Let us now discuss Rosetta Resources (ROSE). ROSE is an exploration & production company that generates approximately 90% of its production from the Eagle Ford Shale basin in southwest Texas and the remaining production from the Permian basin in west Texas. The Fund has owned various amounts of ROSE over the past eight years, with its peak share count occurring on or around the financial crisis when oil prices were similar to the current level. The Fund’s share count troughed at the end of 2013 at approximately 77% less than the peak share count and when oil prices were around the $100 level.
Given the subsequent plunge in oil prices and ROSE’s share price, the Fund increased its exposure by over 60% in the past two quarters. This is the hallmark of our investment strategy. That is, assuming our investment thesis remains intact, we buy stocks when prices are depressed and reduce or eliminate stocks when they are rich.
ROSE’s revenues from oil represented roughly 58% of their most recently reported quarter’s sales, with natural gas liquids (NGLs) and natural gas producing approximately 23% and 19%, respectively, of the remaining revenues. The decline in ROSE during the quarter can be attributed to the rapid decline in oil prices. The company not only performed well over the past year, earning among the highest operating profit margins for small-mid-cap publicly-traded E&P companies, but also we expect the company to increase its production in 2015, despite a substantial decline in its Capex this year. However, given the large decline in oil prices, we expect profits will be down materially this year, but unhedged pre-tax cash flow is estimated to be over $7 a share, given the current depressed spot oil price. It is also worth noting that we believe ROSE has approximately $350 million of hedge profits on its books, again given the current spot commodity prices.
From FPA Capital Fund (Trades, Portfolio) Q4 2014 Letter.
