“The Safe Way to Play the Bakken Gushers” (and a few updates)

by Travis Johnson, Stock Gumshoe | May 11, 2012 2:09 am

Friday File look at a Roger Conrad Bakken teaser, plus some thoughts on a few of our favorites that have been making news this week.

Before I jump on today’s teaser unveiling, a few notes:

There’s been some news and movement this week in a few of the stocks that I follow closely and that I know a lot of my readers find interesting — the Sandstorm Gold (SSL.V SNDXF)[1] share consolidation went through as expected, and it did end up being a 5:1 consolidation, so the stock now is trading in the $8+ neighborhood and, I think, will get some additional investor attention when they list on the Amex later this year (that’s not been announced yet and it could take longer, but I think it is clearly a goal of theirs). If the consolidation results in any weakness in the shares or warrants (which haven’t been consolidated, but did have their terms altered to make them still effectively the same — so it’s five warrants to buy a share now, at a price five times higher than the old strike), I think there might be a lovely little buying opportunity. We’ll see — the stock is certainly down considerably from its highs already, as are most of the gold names with gold prices declining, but I still like Sandstorm very much at these prices and it’s still, if you include both warrants and equity, my largest holding. As long as gold stays about $1,300 or so an ounce, Sandstorm is going to make a lot of money for many years.

My largest pure equity holding now is Africa Oil (AOI.V AOIFF)[2], which I mention only because it announced yet more oil found in that first hole they’re drilling with Tullow (well, Tullow’s really drilling it — but they share ownership 50/50) in Kenya, and the stock went on yet another 30% one-day tear. A reader asked me about that[3] and about how valuation might change earlier in the week, and while it’s still very much a guessing game (and the “real” payoff of producing oil at a meaningful level is many years off), clearly the chances of finding confirmed commercial deposits and developing a real producing oil field are improving. My response to that reader is here[4] (and for the rest of you, I do try to answer questions posed in comments when I can, but I also pay special attention to postings in the Discussion area if I can provide a worthwhile response that might benefit other folks, and I’ve seen some other good, thoughtful responses to postings in that area, so please feel free to use that Irregulars feature if you have thoughts to share or questions to pose [5]to the group).

And several of you have also noted this week that our little CVD Equipment Corp (CVV)[6] has been on a tear recently, even on days when the market is weak. They did announce a new “multi-million dollar” order[7] for equipment to help an aerospace supplier develop next-generation composite materials this week, which certainly could be fairly important (they had about $30 million in sales last year, and the backlog last quarter was $16 million, so it really depends on what “multi-million” means, and they aren’t saying), and last week they were able to complete the sale of their old facility[8] (they’re moving this quarter), so those are good pieces of news. But it’s also worth remembering that it’s a tiny stock and it looks to me like Louis Navellier has revived his teaser campaign that hinted at CVV shares in recent weeks, so that’s probably more than enough to boost the shares in the short term. They should release their next quarterly report in a matter of days, last year it was on May 10.

Finally, in the “catch up” department, Canyon Services (FRC.TO CYSVF)[9] also released results this week — which were good, though investors are predisposed to hate most oil and gas services companies right now and the guidance was not overwhelmingly positive (of the “we still think things are OK, but…” variety). There’s still plenty of drilling for oil and NGLs in Western Canada, particularly in a few of the deep basins where Canyon’s high horsepower pumping units are required, so I see no reason to panic with natural gas prices being low. I can’t try to time my investments based on fluctuating gas prices, as you probably noticed with my commentary on natural gas a couple weeks ago, mostly because I have no skill at forecasting those prices. So I bet on companies that seem to me to have good demand for their products or services, with profitability … and, particularly if they pay a good dividend as Canyon does, I’ll hold on unless I think the company (rather than just their sector) is going out of favor for a good reason. If analysts have any idea what they’re talking about, Canyon now trades at a forward PE of 5 and carries a 5.5% yield. Reason enough for me to stick around, particularly with their being enough visibility for them to at least say that they think they’ll be busy this quarter, though I haven’t bought additional shares since March and I was pretty optimistic then … and it’s down about 15% since my last buy.

And as long as we’re talking “energy” with so many of the picks I’ve noted above, and since falling oil prices and dirt-cheap natural gas prices have so many energy patch investors nervous, I thought we’d take a look at a teaser for an energy stock that promises some safety — the headline from Elliott Gue and Roger Conrad is:

“Income Investors: There’s a SAFE Way to Play Bakken Oil Gushers”

So of course we need to find the answer to that, right? The folks at Investing Daily (that’s Conrad and Gue’s publisher) have pitched all kinds of energy stocks lately — including several bakken-related ones like Continental Resources[10] and Crescent Point Energy[11], but this time around they’re touting a MLP that plays off of this huge US oil field.

