Description

Ever invested in a company that was decimated by a hurricane? If not, here’s your big chance. Despite the huge run-up of oil and natural gas prices, TMR’s stock is hitting fresh 52 week lows and may be the worst performing oil and natural gas exploration stock in the past 12 months, due to poor drilling results, production snafus, and most recently the eye of Hurricane Katrina passing right through the Biloxi Marshlands, the location of approximately half of TMR’s current production. Furthermore, TMR has one of the worst long-term track records for value destruction of any company I have studied, with an accumulated deficit of $173.24 million since inception (with Joe Reeves as CEO and Chairman of the board since 1990). And management has a long history of over-promising and under-delivering.

This accumulation of insult added to injury has resulted in such intense pessimism and pushed the stock price so low that the analysis of this company no longer requires any predictions about future drilling success (no bankruptcy risk as the balance sheet is strong). It’s just a matter of calculating what the company is worth based on the value of its reserves in the ground. The calculation I outline below suggests that this stock should trade at least 54% higher than it does today based on a conservative estimation of year end reserve values net of debt.

According to the 10K and annual report, on 12/31/04, TMR had:

139,183 MMcfe (Natural Gas Equivalent)
Standardized Measure of Discounted Future Net Cash Flows $470,357
Prices used to Calculated above were $42.33 per Bbl of oil, $6.40 per Mcf of natural gas.

Since 12/31/04, 7.5Bcf of reserves had to be written off (this information from the Q2 conference call): Sidetracks on Turtle Bayou were not able to reestablish production.

So 139,183 is reduced to around 131,500 MMcfe.

Another 14,700 MMcfe were used up in the first 6 months of production. So reserves are around 117,000 MMcfe as of 6/30/05, not including reserve additions.

Though TMR has had very poor drilling results so far this year, there were 6 successful wells as of 7/30. Assuming very pessimistically that they averaged 3 bcfe of gross reserves each and net revenue interest of 67% in each, then that is about 12 bcfe addition.

Bottom line: At least 129,000 MMcfe as of 6/30/05.

The last operational announcement (8/24/05) indicated that Menifee was plugged and abandoned, which I suspect led the market to conclude that BML’s future prospects were dim. But the announcement also indicated that TMR has conducted an electric log analysis on its CL&F E-1 well on its Turtle Shell prospect at 15,300 feet and had encountered hydrocarbon bearing sands. They are expected to continue drilling this to approximately 16,600 feet. This is a deeper than usual prospect for TMR and has a much higher reserve potential than their usual prospects. It is of course impossible to know what the reserves for this could be, but it is possible for reserves to be higher than 50,000 MMcfe. It could also be much less than this. Even if it turns out to be as little as 15,000 MMcfe, that would put TMR’s year-end reserves not too far off from where they started. I will assume 20,000 MMcfe for Turtle Shell, 10,000 MMcfe second half production, and no other drilling successes for the remainder of the year. That puts reserves pretty close to 12/31/04 reserves, so I’ll assume that’s what it is at year end.

So what’s it all worth? It’s not possible to calculate that number with any precision. In addition to knowing the natural gas and oil prices at that time, you need access to future expected development and production costs. These costs are likely to be higher as competition for labor and equipment continues to rise.

Well we need to assume something, so for this write-up I’ll make the following assumptions which I think of as being very conservative, as to what the reserves will look like on 12/31/05:

1) Future production and development costs up by 20%
2) Oil and Natural Gas prices up by 20% ($51 oil, $7.7 Mcf Natural Gas)
3) Future expected tax rates stay the same
4) Reserves at 139,183 MMcfe, just like 12/31/04

This worst-case scenario would cause the standardized Measure of Discounted Future Net Cash Flows to be 20% higher, or approximately $564,000 (Side note: Astute observers might note that TMR’s reserves seem to be valued more richly than most other companies on a per MMcfe basis. This is because most of TMR’s reserves are expected to be extracted and depleted in less than 3 years, compared to 7-9 year lives for many other natural gas intensive companies. Discounting by 10%/year obviously makes an 8 year extraction worth less than a 2 year extraction per MMcfe.)

