Buy This Energy Stock
Basement level oil and gas company trading meaningful below the replacement value of their asset with a strong balance sheet and low cost production profile as the margin of safety
Public markets are a wonderful tool for the patient business-minded investor. Everyday Mr. Market quotes you a new price on every equity in the universe. Somedays Mr. Market is optimistic.
“Amazon at $3,000 per share to anyone who wants to drop an order. Google at $2,700 for anyone with the excess cash. Tesla at $1,200.”
Then other days Mr. Market is pessimist.
“Amazon at $1,500 and dropping sharply. Google at $2,000 with no strong bids. Tesla at $650.”
The business-minded investor who focuses on purchasing companies and not stocks, who relies on numbers and not emotions, gets to take advantage of the mood swings of Mr. Market every day.
If you don’t like the price quoted at you one day, just ignore Mr. Market and hold onto your cash. If Mr. Market gets extremely optimistic on a stock you hold, sell it back to him. If Mr. Market pukes on a company you have been patiently waiting to buy, run out into the rainstorm with buckets and try to collect as much water as you can.
The great thing about public markets is that you don’t have to swing at every pitch Mr. Market throws you. This is a game where patience and long-term thinking pays off. Wait, wait, and wait for Mr. Market to throw the right pitch, then swing as hard as you can when that fastball comes your way. Swing for the fences.
My goal in the public markets is to wait for Mr. Market to throw me a pitch where I can buy a company trading meaningfully below its replacement value. I love buying companies where their public market valuations trade below their private market replacement value.
An example of a company that tends to trade under the replacement value of their assets is Macy’s (M). Macy’s is a volatile retail department store company. Sometimes Mr. Market is optimistic on Macy’s and values their assets at or above fair value. Other times, Mr. Market thinks retail department stores have a negative value and prices Macy’s for a considerably cheap valuation.
The thing with Macy’s is that they own some of the highest quality real estate in the world. This real estate is in top demographics including Manhattan, San Francisco, Chicago, etc. Private market valuations imply that this private market real estate has a replacement value of $15-20 billion.
I have a detailed model of Macy’s, including tracking all their owned real estate locations. I have taken advantage of the mood swings Mr. Market has with Macy’s in the past and should Mr. Market value Macy’s significantly under the replacement value of their real estate in the future, I plan on swinging yet again.
But Macy’s isn’t the only company that Mr. Market values under replacement value. Almost every company I invest in typically trades to a meaningful discount to what I think the replacement value is. One company I have previously written up for Alpha Letter Pro Subscribers continues to trade manically with Mr. Markets mood swings. At the current valuation, I think it is trading near the replacement value.
I’ve been an owner of this company for a few months now. The stock price has been extremely volatile. I’m up 50% one week and down towards my initial purchase price the next week. I’ve traded in and out of the stock successfully when Mr. Market is optimistic and bought back in when Mr. Market freaks out about the future.
The volatility in the stock makes sense. The company operates in the highly competitive and commodity dependent oil and gas market. When oil explodes higher the valuation increases. When oil falls, the valuation crumbles.
Despite the highly volatile nature of the oil and gas industry, the setup on this company is almost as beautiful as you can get from the eyeglasses of a trained security analyst.
The company has a large net cash balance that is quite understated as one-time items in Q1 restricted the company from collecting a rather larger pile of cash, which was subsequently collected in Q2.
The low-cost production profile of the company ensures that free cash flow will be generated in an energy bear market. Breakeven production costs at the well are $30 per bbl and trending under $25 per bbl over the next few quarters. Breakeven free cash flow production costs including corporate G&A, should be right around $40 per bbl.
Management is unlocking shareholder value by investing in new offshore wells with low production costs and low long-term decline rates which should meaningfully increase production, putting the company on the screen of larger investors (and frankly larger companies who are acquisitive), driving shareholder value.
Proved reserves at the strip, adding cash and current assets (highly liquid receivables that are not impaired) and subtracting all liabilities implies at the current valuation, investors are purchasing the equity near or under replacement value.
With Brent Crude Oil at $100-110, this company will generate significant free cash flows for investors.
I think this company is worth $8.50-13.00 per share and it is currently trading for $5.82 per share.
I’ve taken a meaningful stake in this company and plan to continue to add on weakness. The stock tends to trade wildly with energy markets and allows business-minded investors to take advantage of Mr. Market’s mood swings.
I hope you enjoy my research. Feel free to reach out if you have any questions.