In Southeastern Asset Management’s third quarter letter, managers discussed three categories of their holdings, the third of which they dubbed a “crash bucket.” Stocks in this elite group consisted of their energy holdings, which as a group had declined more than 60% year to date.
Managers viewed the “crash bucket” in a positive light, saying companies' recovery would eventually bestow “a large part of our significant potential future return.” But all of the stocks save one, Wynn (WYNN, Financial), fell into the energy category, whose price revival depends largely on a recovery of oil prices. Southeastern, where investor Mason Hawkins is chairman and CEO, disagreed that the stocks depended on an upswing in oil, however.
“We believe their long-term fundamentals under the stewardship of their capable leaders should drive prices as contrasted to the short-term perceptions,” Southeastern said. “In the case of our energy holdings, we are not reliant on an energy rebound to move the stocks higher, as our appraisals are over twice the current stock levels based on current depressed commodity futures pricing. Should oil and gas prices move back to their much higher marginal cost of production, the values of these stocks would be materially more.”
Southeastern had eight energy positions at second quarter-end, but the three biggest, accounting for more than 15% of the equity portfolio, were Consol Energy Inc. (CNX, Financial), Chesapeake Energy Corp. (CHK, Financial) and Murphy Oil Corp (HFC, Financial). (The holdings represent 10% of their portfolio overall.)
Consol Energy (CNX, Financial)
Consol Energy shares lost almost 71% year to date. They closed at $9.93 per share on Thursday, against Southeastern’s $31.62 average buy price. The firm doubled their stake in the company right before its price dropped to its lowest price in 10 years, in the two quarters starting in fourth quarter of 2014.
Consol Energy has two segments: exploration and production, which produces natural gas; and coal. The company’s shares tumbled when it released disappointing second quarter earnings in July. A net loss of $603 million, or $2.64 per diluted share, compared to a net loss of $25 million, or $0.11 per diluted share, in the year-earlier quarter.
Consol’s net income for the quarter withstood a pre-tax loss of $829 million in its E&P division as falling commodity prices caused an impairment in the carrying value of its oil and natural gas assets. Revenue for the quarter fell to $202 million from $255 million year over year, primarily because the average sales price fell 39.6%.
Consol has responded to the crunch by taking several measures. First, it increased its total natural gas volumes sold by 45.5% for the quarter. Second, it cut its general and administrative expense by 19% for the quarter and expected to realize $100 million in cost reductions for all of 2015. It almost lost its dividend during the quarter too, cutting the payout to $0.01 per share from a previous $0.06.
A total of $345 million was raised during the quarter by the initial public offering for Consol’s thermal coal unit, CNX Coal Resources (CNXC, Financial). Hawkins said he had begun discussing with management a possible separation of their Marcellus and Utica gas assets, which he believed are worth more than Consol’s total market cap. He also saw profitable possibilities in selling all of its assets, from coal reserves to its port terminal in Baltimore.
Going forward, Consol has given production guidance of 30% production growth over last year for 2015, and aims for 20% further production growth in 2016.
Chesapeake Energy Corp. (CHK, Financial)
Year to date, the share price of Chesapeake, the second-largest producer of natural gas and 11th largest producer of oil and natural gas liquids in the U.S., fell 60% to around $7.78 on Friday.
The company had a similar quarter to Consol in dealing with low commodity prices, but it kept production relatively even. Average daily production increased 1% from the previous quarter, with a 5% increase for oil, 2% increase for natural gas and 6% decrease for NGL. Combined with the lower price of oil, natural gas and NGL, revenues decreased to $776 million from $1.92 million the previous quarter. Adjusted for asset sales, production grew 13% over last year.
Chesapeake cut costs in primarily in capital expenditures and dividends. The amount it spend on acquisitions for unproved properties fell to 79% from the prior quarter, primarily because it spun off its former oilfield services business in June 2014, and it reduced average rig count by 36 rigs to 26. Chesapeake eliminated its dividend effective in the third quarter. In the previous quarter, dividends paid on common stock totaled $118 million, and $86 million for preferred stock.
Financial results for the second quarter included a net loss of $4.1 billion, or $6.27 per diluted share, compared to net income of $230 million, or $0.22 per common share the same quarter a year ago. Much of the loss also stemmed from an impairment of its oil and natural gas properties.
