COMPANY ANALYSIS

MAGNOLIA OIL AND GAS; MGY-NYSE

In the last few weeks I have discovered and invested in some of the best fundamentals I have ever seen in my OGIB career–large inventory of very fast payout wells.

This is another…in fact it may be one of the best ever. It’s new–a SPAC just come to trade–and it’s in the Eagle Ford. (Mark Papa’s CDEV was a SPAC; Jim Hackett’s Alta Mesa (AMR-NYSE) was a SPAC.)

I have LOTS of oil exposure for better or worse; I never know where oil is going. But I do know the best producers. Sometimes I get shaken out on deep pullbacks like Denbury (DNR-NYSE) and sometimes I hold in and close my eyes GeoPark (GPRK-NYSE) and pray.

(Actually, all my purchases based on Q2 economics are doing well…that was a good rationalization of the portfolio.)

But this one makes sense from every angle I look at it. Me taking a few days to research it instead of just buying it has cost me $1/share in cost–remember, invest then investigate!

They just made another acquisition this morning in the Eagle Ford ($135 million), and this report does not reflect that yet, but the stock is moving. When this gets posted to the Members Centre tomorrow, I will update the Quick Facts for my price and the new acquisition.

This morning I bought 10,000 shares at $13.75. Stop loss would be around $12, but the chart is so new it doesn’t really work.

QUICK FACTS

Share Price: $12.40
Basic Shares Outstanding: 232.5 million
Market Cap: $2.88 billion
Net Debt: $300 million
Enterprise Value (EV): $3.18 billion
2nd Half 2018 Production Estimate: 52,000 boe/day (61% oil, 77% liquids)
2018 EBITDA Estimate: $695 million
2018 Capex Budget: $350 million
2019 Production Growth: 10 percent
2019 Free Cash Flow Estimate: $280 million
2018 Ent Value / EBITDA: 4.57 times
2018 Debt to EBITDA: 0.43 times
2019 Debt to EBITDA: 0.02 times (debt free)

POSITIVES

– Already generating free cash flow after capex (yes really!)
– Balance sheet is best in class
– Premium LLS pricing for all oil sales
– Trading at a discount to peers
– Deeply experienced management
– Giddings field provides huge upside potential

NEGATIVES

Not diversified — only in the Eagle Ford/South Texas
– No hedges so fully exposed to commodity prices (maybe that is good)
– Giddings field asset still unproven

http://magnoliaoilgas.com/

BACKGROUND/PROPERTIES

On April 17, 2017 TPG Pace Energy Holdings Corp was formed as a blank check company or special purpose acquisition corporation (SPAC).

A SPAC is formed for one reason — to make an acquisition.

TPG Pace completed its IPO on May 10, 2017 raising $650 million.

The investors who kicked in $650 million of cash entrusted their money to a company run by Dr. Steven Chazen (Chairman and CEO) and Christopher Stavros (CFO).

Chazen was CEO of Occidental Petroleum from 2011 – 2016 when he retired. Before that he was CFO of Occidental from 1999 – 2011. You are likely aware but in case you aren’t, Occidental is a $60 billion plus market cap company and the largest producer in the Permian Basin.

That means Chazen spent almost 20 years at the top of one of America’s largest oil producers.

Stavros had been with Chazen at Occidental as CFO.

You can bet these guys didn’t get involved with this little blank check company for the bi-weekly paychecks. They are incentivized by the equity investment that they have made in the company and are looking to make a HUGE bundle alongside shareholders.

In other words…..they have serious skin in the game.

With the IPO completed in May 2017 the team went to work finding an acquisition that they liked. On March 20, 2018 they announced a business combination with EnerVest’s South Texas division.

This newly combined company was named Magnolia Oil and Gas.

To help finance the acquisition the company announced a $355 million private placement of common stock (insiders participated) and plans to issue $400 million in senior notes.

In total Enervest (the seller) received $1.1 billion in cash and 121 million shares (roughly half of the shares) of the newly formed Magnolia Oil Gas. Enervest isn’t dumping these assets; they retain a significant interest in them.