Shall we check out the clues? Indeed …

“It’s another Bakken breakthrough—America’s biggest oilfield is ready to PAY YOU steady income. Soon you’ll be receiving big distribution checks that might as well be signed ‘From the Bakken with love’ ….

“Follow the “smartest, best-managed energy company in America” into the historic Bakken Shale….

“It all starts with a company I believe is one of the smartest, best-managed companies in the entire energy sector… and maybe the entire planet.

“Now they’ve got a big piece of the action in the Bakken Shale. And it’s going to pay off lucratively for income investors.

“My colleague Elliott Gue and I refer to this company as the ‘Mighty Energy Cash Machine’ because of its amazing ability to fatten the wallets of our subscribers.

“To date, we’ve gained 148.4%… or an annualized gain of 49.4% over each of the three years we’ve owned the stock.
And here’s the sweet icing on this cake…

“Along with triple-digit growth, our subscribers are also enjoying big, fat monthly distribution checks that arrive every single quarter—a solidly pleasing 7.5% is the yield as I write.”

“Even better, these checks are the best kind of checks—the safest, tax-free way to grow your nest egg in the whole world of investing.

“That’s because my favorite pick is a Master Limited Partnership (MLP), making our investment even better. I’ll tell you more about these unique investments later.”

Well-nigh irresistible, no? So who is this Bakken MLP?

Well, as we find out a bit later on, it’s not really a Bakken MLP (at least, if by that you mean a MLP with properties primarily in the area) … it’s a MLP that has recently gotten a toehold in the Bakken Shale.

Here are some more details from the teaser:

“The MLP owns proven, high-producing properties in the Southwest, Southeast, Midwest and Northeast.

“They employ a brilliant, three-pronged strategy of mature well development, inspired acquisitions of new oil and liquids-rich gas wells, and ingeniously opportunistic “hedging,” which I’ll explain in just a bit.

“This strategy results in extraordinarily rapid production growth—the firm has boosted its average daily output by more than 30% over the past year—and steadily rising distribution payments to shareholders.

“What’s more, the CEO projects this company’s capital investments will continue to deliver quarter-over-quarter production growth of at least 6%.”

Since I include that “will explain in a bit” part about hedging, I should let Roger do that explaining, right? It’s only fair. So here goes:

“You can look in every nook and cranny of the energy sector and you won’t find a lower- risk stock than the Mighty Energy Cash Machine.

“That’s largely because this partnership is one of the craftiest “hedge-hogs” in the energy industry.

“By that I mean they know how to lock in very favorable selling prices for all their oil and natural gas production for years to come.

“Indeed, I count them among the best deal-makers in the business.

“They’ve hedged all of their oil output through 2013 and all natural-gas production through 2015.

“Under these existing contracts, they’re guaranteed to receive $97 per barrel for oil production and $5.45 per thousand cubic feet for natural gas.”

“Hedging” is just a way that many energy producers (or other commodity producers, for that matter), “hedge” their future revenues by effectively pre-selling their production in the futures markets — that’s largely why futures markets came into being after all, to help farmers “pre sell” their corn before harvest, to share the risk a bit and finance farming operations and provide some stability for both commodity producers and buyers in a volatile and unpredictable business.

Investors generally hate it when “their” commodity producing companies hedge actively during times of rising prices (that’s why just about all the big gold miners closed out their hedges, sometimes at substantial cost, over the last couple years), but, of course, they happily gloat about it when the hedgers get it right — as when Southwest Airlines was the only airline that was profitable for a while because they had hedged away the high fuel prices everyone else was paying, or when producers, like this one being teased here, see falling prices but manage to pre-sell their future production at rates far above current prices (like that natural gas hedge at $5.45, which is more than twice the current benchmark price). Being an “aggressive” hedger usually means you have a singular focus on taking commodity price risk out of your operations and making sure you’re profitable and — in the case of this company, since it’s an income-focused MLP — can sustain and/or grow your distributions, even if that means you risk doing worse than your peers if prices go far higher and your hedges no longer look prescient.

Which is tough, I imagine — CEOs hate to underperform their peers, like most of us they don’t mind failures that they can blame on the market (“all other oil stocks are going down, too, we can’t help it”) but they fear taking risks that mean they miss out on booms or otherwise possibly diverge from the pack. So in some ways it takes a singular kind of management to go your own way on this — no other airline hedged as aggressively or effectively as Southwest, which is probably because they have always thought differently than the other airlines, and few companies were rushing to pre-sell their forward oil production in the $90s when their fever-soaked dreams (and the chatterboxes on CNBC) told them it was headed to $150.