Revenue totaled $3.03 billion, down from $5.15 billion, largely due to lower sales prices. Chesapeake received an average of $51.21 per barrel of oil in the quarter, collapsed from the $97.49 per barrel it received last year at the same time. Natural gas prices dipped to $0.75 versus $2.76, while NGL fell to $1.90 from $21.03 per barrel.
Going forward, Chesapeake said it raised its 2015 production guidance by 4% to 660,000 barrels of oil equivalent per day. It also planned to hit its annual capex guidance of $3.5 billion to $4.0 billion and reduced its guidance for production and general and administrative expenses. Southeastern remained optimistic about the company and its valuation, according to his third quarter letter:
“Concerns remain over the company’s liquidity profile, but management made major strides to improve realizations by successfully renegotiating two contracts with pipeline operator Williams that reduces transportation costs,” they said. “Additionally, on October 1 the company announced the renewal of its $4 billion credit facility. Comparable asset sales in overlapping basins, such as Encana’s sale of Haynesville assets, further confirmed our appraisal of Chesapeake. The company’s shares remain more heavily discounted than its peers, yet CEO Doug Lawler is keenly focused on realizing value for shareholders even in this depressed energy price environment. Further reducing costs, including the recently announced 15% headcount reduction, coupled with asset divestitures, should lead to a stock price more in line with intrinsic value, which we appraise at twice the current price assuming the underlying commodity prices remain depressed.”
Murphy Oil Corp (HFC, Financial)
Murphy Oil Corp shares were down 44% year to date and traded around $28.41 per share Friday. Murphy Oil is an international oil and gas company that owns several subsidiaries. It produces oil and natural gas in the U.S., Canada and Malaysia, and explores for oil and gas globally.
Compared to second quarter 2014, the company produced 3.9% fewer barrels of oil equivalent per day in the second quarter, at 201,952 barrels on average, beating its guidance of 197,000 barrels. Total natural gas liquids produced were 9,779 barrels per day, an almost 14% increase. Crude oil, condensate and gas liquid production declined 7.3%, to 121,262 barrels of oil equivalent.
Lower prices for crude oil forced Murphy to reduce its capital expenditures 38% year over year, which included lower spending on exploration in the Eagle Ford shale and offshore Malaysia, and on exploration drilling primarily in Cameroon. Murphy paid out $124.6 million in dividends for the quarter, leaving the level per share unchanged, and repurchased 5,236,709 shares at a cost of $250 million in the first half of the year using borrowed money. The company also reduced its headcount by 7%.
For its second quarter financial results, Murphy shared a net loss of $73.8 million, or $0.42 per diluted share, compared to a net gain of $129.4 million, or $0.72 per diluted share, in the second quarter of 2014. Lower oil and gas prices were responsible for most of the loss and were offset to a limited degree by lower exploration and expense and supply costs. Total revenues fell by 45% year over year to $738.3 million.
For full-year 2015, Murphy forecast 200,000 to 208,000 total barrels of production and $2.3 billion in capital expenditures, along with oil price estimates of $52.29 and $54.72 in Malaysia.
“Although the company is aggressively attacking its overall cost structure, a continuation of very low commodity prices would continue to lead to adverse affects on the company’s income and cash flow,” Murphy said in a filing, also naming reductions in proved reserves, impairment charges, cost containment measures, higher debt levels and an adjustment to its dividend.
The fall in the stock during the quarter, Southeastern said, “happened despite beating estimates on production and operating cash flow (OCF) and raising production estimates for the rest of the year. Murphy management is focused on driving costs lower and shortening drill times while improving production efficiency to reduce capex to cash flow levels. Furthermore, after disappointing international drilling results in recent years, the company will not invest in higher risk, higher cost wells at this time; instead, management plans to focus rig commitments and to allocate capital to higher return opportunities near lower-risk existing infrastructure where the company has had prior exploration success. Murphy remains well capitalized with diverse cash flow sources and an investment grade rating. It also has non-core pieces that could be monetized to unlock value. CEO Roger Jenkins continues to repurchase shares at the company level and invest personally.”
Oil prices ended the week down almost 6%, their lowest level in about a month, as the U.S. dollar strengthened. West Texas crude fell 1.7% to $44.60 per barrel and Brent crude 0.2% to $47.99 per barrel.
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