The assets acquired by Magnolia Oil and Gas are producing properties focused exclusively on the Eagle Ford region in South Texas. In total 359,000 net acres were acquired that are split between Karnes Count and the Giddings Field.

The acreage split is interesting. Of the 359,000 total acres only 14,000 acres are represented by Karnes County–yet it is Karnes County that is clearly the most valuable part of the transaction at this time.

That could change.

As of today Magnolia is running two drilling rigs in Karnes County where production will be over 40,000 boe/day by YE 18, and one rig in the Giddings Field which is producing over 10,000 boe/day. There are plans to add a second rig in early 2019 in the Giddings Field.

One very clear benefit of operating in South Texas is that Magnolia will receive 100% LLS pricing for all of its oil production. LLS continues to receive a premium to WTI pricing while Permian operators are receiving a discount to WTI.

Don’t underestimate how big of an advantage that has been in 2018. At times LLS has been $15 per barrel higher than Midland Crude.

Remember, almost all of the change in the price of the commodity drops directly to the bottom line for these producers.

Moving a company’s netbacks from $30 to $45 increases cash flows by 50 percent…so that is a huge difference.

MagnoliaCore Karnes County Position

The 14,070 acres that Magnolia acquired in Karnes County is some of the best rock in the horizontal oil business. Two formations are targeted in Karnes County — the Eagle Ford (two different zones of it) and the Austin Chalk (two different zones of it as well).

You can see in the heat map above that the acreage acquired by Magnolia (shaded yellow) is right in the middle of the highest initial production (IP) per 1,000 feet drilled area (shaded red).

When this acquisition took place in March 2018 with oil at $58 per barrel the 5,000 foot lateral wells here were paying out in 5 to 6 months and producing 330,000 boe in their first year.

That is obviously outstanding and has only got better with oil prices rising.

Production is only targeting the two formations (4 zones in total) but there is additional stacked pay on this acreage. A third Austin Chalk zone will be tested later in 2018.

The acreage is 65% operated with EOG Resources operating half of the non-operating acreage–one of the best producers in the country.

Magnolia has an average 86% WI in its operated acreage.

Magnolia has two rigs running here and will spend $210 to $230 million in 2018 drilling 80 wells. Seventy percent of those wells will be into the Eagle Ford and the rest will be into the Austin Chalk.

At the end of 2017 there were 314 gross producing wells (141 net to Magnolia) on the acreage. Management believes that there are 670 gross (265 net) additional Eagle Ford locations to be drilled and another 355 gross (170 net) Austin Chalk locations. Magnolia will operate 77% of those remaining locations.

This drilling inventory count assumes 250 foot stagger-stack spacing in the Lower Eagle Ford, 600-foot spacing in the Upper Eagle Ford, and 300-500 foot spacing in two landing zones of the Austin Chalk.

The inventory should be enough to keep the company busy for a decade assuming the 2018 pace of drilling is continued.

This truly is the core of the core of the Eagle Ford. It is oily and prolific. Eagle Ford wells produce 216,000 barrels (74% oil, 86% liquids) in their first 12 months and Austin Chalk wells produce 332,000 barrels (63% oil, 80% liquids).

As I mentioned these production rates are providing paybacks of less than six months. Break-even oil prices are between $28 to $32 per barrel.

Every oil producer says that they have rapid payouts on their wells. Nothing actually shows it like the cash flows that they generate. A pure-play horizontal producer will struggle to grow production while living within cash flow without fast payouts.

Not a problem for Magnolia in Karnes County! Check out the 2018 numbers below….

At $58 WTI prices the Karnes County property was set to generate $492 million in cash flow while the company invested only $221 million drilling. That is $271 million in free cash flow while growing production somewhere close to 15 percent from 35,000 boe to 41,000 boe.

That is as good as I have seen…….better perhaps.