A couple more clues, to reinforce that “income” bit:

“… this stellar MLP is expected to grow its already generous distributions at a 7% to 9% annualized rate over the next few years.

“Indeed, they’ve increased their dividend twice in the past 15 months.”

Not bad, since we know that dividend growth is generally more appealing than high current dividends … but having both is perhaps even nicer.

And finally, that Bakken connection …

“Now They Own a Big Chunk of the Bakken

“This is great news for investors. The MLP’s reputation for brilliant management and excellent results promises wonderful things to come in one of the greatest oilfields ever discovered in North America….

“So far the Mighty Energy Cash Machine has built its acreage position to 17,000 net acres in the Williston Basin, which includes the Bakken Shale. I expect them to acquire even more in the near future.

The partnership’s net production from the 65 Bakken wells in which they’ve participated so far has averaged a very profitable 3,500 barrels of oil equivalent per day—up 40% over the production at the time of the acquisitions.

“This year the company plans to spend approximately $54 million in the Bakken to participate in about 100 horizontal wells.

“In the Bakken, as in all their ventures, the MLP’s strategy is tailor-made for long-term investors. Management always ensures all acquisitions are proven oil reserves. This keeps risk to a minimum. The chances of hitting dry wells are therefore low.”

Ooops, I already said “finally,” didn’t I? Well, Conrad also teases a couple other properties that this partnership owns … including some projects in the LA Basin and the Permian Basin, but apparently their big thrust now, even bigger than the Bakken push, is in the Granite Wash. Here’s what he says about that bit:

“My Top Pick is ‘All Over’ the Liquids-Rich Granite Wash with 600 Drilling Locations to Date

“The company bolstered its ‘full speed ahead’ strategy last year with the purchase of additional prime acreage in the Granite Wash.

“After nailing down over $530 million in acquisitions in the Wash, they’ve pinpointed 600 of the best drilling locations. Rates of return on these wells are expected to be greater than 50%.

“Overall, the partnership is looking to drill about 340 new wells this year with 53% of the announced capital budget earmarked to the Granite Wash.

“This level of spending points to at least 75 new horizontal wells slated for drilling in the liquids-rich Wash.”

OK, so now we can really say “finally” and pull the Thinkolator out of the closet for a quick session. Toss in that abundance of clues, and the answer comes out lickety-split: this is Linn Energy (LINE), probably the most well-known of the producing MLPs.

What’s a producing MLP? Well, most Master Limited Partnerships (sometimes they just call themselves “publicly traded partnerships”) are infrastructure companies — MLPs are set up to distribute cash flow from steady, predictable businesses to income-focused investors, not to ride the waves of euphoria and fear that characterize the life of an oil explorer. But there are some MLPs that focus on proven, producing oil fields where they can predict with some degree of certainty that they’ve got many years of solid production ahead — and in most cases, certainly with Linn Energy, they improve that predictability further by hedging that production to make sure they’ve got some visibility on their future ability to pay out good (and hopefully rising) distributions.

I’ve liked Linn Energy for years, but somehow at the times when I’ve taken a look at the stock it always happens to be a little more expensive than I was hoping after a bit of a run up, and I’ve never owned it (and to give credit where it’s due, Bryan Perry was pounding the table for this one in 2009 [12]when it was, in retrospect, a great buy despite the fact that it was already up 30%).

I really admire their management for navigating such a crazy business with aplomb — after all, despite the fact that oil went from $150 to $30 during the financial crisis they never cut their distribution from 2008-2010. They didn’t raise it during that time either, not until last year (they’ve now raised it twice since last Summer), but it’s notable that they didn’t have to cut it. That’s all due to their active hedging — back in 2008 and 2009, for example, they were able to tell folks that they could just about guarantee the distribution through 2011 because they’d already set their sale prices (of course, they still had to actually produce the oil and control their own production costs, so there’s always some risk, but they’re quite large and diversified now). The stock still got hammered, but those who bought in during the crash, buying that “almost guaranteed” yield of 13% or so at the time, are undoubtedly quite pleased that they did so.

So is it a good buy now? Well, it’s not as dramatic a one — the yield is a very nice 7.5% at the current level and they are likely to keep raising that dividend each year as long as the energy markets don’t fall apart, and they do have hedging in place as teased — they said in their 2011 results press release[13] that they had hedged natural gas through 2015, and also hedged 80% of their oil through 2015. So that’s a nice backstop for the shares, and they have been very active acquirers (and equity sellers — like most MLPs they need to finance at least some of their growth by selling shares since they are limited in the amount of cash flow they can reinvest into the business) — and yes, they did acquire a sizable stake in the Williston Basin about a year ago, and in the Granite Wash over the winter.

