Magnum Hunter Resources (MHR) is engaged in the exploration for and the exploitation, acquisition, development and production of crude oil, natural gas and natural gas liquids, in three unconventional shale resource plays in North America: the Marcellus Shale, Utica Shale, Eagle Ford Shale and Williston Basin/Bakken Shale. In total, the company owns approximately 560,072 net acres, with 170,000 net acres in its core resource areas, including 58,426 net acres in the Marcellus Shale, 61,151 net acres in the Utica Shale, 24,000 net acres in the Eagle Ford Shale and 76,739 net acres, which includes lands from the recently announced April transaction, in the Williston Basin.
Source: MHR March 2012 corporate presentation, before April 2012 Williston Basin acquisition
Since the company’s restructuring in May 2009, when the new management team led by Chairman and CEO Gary Evans took over, Magnum Hunter significantly increased shareholder value through a combination of acquisitions, joint ventures and ongoing development drilling efforts. Evans, while leading a previous version of Magnum Hunter Resources, merged with Cimarex Energy in a transaction valued at $2.2 billion. Is the past prologue? Evans certainly is building the company to repeat its previous success: CNBC interview.
An under-valued asset at MHR is the company’s midstream operations. Through its Eureka Hunter Pipeline System, involving 207 miles of pipeline, gathering systems and rights of way for of natural gas produced in West Virginia and Ohio, the company noted in its year-end 2011 earning press release that the gathering capacity of the pipeline system was approximately 60,000 Mcfe/d with plans to continue to expand.
In October 2011, the company entered into certain midstream services agreements with MarkWest Liberty, to which MarkWest will provide long-term gas processing and related services for natural gas produced in northwest West Virginia by both Triad Hunter and other producers that is gathered through MHR’s Eureka Hunter Pipeline System.
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During 2012, MHR expects to invest approximately $150 million for its upstream operations and approximately $50 million for its midstream operations. The Eureka Hunter Pipeline System provides MHR the opportunity to develop substantial natural gas and natural gas liquids resources in the Marcellus Shale and Utica Shale, as well as provide the opportunity for substantial cash flow from the gathering of third party volumes of natural gas.
At December 31, 2011, MHR reported proved reserves of 44.9 MMBOE (48% oil) an increase of 235% from 2010. The company produced an average 5,510 BOEPD during 2011, representing a 324% increase from 2010. MHR exited 2011 producing in excess of 12,500 BOEPD. The company’s most recent presentation (March 2012) guides investors to a production exit of 16,000 BOEPD. During the interview with Jim Cramer on CNBC’s “Mad Money” on February 13, 2012, Evans noted that production was at 14,000 BOEPD. Company spending in 2012 is estimated to be $200 million. The aggregated analyst 2012 EBITDA estimate posted on Bloomberg is $160.9 million. We note that as of December 31, 2011 the company had $108.0 million undrawn on its $250 million revolver.
Recent E&P Acquisitions:
Eagle Ford Shale
September 2009: Sharon Resources, Inc. – Purchased inventory of drilling locations focused in the Eagle Ford Shale located in South Texas.
May 2010: Hunt Oil – Expanded their Eagle Ford Shale position through additional leasing activities and entry into two joint ventures, one with Hunt Oil Company, and the other with a private independent oil and gas company in October 2010.
Williston Basin
May 2011: NuLoch Resources Inc. – Acquired the company adding 5 MMBOE of proved reserves, 124 producing wells, 347,531 gross (76,000 net) lease acres, and 338 low-risk horizontal unconventional locations for approximately $327 million.
April 2012: Eagle Operating Inc. – Acquired working interest ownership in 191 existing wells on approximately 15,500 gross mineral acres in the Williston Basin of North Dakota. Net production from the acquisition is approximately 350 BOEPD and proved reserves were 2.1 MMBOE. MHR increased its working interest from 47% WI to 95% WI. The purchase price was $48.5 million in cash and shares ($6.74 per share).
Marcellus Shale
February 12, 2010: Triad Energy Corporation – MHR acquired the company out of bankruptcy for $81 million. The acquired assets are located in West Virginia, Ohio and Kentucky, in the Appalachian Basin, and include 5.1 MMBOE of proved reserves, over 2,000 producing wells, over 88,417 net acres, including over 47,000 net acres in the Marcellus Shale, approximately 182 miles of natural gas pipeline, three drilling rigs and service equipment; and two commercial salt water disposal facilities.
December 2010, January 2011, June 2011: Three separate PostRock Asset Acquisitions – Aggregate purchase of PostRock included approximately 13,293 gross (10,389 net) lease acres, comprised of 4,228 gross (2,114 net) lease acres in Wetzel County, West Virginia and 9,065 gross (6,161 net) lease acres in Lewis County, West Virginia, eight proved developed producing wells and 27 identified horizontal unconventional drilling locations. The total purchase price of these properties consisted of approximately $24.7 million in cash and 3,201,360 restricted shares of common stock of Magnum Hunter.
April 2011: Windsor Asset Acquisition – Acquired properties located in Wetzel County, West Virginia from a privately-held independent oil and gas company for a purchase price of $20 million in cash. The acquired properties represented the remaining 50% non-operating working interest in approximately 4,228 net lease acres in which Triad Hunter already owned the 50% operating working interest, which it had previously acquired through the PostRock asset acquisitions.