MagnoliaGiddings Field

Magnolia has also acquired a huge land position in Giddings Field – 345,000 acres that is now producing just 10,000 boe/day. The nice part is that this acreage is 99% held by production so there is big optionality here forever……no drilling required unless desired!

The potential here is in the Austin Chalk formation and there have been some recent advances made with high intensity fracs that are very encouraging.

Recent well results on Magnolia’s land have had four wells average 30 day IP rates per 1,000 lateral feet of 317 boe/day (49% oil) and 60 day IP rates (IP60) of 353 boe/day.

Those kinds of IP rates are good for 5 to 9 month payback periods. Magnolia estimates that there are at least 1,000 gross drilling locations (about half that net) using conservative spacing assumptions.

There is more work to do in order to de-risk this property, but the size of the prize is very large. Also worth noting that other operators have ramped up activity here….which is also encouraging.

Magnolia is running one rig here and will spend about $40 million in 2018. A second rig will likely be added in early 2019.

The Giddings Field was discovered way back in the 1920s and was developed with vertical wells in the late 1970s where the formation was naturally fractured. Today companies are using modern fracking technology to target the parts of the field that aren’t naturally fractured.

There are other formations on the land that may have potential down the line (Eagle Ford, Buda, Georgetown).

No doubt, there is HUGE potential here. Let’s not count our chickens but if those 1,000 drilling locations get proven up it tacks another 20 years of extremely profitable drilling into the company’s inventory.

FINANCIALS/BALANCE SHEET/VALUATION

It is a pleasure to tell you about the finances of Magnolia Oil and Gas…..because they are a thing of beauty.

Let me start with the balance sheet. The company has $400 million of senior debt outstanding and has $100 million of cash in the bank.

Against that $300 million of net debt I believe EBITDA is going to come very close to $700 million in 2018.

That would mean that 2018 debt to EBITDA is less than 0.5 times. Pristine.

But there is more….because the balance sheet is rapidly changing for the better. This company is significantly underspending cash flow.

Against $650 million plus in cash flow in 2018 Magnolia will spend only $350 million in capex (while growing production by 15 percent). That means that the company is deleveraging at an annualized rate of $300 million.

The same sort of excess cash flow…..or free cash flow as we like to call it is expected in 2019 as well. By the end of 2019 Magnolia could have no net debt if it chooses. Did I mention that they are growing production by 10-15% while doing this?

Less than six month payouts on wells, that is how this is possible.

In addition to the $100 million in cash Magnolia has an undrawn $550 million bank line — so loads of liquidity.

The company is growing (while spending 65% of cash flow), it is generating free cash flow (like $300 million worth) and the balance sheet is perfect.

For that the stock must be at a premium valuation right?

Nope. Since it is a newly formed company the analysts are just picking up the story. Consider the following….

Eagle Ford focused companies trade for 6.5 times 2018 EBITDA. Companies of a similar size trade for 6.3 times 2018 EBITDA. The E&P group overall trades for 6.9 times 2018 EBITDA.

Meanwhile Magnolia Oil and Gas trades for 4.57 times 2018 EBITDA…….a 30 percent discount.

This company should trade at a premium to the average company. There is nothing average about the free cash flow this company is generating while growing or the balance sheet that it has.

STOCK CHART(S)

WHAT THE ANALYSTS SAY

FIRM TARGET PRICE

Northland Capital $20.00
SunTrust $18.00

CONCLUSION

As an investor you have to try and remain disciplined….waiting for the right company to come your way.

This one makes it worth the wait.

Top management — check

Rapid payouts — check

Perfect balance sheet — check

Free cash flow — check

Upside optionality from huge acreage position — check

Discounted valuation —- check

Magnolia Oil and Gas ticks all of the boxes and then some.

And of course, the other thing is that US companies trade at a higher multiple than Canadian ones, giving me more leverage as well as a lot more liquidity. Woe Canada!

I OWN 10,000 SHARES AT $13.75 AND STOP LOSS IS ROUGHLY $12

 

-Keith

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