|Shares Out. (in M):||17||P/E||15.2x||10.9x|
|Market Cap (in M):||854||P/FCF||17.1x||8.0x|
|Net Debt (in M):||-70||EBIT||93||125|
A fortress balance sheet, quality assets, significant discount to liquidation value and a CEO very much aligned with shareholder interests and a history of doing the right thing: Isn’t that what we all say we want? Contango, which was an excellent VIC writeup by mpk391 in December, 2008, meets all these requirements and is only slightly (10%) higher today, even though most developments in the ensuing period have been positive. You also have to love a CEO who weaves an entire investor presentation around The Big Lebowski: http://www.contango.com/investor/events/20091001/ogis100109.pdf
After repurchasing 7% of its stock in late 2008 and into the first part of 2009 (average price of $42.30), Contango has 16.5MM shares. With no debt and $70MM in cash as of early January, the enterprise value is $784MM. The valuation/mcfe is $2.15, versus $2.02 a little over a year ago when first recommended on VIC. Remember when looking at this valuation that Contango has an exceptionally low cost structure: Full cycle costs run about half the industry average. Why? The company has only 7 employees; virtually everything is outsourced. Also, the wells are very large which create economies of scale.
In the September 30 Q, the PV-10 was $84/share. This certainly will be higher in the next quarterly report as the gas strip has moved up. Note this is a pre-tax number, but at current prices an after-tax appraisal gets to the $65-70 range. Another way of backing into a valuation in the same neighborhood is to look at what Contango was willing to pay for partial interests ($3.10/mcfe, or $68/share) in its two major wells in early 2008, with proceeds from the sale of its Fayetteville shale interests.
One other way of looking at the current economics of the company is to analyze the 9/30 quarter, when gas was very low, through the lens of current prices. At $5.50 gas, versus the $3.40 realized then, and the slightly higher oil prices that prevail today, Contango would have earned $1.30/share. A third way of looking at it is that the company is generating $10MM cash monthly before drilling. Not coincidentally, I believe, Ken Peak announced a Calendar 2010 (note that the FY is 6/30) capital spending plan of $120MM. (see page 14 for a breakdown)
Wildcat drilling is obviously highly risky, although as mpf details in his analysis Brad Juneau and team, who are Contango’s exploration partners, have an excellent long-term record, first at Zilkha Energy in the 1990’s and now on their own. But, as last week’s announcement of the successful Nautilus well shows, it can be highly lucrative, especially given large targets. At $5.50 gas, Nautilus, which will start producing this summer, should have annualized pre-tax cash flow of over $20MM, against a total cost of $29MM. Page 18 of the second presentation shows the economics in a slightly different format.
In October, Contango announced a JV with Patara Oil, committing to a $20-25MM investment in a basket of 15 Cotton Valley gas wells. Peak projects a cash on cash return of 15% for relatively low risk proved reserves. There are tax benefits that sweeten the deal as well. I don’t consider this that big a deal except to show a threshold level of returns that he finds acceptable.
In June Peak announced that he would sell 200,000 shares, or 6% of his holdings, through this plan over the next year. He had not sold a single share before that point. I consider this a non-event.
Most of you reading this far have probably seen the Short recommendation on Chesapeake Energy posted in November. Its author lays out a case for another leg down for gas prices in 2010. I am not totally convinced but it could easily happen. Peak has talked about this as well but would see it as an opportunity: “As painful as the busts are, they are also the time when the most and best opportunities develop.” Though it’s hard to make a case that Contango would be a good stock in the near-term in such an adverse pricing climate, I don’t think that stock would retest the mid-$30’s reached last spring, as that came about in the perfect storm of a major seller and a horrible overall market in addition to weak gas prices. There are many ways to hedge out pricing exposure if one likes the long-term dynamics Contango offers.
Contango sells at a wide discount to current value. Moreover, it is managed by a very smart guy who is motivated by the stock price and should grow the underlying value in the years ahead. (Note that in addition to the 3MM shares he owns the price of the stock is one of the two primary determinants of his bonus). With flat or higher natural gas prices the stock should take care of itself. In a down pricing environment I think there is a fair amount, although not total, protection from the balance sheet and its low-cost producer status and highly attractive opportunities would undoubtedly emerge for the company.
1. Continued exploration success.
2. Major asset sale (as proposed in the summer of 2008) or sale of the entire company.
|Entry||01/15/2010 02:58 PM|
What are using for your estimate of current cash flow (ie your Year 0 Annuity in Observation & Question #1)? If you are using a value that is too high, then this could explain the discrepancy.
|Entry||01/15/2010 03:56 PM|
I believe the PV-10 valuation assumes Contango will drill a handful of rate acceleration wells at some point in the future. Mary Rose 4 was a rate acceleration well, and the original plan was to drill 4-5 more. But that was before gas prices tanked, along with the stock, prompting management to postpone the rest of said wells in favor of share repurchases. Contango could go ahead and drill these if gas prices improved in the future. Note that their platform was built for a much higher throughput than current levels.
Also, I didn't see much in the way of negative reserve revisions when I looked at the histories of their auditor's other clients. (If anyone disagrees please let me know!)
|Subject||RE: RE: Reserves|
|Entry||01/15/2010 07:40 PM|
That's a good response - but where I had trouble make that work was the fact that future development costs were stated as only $16MM. Would $16MM of development capital ramp production enough?
|Entry||02/10/2010 01:52 PM|
No surprises. FD EPS $1.18 (with gas prices significantly lower than today). Cash now $93.5MM ($5.67/share) and no debt. Next corporate events: The Dude well and possible farm-in news.