I think that with the producing MLPs, you’re probably better off with big, diversified operations that hedge actively and that have historically been able to replenish their reserves in most years (or better yet, grow them without heavy dilution) — not too different from the pipeline MLPs, where I also think you’re smarter to stick with the big firms with national footprints and some diversification. That pretty well describes Linn Energy, so I can’t come up with a good reason to be particularly wary of this pick if you’re looking for decent income and the potential, if they can really boost production by 20% or more as they seem to think with their new properties, for some substantial hikes in the distribution that bring with them capital gains (as the price goes up to reflect the higher dividend payout).

If you’re looking for similar companies to compare LINE to, the other somewhat comparable producing MLPs that I’ve looked at from time to time are Breitburn Energy Partners (BBEP), which Conrad also teased last year[14] and which is a bit riskier, and Legacy Reserves (LGCY), which probably has the most similarity to LINE but is far smaller and was touted by Carla Pasternak a couple years ago[15] — there are also a handful of others, the Dividend Detective has a good list of many of them here[16].

And along similar income-focused lines, as we’ve seen in recent months, the oil trusts have also come back into popularity among US investors and a few new ones have been started over the past year or so, we took a look at a couple of the new ones that were recently teased here[17] (do note that the trusts generally aren’t structured like MLPs, so they may not have the same tax-deferred income advantages, and they’re also less flexible — unlike MLPs, trusts can’t go out and acquire new properties or reserves in new areas — I don’t know if they’re allowed to hedge at all, but it wouldn’t be surprising if they were hobbled in that way, too, they’re far more passive than the MLPs).

LINE will be interest rate sensitive, but the high yield already accounts for that, and it will move in sympathy with commodities sometimes even though they’ve locked in pricing for a few years (which means a big drop in oil prices might bring a buying opportunity, as it did in 2008-2009). That said, I like and admire Linn’s performance but I don’t personally own it (yes, I see you snickering in the back — I do realize that’s probably a reason to buy the shares, if I don’t own it it’s bound to go up). I know there have been quite a few LINE fans in the great Gumshoe readership, so feel free to chime in if you’ve been following the stock and have any thoughts to share.

  1. Sandstorm Gold (SSL.V SNDXF): http://www.stockgumshoe.com/?tag=sandstorm-gold
  2. Africa Oil (AOI.V AOIFF): http://stockgumshoe.com/tag/africa-oil-aoi-v-aoiff/
  3. A reader asked me about that: http://stockgumshoe.com/2012/05/microblog-significant-additional-discovery-in-the-africa-oil-ngamia-well/
  4. My response to that reader is here: http://stockgumshoe.com/2012/05/microblog-significant-additional-discovery-in-the-africa-oil-ngamia-well/
  5. please feel free to use that Irregulars feature if you have thoughts to share or questions to pose : http://stockgumshoe.com/discussions/
  6. CVD Equipment Corp (CVV): http://stockgumshoe.com/tag/cvd-equipment-cvv/
  7. new “multi-million dollar” order: http://finance.yahoo.com/news/cvd-equipment-corporation-receives-multi-205100195.html
  8. complete the sale of their old facility: http://finance.yahoo.com/news/cvd-completes-building-sale-211500061.html
  9. Canyon Services (FRC.TO CYSVF): http://stockgumshoe.com/tag/canyon-services-group/
  10. Continental Resources: http://stockgumshoe.com/reviews/energy-strategist/the-one-u-s-energy-stock-i-would-buy-if-i-were-permitted-only-one-pick-right-now-elliott-gue/
  11. Crescent Point Energy: http://stockgumshoe.com/reviews/canadian-edge/ride-to-oil-riches-with-the-lucky-tombstone-kid-stake-your-claim-in-the-three-bakkens/
  12. Bryan Perry was pounding the table for this one in 2009 : http://stockgumshoe.com/reviews/25-cash-machine/this-one-little-stock-could-double-your-money-bryan-perry/
  13. 2011 results press release: http://ir.linnenergy.com/releasedetail.cfm?ReleaseID=650843
  14. Breitburn Energy Partners (BBEP), which Conrad also teased last year: http://stockgumshoe.com/reviews/big-yield-hunting/mlp-yielding-10-2-makes-big-bold-bullish-move/
  15. touted by Carla Pasternak a couple years ago: http://stockgumshoe.com/reviews/high-yield-investing/130-million-acquisition-could-send-this-high-yield-oil-stock-soaring/
  16. Dividend Detective has a good list of many of them here: http://www.dividenddetective.com/mlp_directory_exp.htm
  17. we took a look at a couple of the new ones that were recently teased here: http://stockgumshoe.com/reviews/energy-strategist/yielding-13-0-today-and-set-to-pay-out-even-more-tomorrow-whats-the-next-millionaire-making-prudhoe-bay/

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