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Investors Keep Misjudging Contango Oil & Gas

|Includes:Contango Oil and Gas Company (MCF)
Natural gas exploration company Contango Oil & Gas (NYSEMKT:MCF) has seen its share price drop by one-quarter since the end of April while natural gas prices have remained stable or risen slightly.

Contango is a classic “jockey” stock, with founder, chairman and CEO Ken Peak not only owning close to 20% of the company, but also demonstrating time and time again his regard for the interests of all shareholders.

For example, when the company revised down its reserve estimate, negatively impacting pre-tax PV-10 by 3-5% due to new bottom hole pressure data in June, Peak stated, “…it is right that the economic pain of this downward revision be shared, therefore, neither myself nor any Contango employee will receive a bonus or stock options for the fiscal year ending June 30, 2010.” Peak’s salary: $150,000.

While the positive signaling effect of Peak’s action on bonuses and options may well have been worth more than the 3-5% decrease in PV-10, investors sold off the shares by 10% in the three days following the June 10th announcement. Contango’s stock price, which recently hovered at $45 per share, has also been negatively affected by investor sentiment following the BP oil spill. However, while Contango’s operations are concentrated in the U.S. Gulf of Mexico, the reserves are located in shallow water and can be produced in a proven way. Contango shares have rebounded modestly following an operations update on July 21st, in which the company stated that new wells had brought total production to 107 Mmcfed, a 19% increase over the production reported in the June 10th announcement.

Contango has also been busy buying back shares at well below our estimate of intrinsic value, bringing the share count to just under 16 million, 10% lower than at the start of the repurchase program in September 2008. The company has a rock-solid balance sheet, with no debt and $30 million in cash.

Most importantly, this “jockey” stock trades at roughly one-half the discounted value of expected future net cash flows from sales of natural gas.

At a minimum, it appears that with Ken Peak at the helm, investors should capture the full discounted value of the company’s reserves, providing a strong return with low fundamental downside risk. Any future increases in reserves and any premium paid for Contango in a potential sale of the company would further enhance the return to shareholders.

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Disclosure: No positions
Stocks: MCF