|Shares Out. (in M):||3||P/E||0||0|
|Market Cap (in $M):||225||P/FCF||0||0|
|Net Debt (in $M):||75||EBIT||0||0|
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Prime Energy Corp – Prime Permian Land Play & Charlie Munger Style Cannibal
Low oil prices, falling oil stock prices, bearish sentiment even among value investors – now is the time for an oil e&p stock recommendation. And not just any oil stock, but a small cap oil stock. That is trading near multi-year highs, and where much of the value in undeveloped land.
Meet Prime Energy (PNRG). Now that you’ve heard the worst, here is some of the best – it is trading at a material discount to its public peers and private comps in the “hottest” part of the Permian basin. It is run by owner operators who have managed the company for 30+ years, and who along with a few other shareholders own 90%+ of the company. And it has been actively buying back shares at a substantial discount to both the current share price and NAV.
If you’re going to have a “boring” business model like Prime’s, where you develop mostly within cash flow, and have mostly emphasized development of low cost, conventional oil and gas fields, the best place to have been doing it is the Permian basin. Much like how Pioneer (PXD) got lucky in that its conventional activities included hundreds of thousands of acres in the core of the Eagle Ford and the Permian, Prime happened to be active in some of the best land in the Midland Basin in the Permian, and at a smaller scale in what is now called the STACK play in Oklahoma.
The degree of luck here is remarkable – with 16,500 net acres in the Midland basin (in the core counties Midland, Martin, Reagan and Upton), and 6,500 net acres in the STACK play in Canadian and Grant counties, at recent transaction prices of $35,000 per acre in the Midland Basin and $14,000 per acre in the STACK play, Prime’s 3 million fully diluted shares could be worth $217 per share, excluding other assets, production value and debt, versus a current share price of $75 per share. Even using a discounted land value of $18,000 per acre in the Midland basin and $5,000 per acre in the stack, that still leaves Prime with an acreage value of $107 per share.
Obviously debt should be deducted in an NAV calculation and production and other assets should be accounted for. With a reasonable assumption of $50,000 per boepd value for production (which at just over 50% oil, with most production in the Permian and Oklahoma, is consistent with recent transactions), and factoring in the $90 million of debt (all senior revolving bank debt, with additional borrowing capacity), this nets to $114 per share using the low acreage value estimate and $262 using the recent transaction based estimate.
The above does not give benefit for cash or for in the money hedges, as they net out with other working capital and asset retirement obligation items.
There are other factors relevant to this investment, but the above covers the high level investment thesis. Below, I will cover some other relevant considerations.
1) The price of oil:
I don’t know what happens to the price of oil in the short run. In the longer term, I think oil prices rise to the global marginal cost of production, which is very likely substantially higher than current prices. The price of oil is not a huge factor in this investment unless it goes down substantially. And it probably makes sense, if buying Prime Energy, to short a basket of other small to mid cap Permian E&Ps such as Callon, Diamondback, RSP, Parsley, etc). This short will help protect against a mark to market loss if the price of oil declines further, and will help preserve value if Midland basin acreage values deteriorate.
2) The value of Permian land
Despite the fall in oil prices, acreage in the Midland basin part of the Permian is garnering record high prices in private transactions, and companies with Midland basin acreage are trading at high implied acreage values. This is due to the high rates of return available from multiple zones – offering the opportunity to drill more wells in one section of land than an E&P company might be able to in other areas like the Bakken or Eagle Ford. Currently, E&P companies are claiming there are 6 viable zones across parts of the Midland Permian, and companies like Diamondback and Callon are reporting “net effective acres” on the basis of that multi-zone potential and the ability to drill an increased number of wells per acre.
To some extent an investment in PNRG is a bet on Permian acreage value. It is also a bet on smart owner operators who are aggressively buying back stock and are prudently managing their business with an eye towards eventual sale. As discussed above, it is possible to “arbitrage” this value by shorting a basket of Permian E&P companies as a hedge.