As of 6/30, TMR had $75m in long-term debt, $2m of notes payable, and $13.6m cash that I consider to be part of required working capital. I assume that TMR will need to draw down its line of credit as Biloxi production is likely to be off line for a few months after the aftermath of hurricane Katrina (revenue will be reduced, but this will be somewhat offset by reduced CapEx as they will likely be down to 1 working rig). It is my understanding that TMR does not have business interruption insurance. So figure about $100m total debt by the end of 2005.

$564m 12/31/05 reserves
$100m expected 12/31/05 debt

$464m minimum value for the company.

Based on $3.47 8/31 closing price and 86,662,000 shares, current market cap is $300.7 million.

If TMR were to rise to my best guess of its reserves value by 12/31/05, the increase would be 54% to $5.35.

It’s worth pointing out that the CEO and COO have just started to buy small amounts of stock on the open market, and that they both have significant ownership interests.

It’s also worth pointing out that, because most of its reserves can be extracted in less than 3 years, TMR is more leveraged than just about any other natural gas producer to short-run natural gas prices. In the aftermath of hurricane Katrina, it’s not outlandish to think that natural gas may remain above $10 per Mcf over the next year or two, during which time TMR can extract a large portion of its natural gas reserves and bring in revenues far in excess of their (admittedly very high) capital expenses. TMR’s has just run out of some terrible hedges in July and has in place some pretty good hedges going forward for a portion of its production. If TMR follows recent practices, they will soon announce another round of hedges that will lock in a fairly sizeable chunk of their reserves at very high prices.

That’s all you really need to know about this company to see why it’s absurdly cheap, but here’s some extra information anyway:

This name has been written up twice on TMR and the Biloxi Marshlands play was a critical part of the story the last two times. After disappointing results in the past half year, especially the recent Menifee dry hole (this was considered to be a prospect with a high probability of success), it is hard to remain optimistic that Biloxi will turn out to be a great play or even a mediocre play. If it weren’t for very high natural gas prices, Biloxi probably would not have even paid for itself due to all the expenses sunk into exploration and 3D seismic processing. And management actions (such as exploring many of their other properties and announcing a partnership with a Texas driller going for longer lived reserves) have suggested that management no longer strongly believes that Biloxi will be a great play. At the current stock price, it doesn’t really matter.

In the short run, TMR’s stock price could go lower if the market has a knee-jerk reaction to Biloxi production dropping to zero for several months. This may happen. The eye of the hurricane passed exactly through Biloxi Marshlands. The company put out a press release on Monday which says that tried to prepare. Expect an announcement within the next few weeks, after the company assesses the damage. Of course, if damage miraculously turns out to be minimal, the stock price will probably pop up quite a bit to reflect higher natural gas prices. On the other other hand, maybe another hurricane hits a month from now that’s even worse. Who knows.

TMR has options on leases that they will need to exercise in December. It is possible that some of the poor recent drilling results are somewhat influenced by testing prospects that do not have the highest probabilities of success, but rather an attempt to determine if optioned leases with certain 3D seismic profiles are worth converting into leases. If so, this suggests another source of potential upside for TMR, as they may be saving some of their higher probability prospects (which they’ve already decided to lease) until 2006.

Yet another source of potential upside is the completion of another round of 3D Seismic reprocessing, which will be happening in the next few weeks. Given this company’s history of poor drilling success, I’m not counting on newly reprocessed 3D Seismic to improve their drilling success rates. But it might happen.

In sum, TMR is trading far below any conceivable calculation of their reserve value. Pessimism is at an extreme after the eye of the hurricane passed right through Biloxi. It won’t take much happening right for TMR’s stock price to increase 50%. If a few things go right (minimal hurricane damage, continued high natural gas prices, a high reserve addition from Turtle Shell, and better drilling results in 2006), the stock could easily triple.

P.S. My sympathies are with those who were impacted by the devastation of Hurricane Katrina. I hope that the next time a big hurricane hits, everyone is able to evacuate in time.

Catalyst

2005 reserve report (next Spring)
Announcement of Turtle Shell drilling result (in a few weeks)
Minimal hurricane damage (possible, but not likely)
Improved drilling results in 2006