Usually, I would not consider resource stocks to appropriate value investments for the simple reason that commodity prices are too unpredictable. Unpredictable cash flows and the high levels of capital spending usually required to keep commodity companies functioning, can often result in high levels of debt and a sudden reversal in fortunes. Of course, some times the opposite can be true and resource companies can become ‘rags-to-riches’ stories, although all you need to do is to look at former Brazilian billionaire Eike Batista to see how quickly the fortunes of resource investors can change.
However, one company that has been consistently showing up in my value screens and on value blogs is Contango Oil & Gas Company (NYSEMKT:MCF). Contango is interesting because at present, the company’s enterprise value and market capitalization are both below the company’s combined proved PV-10 value (based on 12/31/13 SEC pricing), which currently stands at $987 million. At present, Contango’s market capitalization is just shy of $720 million and enterprise value was $902 million as of January 31, 2014. Contango’s management believes that the company has upwards of $2.6 billion of unproved potential PV-10 reserves, which takes the total unproven asset base to a potential $3.6 billion; implying that the company is trading at an even deeper discount to unproven assets.
Contango Oil & Gas’s location increases investor demand
A discount to the value of reserves is not common trait for oil & gas exploration and production companies. What’s more, Contango Oil & Gas Company (NYSEMKT:MCF)’s hydrocarbon bearing assets are located within the United States and the Gulf of Mexico, two regions where listed operators usually trade at premiums to their asset bases due to strong investor demand for exposure to the sector.
Here are two quick examples to provide a comparison, both of which have a similar market cap to Contango Oil & Gas Company (NYSEMKT:MCF). Resolute Energy Corp (NYSE:REN) has plays in the Permian, Aneth Field and Wyoming has a PV-10 value of $1.13 billion and currently trades at an enterprise value of $1.3 billion. Meanwhile, Triangle Petroleum Corporation (NYSEMKT:TPLM) is a growth-oriented, independent energy company with 94,000 net acres in the Williston Basin. Triangle is targeting the Bakken Shale and Three Forks formations in North Dakota and Montana. The company placed a PV-10 value on its reserves of $224 million at the beginning of last year, compared to an enterprise value of $925 million.
Attractive asset base
So, Contango is undervalued compared to its asset value and peers. But it’s not as if Contango Oil & Gas Company (NYSEMKT:MCF) deserves this discount. Contango actually has quite an attractive asset base with plenty of room for growth during the next few years. Included in these assets are the company’s 7 existing drill-ready shallow-water prospects in the Gulf of Mexico, which will cost the company in the region of $12 million to $16 million to drill each. On average these wells have a PV-10 of $59 million and payout is expected to occur within 2.2 years of completion. In total these reserves have a PV-10 of $504 million.
Contango Oil & Gas Company (NYSEMKT:MCF) is in position to drill 2 to 3 of these prospects per year but 79% of these reserves are natural gas, which could explain the low valuation currently assigned to the company. 78% of Contango’s Q4 2013 Gulf of Mexico production was natural gas.