Preferred (MHR-D), which has a $50 par value, traded as low as $42.65, down 9.2% on the day, and implying a 9.3% yield.
Magnum Hunter common shares (MHR) have been under pressure this week along with the rest of the group, but today's move in the preferreds was sudden.
The impetus seemed to be Standard & Poor's decision to rate Magnum Hunter's proposed senior secured second-lien term loan "B," which is actually one notch above the rating agency's issuer-level rating of "B-" on Magnum.
While S&P maintained a "stable" outlook, the ratings agency did change its outlook on Magnum's liquidity from "adequate to less than adequate" citing concerns about free cash flow through 2015.
I don't think it's worth column space to bash the ratings agencies here, as so many others have done it so well for the last six years. Anyway, in the last five months Magnum has taken the following liquidity-enhancing actions:
- Received $150 million through a private placement of stock with Relational Investors.
- Sold certain assets in its Williston/Bakken play in Divide County, ND for $23 million.
- Announced (Thursday) an agreement to sell other Divide County assets for $85 million.
- Agreed -- as part of a broader transaction -- to sell a 6.5% interest in the Eureka Hunter pipeline to Morgan Stanley Infrastructure for $65 million, with closing anticipated in mid-January.
- As part of the Eureka Hunter transaction, it has the right to opt out of $40 million of capital expenditures in rolling 180-day periods, which would effectively lower Magnum's stake in the pipeline.
Even if you don't give Magnum credit for "foregone" capex from Eureka, that's $300 million in liquidity.
Obviously, what is producing liquidity (with the exception of Eureka Hunter) would lower Magnum's reserve base, which typically lowers an exploration and production (E&P) company's borrowing base.
But those reserve adjustments were obviously comprehended in the company's new $50 million revolving facility and $340 second-lien term loan. Net net, the new facilities add $134 million to the bank financing that was available to Magnum on Sept. 30, of which $115 million is available immediately.
Magnum's upstream capex in the first half of the year was $77.5 million, a number CEO Gary Evans has said would be a good baseline for upstream capex in the second half. So that's a little more than $150 million.
Magnum also spent $52 million in capex on Eureka Hunter, but under the new agreement with Morgan Stanley, the company can opt out of up to $80 million in Eureka Hunter capex per year.
Finally, Magnum spent $60 million on leasehold acquisitions in the first half of 2014, but those are obviously discretionary purchases. I believe those purchases will slow because the richness of gas production from Utica wells (and Magnum holds the area record with its 46.5 Bcf initial production rate from its Stewart-Winland 1300U well) has driven up land prices there. The easy land purchases have been made. Now it's time to drill, baby, drill and Magnum has the liquidity to do that.
So, I was selling things I love today to buy Magnum's Series C Preferred (MHR-C), Series D Preferred (MHR-D), and Series E Preferred (MHR-E). I couldn't believe the good fortune for myself and my clients to lock in such attractive yields. And in an extra special bonus, preferreds of other E&P names went down in sympathy with MHR-C, MHR-D and MHR-E.
I was loading up the truck with Guru favorite Gastar Exploration's Series B Preferred (GST-B) and buying the Series A Preferred (GST-A), as well, which I thought has been priced out of my range (yield too low) forever.
Market overreactions can be beautiful things. The oil price, as measured by West Texas Intermediate (WTI) seems to have stabilized at above $85 after a wild week. And that's not really the point for Magnum as they continue to sell their oil-producing assets in the Bakken shale. Natural gas futures have done very little this week, and at $3.86 are still above the July lows.
Oil prices move based on such a witches' brew of global factors that it drives pundits crazy. Natural gas is priced locally. Farmer Jim's arthritic big toe (sadly not a joke) is telling him this is going to be a cold winter and Nat Gas prices at the Henry Hub will return to the $4 mark. Even setting aside Magnum's aggressive gas hedging program, the gas price is what should be looked at as a benchmark for Magnum, and I am bullish on the outlook for a rebound in prices for the heating season.