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Lagging Natural Gas Play May Outshine in 2007
By Michael Brush
Exclusively for InvestorIdeas.com
December 14, 2006
While many North American natural gas plays are flat for 2006 following a very volatile twelve months, shareholders of Denver-based Cimarex Energy (XEC) won’t even manage to break even this year.
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Instead, they’ll be down about 10%.
Their chief problem: Several times this year Cimarex has missed production estimates -- most recently when it announced earnings in early November.
That’s put analysts and investors in a sour mood. After all, having exposure to volatile energy prices by owning production company stocks is bad enough. Who wants one that can’t meet its production targets?
This explains why analysts have hold ratings on the stock, along with price targets that are just barely above Cimarex’s recent stock price of $37.50.
For insiders, however, it’s another matter.
Since early December, chief executive F. H. “Mick” Merelli has purchased an impressive $1.7 million worth of his company’s stock. As we have seen repeatedly, a stand off between bearish analysts and bullish insiders often makes for a good opportunity to earn some profits by siding with the insiders. I think we have another chance to do that with Cimarex.
Savvy insider
I don’t mind betting along with Merelli, for a couple of reasons. First, he’s a long-term veteran of the industry who was the president and chief operating officer at the energy company Apache (APA) in the late 1980s. He then headed Apache spin off Key Production.
Second, Cimarex looks cheap. According to calculations by Chris Pikul at A.G. Edwards, Cimarex trades for an enterprise value that’s just north of three times next year’s cash flow. That’s about half the 6.1 times average for other small cap exploration and production companies. Cimarex has a price to sales ratio of around 2.2, compared to 3.9 for XTO Energy (XTO) and 3.6 for Newfield Exploration (NFX).
Why Cimarex is so cheap
The company does have a solid collection of mainly low-risk assets in the Anadarko Basin, Permian Basin and South Texas, and along the Gulf Coast and offshore in the Gulf of Mexico. And despite a recent purchase of Magnum Hunter, which brought Permian Basin and Texas Panhandle assets on board, Cimarex likes to “grow through the drill bit.”
That means it has more comfortable debt levels than competitors who grow through acquisition. But it also means that problems with production and development get magnified -- since there are few acquisitions in the mix to help make up the difference.
Last quarter, for example, Cimarex production came in about 2% below expectations. And for the third time this year, the company lowered its 2006 guidance. Cimarex blamed production declines on the Gulf Coast, mechanical problems in some wells, delays in bringing on new production in the Gulf of Mexico, and disappointing exploration in Louisiana.
All of this has left a bad taste in the mouth. “While production could be hitting a trough before moving higher into 2007, and despite a preponderance of moderate-risk assets, we believe it is unlikely investors will pay forward for what appears to be an incrementally higher-risk growth profile,” says A.G. Edwards’ Pikul.
What might turn things around
Cimarex chief Merelli, however, is quite willing to pay forward for expected growth. Pikul – even though he’s a skeptic -- outlines where that growth could come from:
- Lost production could be recovered in the next few months.
- Recent discoveries in the Texas panhandle and South Texas could get fourth quarter volumes “going in the right direction again.”
- Cimarex could see some success in higher-risk areas like the Gulf of Mexico and South Louisiana.
“We think the issues will be rectified in a timely manner, so we have left our long-run forecast unchanged,” agrees Morningstar analyst Justin Perucki. He has a five-star rating on the stock, Morningstar’s highest rating. Cimarex, he says, has a “decent shot” at adding shareholder value over time.
The bottom line: In a market that regularly keeps hitting new highs, I’ve been favoring insider-buy stocks that have gone up less – ones that have lower relative valuations. Cimarex fits the bill. As always with insider-buy stocks, you may need to have a time horizon of a year or more with this one to see decent gains.
Disclaimer
At the time of publication, Michael Brush did not own or control shares in any of the companies listed in this column. Mr. Brush is an independent columnist for this web site.
For more on Insiders Corner disclosure, see the disclosure section in About Insiders Corner: http://www.investorideas.com/insiderscorner/. InvestorI deas.com Disclaimer: www.InvestorIdeas.com/About/Disclaimer.asp . InvestorIdeas is not affiliated or compensated by the companies mentioned in this article.
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