One other thought – some investors, such as Greenlight, are short Permian focused shale players like Pioneer. Prime Energy could be a value priced long that could help offset some of the negative convexity associated with shorting an oil equity at low oil prices. However accurate or inaccurate the Greenlight short thesis, it makes sense to have some offsetting long exposure if oil prices recover, particularly if it is possible to match that exposure via going long a value investment that is a) buying back shares and b) trading at a fraction of the per acre value peers are trading at
Given the delay in getting this out (started working on this when the stock price was in the 50’s) it made sense to put it out before finalizing a comp table. There is lots of easily accessible investment bank research on Permian focused E&P companies, and there are numerous recent transactions that can be pointed to.
4) Is Prime’s land “core”?
An obvious question is going to be “how do you know Prime’s land is ‘core’”. The answer is that even “non core” land outside of Midland county, but in the few other counties Prime has land in, is transacting for over $30,000 per acre net of production value, as seen in recent acquisitions by Diamondback and RSP. Also, a substantial portion of Prime’s land is in a non-operated joint venture with Apache. Apache has millions of net acres in the Permian basin and is currently developing its highest return land to dig itself out of its perceived North Sea / Egypt hole. Prime’s land being a part of this project is a positive, and the right to participation in these wells would likely go for a premium, as seen by a recent non-op deal between TPG and Legacy Resources (LGCY) valuing less core non-op land by a worse operator at over $25,000 per acre.
5) What about cash flow multiples, DCF, etc?
Obviously cash flow matters, as does modeling out the future production and reserves of a company. However, after conversations with management regarding the direction of the company (preparing for a sale in a market recovery), and reviewing the assets, debt position, and corporate history, it makes more sense to focus on asset value and likely sale value. At ~10x EV/annualized Q2 cash flow, Prime is not cheap, but is also not particularly richly priced compared to its peers. And considering its substantially larger land base, its history of stock buybacks at accretive prices, and its moderate debt position, the NAV should drive the stock price more than run rate cash flows at below $50 oil.
6) What about the STACK?
Prime’s central Oklahoma STACK land is at least partially in the sweet spot of the play. Like the Midland Permian, the STACK has multiple zones stacked on each other (thus the name), driving premium prices for core land. Multiple operators have verbally corroborated Prime’s land position, and have confirmed the high value estimate used here for that land. Even non core land in the area is selling for thousands of dollars per acre (see the recent Gastar land divestiture).
7) Isn’t the stock illiquid?
Yes. Liquidity has been improving recently, but the company had already bought back 20,000 shares just in the first two quarters of 2015 (at a 12% discount to the current price, and representing a material portion of shares traded).
8) Why is this so cheap?
What is remarkable is that this stock is essentially unknown. There is no research coverage on it. No investor presentations. Extremely non promotional management (it took quite a bit of perseverance to get them on the phone). With the relatively limited float, solid owner operator management with a good track record, and top tier assets, it has the potential to revalue substantially to trade more closely in line with its peers, at a multiple of the current share price. I have had a few conversations with smart E&P investors who look for good small cap investments in the space, and they had not even heard of it.
Disclaimer: Opinions expressed herein by the author are not an investment recommendation and are not meant to be relied upon in investment decisions. The author is not acting in an investment adviser capacity. This is not an investment research report. The author's opinions expressed herein address only select aspects of potential investment in securities of the companies mentioned and cannot be a substitute for comprehensive investment analysis. Any analysis presented herein is illustrative in nature, limited in scope, based on an incomplete set of information, and has limitations to its accuracy. The author recommends that potential and existing investors conduct thorough investment research of their own, including detailed review of the companies' SEC filings, and consult a qualified investment adviser. The information upon which this material is based was obtained from sources believed to be reliable, but has not been independently verified. Therefore, the author cannot guarantee its accuracy. Any opinions or estimates constitute the author's best judgment as of the date of publication, and are subject to change without notice.
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