Cimarex Poised to Perform in Wake of Amaranth Failure

While perhaps not as spectacular a failure as that of Long Term Capital Management, the reversal of fortune at the Amaranth hedge fund has had a major impact on the market. The sheer volume of positions Amaranth has been forced to unwind has exacerbated the problem, pushing down natural gas even further. Amaranth continues to liquidate positions, and as it does so, natural gas will continue to drop.

Natural gas will stop its fall when Amaranth’s liquidity crisis ends. This will happen in one of several ways. Amaranth will liquidate everything and close up shop, sell enough to restore solvency, or sell distressed assets to a buyer with greater liquidity. Bloomberg reports that another hedge fund, Citadel Investment Group, is in talks with Amaranth to take over open energy trades. Were this to happen, Citadel would be in a position to sit on trades and close the book over time, removing downward pressure from the market.

Natural gas prices would appear to be near a bottom and should rise somewhat once this situation is resolved. In order to take advantage of this, there are several stocks with a natural gas focus in North America that are good buys. My favorite is Cimarex (XEC).

Cimarex is an oil and gas exploration company with all of its activity in the United States. The product mix is 70% natural gas and 30% oil. Cimarex has historically not hedged but announced in August that it had begun hedging natural gas, locking in about 15% of production above $7.

At Tuesday's close of $35.02 (within $1 of the 52-week low and well off the high of $47.80), the company has a P/E of 7 against last year’s earnings. With oil and gas prices down it’s likely that profits will decline as well, but even at 2004’s level of $3.59 per share, the P/E is below 10. Of course, this is offset somewhat by higher production levels than last year given the mild Gulf hurricane season.

Cimarex has been very successful in developing new wells. In 2005, the company drilled 382 wells with a remarkable 88% success rate, resulting in the replacement of 183% of production. The company has announced that it will spend $1 billion on exploration and development this year, up 50% from last year’s number. So far the company has continued its high success rate (134 wells with an 89% success rate in Q2). Sixty percent of the company’s acreage is undeveloped, so there is plenty of opportunity left to grow the already impressive proved reserves 1.4 trillion cubic feet equivalent.

Cimarex is poised to perform well even with oil and gas prices below current levels. The company recently instituted a dividend, has been buying back stock and paying down debt. Would I bet the house on it? No, Amaranth shows the danger of that. But if you can buy at these levels and can wait out (and perhaps buy on) any further drops, I believe you will be amply rewarded.

Update: According to CNBC, Amaranth has transferred its entire energy portfolio to Citadel and JP Morgan Chase (JPM). There’s still a lot of volume to unwind, but now that we’re out of crisis mode, the natural gas market should settle down.

XEC 1-year chart:

Neal Shanske may own securities mentioned in this article.

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