Annual Reports Can "Hide" Valuable Assets


I recently took a deeper look at three important numbers from Magnum Hunter Resources long-delayed annual report. Today, I want to drill down even deeper into the report (which can be accessed here - link opens a PDF), and look at some areas that investors often overlook when considering an energy stock. In this case, I want to look at the company's "hidden" assets.

Value in the middle
When investing in an oil and gas company, investors typically choose a company based on where it's extracting its oil and gas. Some investors are looking to invest in hot oil plays like the Bakken, while others are seeking a more broad-based approach. What's important to realize is that sometimes, companies operating in developing plays run into problems caused by lack of pipeline and processing infrastructure. This can cause production reductions and impact returns.

In Magnum Hunter's two core operating areas, the Williston Basin and the Appalachian Basin, it has felt this impact directly. The company has been forced to endure production shut-ins because critical midstream assets, like those now in service by MarkWest , weren't yet available. Further, in order to access MarkWest's plants, Magnum Hunter has been building the pipeline infrastructure critical to connect its gas to these plants. As seen in the map below, Magnum Hunter's Eureka Hunter Pipeline is providing it with critical access to MarkWest's new Mobley plant:

Source: Magnum Hunter Resources Investor Presentation.

If Magnum Hunter had to wait for some other company to build these pipes, it might have been forced to wait even longer to be able to process its gas. This is one reason why many exploration and production companies are forced to expend capital on midstream assets; it can be the quickest way to be able to develop the oil and gas in the region. However, sometimes investors overlook these assets because the focus is on the oil and gas potential. That, in a sense, hides these assets from a company's value, which it can unlock through a sale or other form of monetization.

Magnum Hunter has been taking steps toward the full monetization of its midstream assets. The company sees the potential for more than $750 million in gross proceeds, or between $400 million and $500 million net. Magnum Hunter could use those proceeds to give it the balance sheet flexibility to invest in new oil and gas wells. This could prove critically important, as the company's long-term debt level has ballooned from just $26 million in fiscal year 2010, to the $986 million in reported in its first quarter 10-Q this year. Nearly $600 million of this debt carries an interest rate of 9.75%, so cash on hand will be necessary to make annual interest payments.

Drilling down into hidden value
The other hidden asset at Magnum Hunter is its Alpha Hunter Drilling business. The company owns several drilling rigs that it uses to drill wells on its acreage. In addition to this, the company does lease out these drilling rigs on the spot market, when idle. The value here is two-fold, as owning its own rigs saves the company money while it's also earning money when the rigs are leased out. Below, is a slide from the company's most recent investor presentation detailing its latest drill rig.

Source: Magnum Hunter Resources Investor Presentation.

A great example of the potential a hidden asset like this can have on a company is found at Oasis Petroleum . The company has been building out its Oasis Well Services business in an effort to lower its well costs in the Bakken. Oasis invested $24 million initially, which has been money well spent. The business is expected to save Oasis about half a million dollars per operated well. Not only that, but the company produces cash flow from the business to the tune of about $200,000 per gross well as its non-operated partners pay Oasis for the service. These savings have enabled Oasis to completely pay back its initial equipment investment.

Final Foolish thoughts
Dabbling in vertical integration by owning hidden assets like midstream assets, or an oil-field services business, can help an oil and gas producer lower costs, as well as give its production access to the marketplace. However, the capital spent to develop these assets represent somewhat of an opportunity cost, as the capital might be better spent at some point on its core business of increasing oil and gas production. That's why it's important for investors to drill down deeper into a company to see if there are assets that the market might be missing, because these hidden assets could yield significant future value.

Magnum Hunter isn't the only company that has assets hiding in plain sight, in fact, finding the right plays that are "hidden" from the rest of the market is a great way to pad your investment nest egg. The Motley Fool has uncovered three stocks that we are offering a comprehensive look at, which are set to soar during this transformation in the energy industry. To find out which three companies are spreading their wings, check out the special free report, "3 Stocks for the American Energy Bonanza." Don't miss out on this timely opportunity; click here to access your report -- it's absolutely free.

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Fool contributor Matt DiLallo has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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Originally published