Shareholders in Magnum Hunter Resources (MHR) have had a rollercoaster year. After moving steadily higher in the first five months of the year, shares have crashed from their highs of $7.71 in February, to a price of $3.92 at the end of last week. Investors have been scared off over the year by lower energy prices, a secondary offering, a somewhat complex share structure, a restatement of earnings from an accounting mistake, and continued acquisitions by management. However, investors seem to be ignoring the possibilities of several catalysts being realized in the next several months, which should provide meaningful improvements to the profitability, production, and financial standing of Magnum Hunter.
The first catalyst will be the opening of MarkWest Energy's (MWE) Mobley processing plant, which was scheduled to open at the end of November. The opening of the plant could slip into December, as MarkWest has blamed the recent storm that struck the Eastern US as causing a slight delay. However, whenever this plant opens, Magnum Hunter is expecting to see an uplift of realized natural gas prices of $1.25-$1.50 per MCF. This will push IRR's on wells drilled in Appalachia upwards of 60%, on par with the IRRs seen in the oil focused plays the company has. Even more exciting, Magnum Hunter has been holding production back, shutting wells and not completing other wells, in anticipation of this plant opening. Once it finally opens, MHR should see a meaningful jump in both production and revenue almost instantly, and those gains will continue as previously uncompleted and shut in wells come back online. The most recent conference call details about 1,900 barrels a day shut in, and another 1,500 barrel a day of NGLs that should be realized once the Mobley plant begins operations, in addition to three 100% owned wells and five 50% owned wells that will begin producing once the plant is up and running. Most of this production can be turned on quite quickly, meaning production should step up meaningfully after the plant begins operating.
A second catalyst is the completion of Oneok's natural gas gathering system in the Bakken. Magnum Hunter, like other producers in North Dakota, has been flaring the gas that is being produced from its oil wells, due to a lack of gathering infrastructure. Oneok's system should be completed in March 2013, and Magnum Hunter expects this system to not only improve production and profitability, but will lead to an increase in reserves, which will allow Magnum Hunter to improve its borrowing base.
The third, and perhaps most game changing catalyst, comes from an increased level of detail out of MHR's Q3 conference call about monetization of the Eagle Ford assets. MHR has hired an investment bank to shop the 26,000 acres in the Eagle Ford, mostly in Gonzales and Lavaca Counties, and has shown the assets to over 15 companies, according to management. The companies are mostly domestic companies, and other leaseholders in those counties have expressed interest in the acreage. An announcement could come as early as December. With prices in the Eagle Ford going for between $20,000-30,000 acre, a deal to sell this division could raise in the neighborhood of $650 million. The money raised is intended to be used for cap ex, to pay down debt, and for possibly redeeming some of the preferred shares. This will help simplify the balance sheet, as well as lowering financing costs going forward.
A fourth catalyst involves the company's 81,000 net Utica Sale acres. Magnum Hunter is in active discussions with different firms about a joint venture for this acreage, including foreign partners. They plan on drilling a one or two test wells in the Utica in the first quarter, regardless of whether or not a JV deal gets announced. Anadarko and Gulfport have both been showing great production results in the counties just to the north of MHR's acreage, and Magnum Hunter is hopeful that these results bode well for the acreage they hold. A Utica announcement could come in the January/February time frame, adding another possible stock moving announcement for Magnum Hunter into an already exciting few months.
While the Mobley plant and the gas gathering system in North Dakota are important steps in the business of Magnum Hunter and are guaranteed to happen, the Eagle Ford monetization and Utica test wells and/or JV are potentially game changing. Assuming a $25,000 price per acre in the Eagle Ford, MHR will raise $650 million. They have already partially monetized the midstream division, and retain $300 million in value there. That's $950 million in value, not including the Williston or Appalachian Basin acreage. Compare that number to the current market cap of about $650 million, plus the Series C preferred has $100 million outstanding, and the Series D has about $205. There is also about $175 million in debt on the revolver, and $450 million on the bonds, for an enterprise value of $1.5 billion. Subtracting out the Eagle Ford and midstream values give you $640 million for the rest of the company, comprising of assets that should be producing about 15,000 Boe/d at year end, in three of the most exciting shale plays in the world. Put another way, if you add up MHR's acreage in the Williston Basin and Appalachian Basin, which includes the Marcellus and Utica Shales, those assets are currently being valued at $1,055/acre. Compare that with numbers like the $15,000/acre JV Chesapeake signed last year, and it's easy to see that the market is severely undervaluing Magnum Hunter Resources.
Given the number of potential catalysts set to take place between now and the end of the first quarter of 2013, investors wanting to play MHR aggressively from the long side should look at purchasing the May 2013 $5 calls. The calls closed Friday at $0.37, and will provide access to the upside out long enough to span not only Q1 2013 but likely the Q1 earnings release as well. In that time, catalysts that are guaranteed to happen include the updates to reserves, production, and profitability from the Mobley Plant in the Marcellus, as well as the gas gathering system in North Dakota. Investors also have possible upside from an Eagle Ford monetization, Utica test wells and possible JV announcements. Other potential catalysts are higher natural gas prices from colder temperatures in the coming winter months, and potentially more details on an IPO of the midstream division, which is planned for some time this year. While shares would have to rally 30% before these calls were in the money, these small E&P names tend to take off upon announcements of large deals with bigger international players, making the calls a higher risk, higher reward play. Less aggressive investors should consider buying shares in this $3.90 range.
The market has been ignoring Magnum Hunter's prospects, choosing to focus on what has gone wrong, and not what management is doing right. With management looking to begin to monetize assets, now is the time for investors to come back to the name, before the large announcements that are likely over the next five months.
Disclosure: I am long MHR.
Additional disclosure: Also long MHR Jan $5 calls and May $5 calls