December 2011: Stone Energy Joint Venture: Plan to jointly develop a contract area consisting of approximately 1,925 leasehold acres in the Marcellus Shale in Wetzel County, West Virginia. Each party owns a 50% working interest in the contract area. Stone Energy also contributed to the joint venture certain infrastructure assets, including improved roadways, certain central field processing units (including water handling), and gas flow lines, and agreed to commit its share of natural gas production from the contract area to gathering by its Eureka Hunter Pipeline System.
Southern Appalachian Basin
April 2011: NGAS Resources, Inc. – Acquired NGAS in a stock-for-stock exchange pursuant to which shares of common stock of Magnum Hunter were exchanged for shares of NGAS. The NGAS assets acquired by us included 63.1 Bcfe (10.5 MMBOE) of proved reserves, production from approximately 1,364 wells, approximately 322,390 gross (275,684 net) lease acres, predominately in Kentucky, and a multi-year inventory of approximately 586 low-risk horizontal unconventional drilling locations.
Utica Shale
February 2012: Acquired leasehold mineral interests located primarily in Noble County, Ohio from a third party for a total purchase price of $24.8 million. The acquired lease acreage consists of approximately 15,558 gross (12,186 net) acres that are presently prospective for the Utica Shale. Price-per-net-acre value of $2,035 compares favorably to recent Utica transactions: $15,000 paid by Chesapeake and an average of $2,700 paid by Gulfport. BP announced on March 27, 2012, it purchased 84,000 acres targeting the Utica/Point Pleasant formations. Range Resources showed on page 23 of its most recent presentation both its acreage position and the wet gas fairway in northeast Ohio/northwest Pennsylvania prospective for the Utica/Pleasant Point formations. Range holds 190,000 acres that the company believes are prospective for the Utica/Point Pleasant formations. Noble County, Ohio is shown to be in the wet gas fairway.
The truth will be found through the drill bit, but MHR is certainly in well positioned in Ohio.
Valuation
We looked at the company’s valuation based on a three methodologies including reserves, production and EnerCom’s Five Factor Model (5FM).
We note that as of market close on April 5, 2012 shares of MHR were trading at $6.19 per share. Using our three methodologies, we are estimating Magnum Hunter’s basic and diluted share value to range between $8.09 and $14.36 per share.
Net Asset Value: Proved Reserves
As of December 31, 2011, MHR had proved reserves of 44.9 MBOE, 46% of which are proved undeveloped and 48% of which are oil. For our valuation, we adjusted the year-end proved reserves to include the 2.1 MMBOE that the company acquired in April 2012, increased the shares outstanding by 296,736 to account for the equity portion of the deal financing, and increased debt by $48.5 million for the cash portion of the deal financing. The average enterprise value to proved reserves for an operational focused peer group was $27.30 per BOE. Assigning a probability of success to the proved value, and assigning a $10,000 per acre valuation to the 19,640 net undeveloped acres in the Eagle Ford and $2,035 per acre to the 61,151 net undeveloped acres in the Utica, we estimate MHR shares to be worth $10.30 per basic and diluted share. Our model assumes a midstream value of $288 million based on the company’s remaining 72% interest in Eureka Hunter that MHR kept after selling a 28% interest to ArcLight Capital Partners, LLC on March 21, 2011 for $100 million.
Net Asset Value: Production
For the quarter ending December 31, 2011, MHR produced an average of 9,124 BOEPD. For our valuation, we adjusted the production rate to include the 350 BOEPD that the company acquired in April 2012, increased the shares outstanding by 296,736 to account for the equity portion of the deal financing, and increased debt by $48.5 million for the cash portion of the deal financing. The average enterprise value to flowing production multiple for the same per group used in the proved reserves valuation was $120,790 per BOEPD. Assigning this multiple to MHR’s production rate and using the same undeveloped acreage and midstream valuation assumptions as we did in the proved reserves valuation, we estimate MHR shares to be worth $10.43 per basic and diluted share. We note that the company is growing production quickly, doubling daily production between Q3’12 and Q4’12.
A high-case valuation for Magnum Hunter, using Evans’ statement on CNBC about MHR’s current production rate of 14,000 BOEPD and using a price-per-share valuation ratio based on a company’s daily production rate, MHR’s stock price could be as high as $14.36 per share.
EnerCom’s Five Factor Model
Using EnerCom’s proprietary Five Factor Model (5FM), on March 30, 2012, MHR’s 2012 P/CFPS ratio should be 8.1X, rather than the 6.4X that it presently trades, a difference of 27%. This would imply a share price of $8.09 per share.
This 5FM analysis compares MHR’s 2012 estimated price to cash flow per share to EnerCom’s 28-company small cap peer group. EnerCom’s 5FM was designed to be used as a starting point for evaluating E&P and OilService relative valuation – against a large group of companies or a selected set of operating or market cap peers. The Five Factors are metrics that we believe management teams have the most control over – costs/expenses and growth. The table below compares MHR’s ECI Value Drivers to EnerCom’s 28-company small cap peer group (as of March 30, 2012).
By focusing on the key variables that management can control, the 5FM helps identify the strongest teams most capable of creating value at any point of the energy cycle, making one’s view of commodity prices a separate decision. When a company is evaluated using the 5FM versus a selected set of peers, we find that the resulting Predictive Value can explain more than 85% of the variability in a company’s forward price to cash flow per share. We believe the 5FM can be an early signpost in identifying potential disconnects between company value and market perception.
Composite Valuation
Assigning a weighted average to the three valuation methodologies, we estimate shares of MHR to be valued at $9.57 per basic and diluted share. Based on this understanding, we believe our 5FM is pointing to an undervalued situation, where MHR is trading below several key benchmarks, including relative P/CFPS multiple, and NAV.
