Checking Out Miller Energy Resources

Continuing to look over some of the independent oil and gas companies we are now looking at Miller Energy Resources (ticker:MILL).  MILL has 2 cumulative preferreds outstanding at the current time. (NOTE THAT MILLER WILL RELEASE EARNINGS ON 12/10/2014 SO MOST RECENT DATA WILL BE AVAILABLE THEN–THE DATA BELOW IS BASED ON INFO FROM THE QUARTER ENDING 7/31/2014).

MILL’s common stock is now trading at $1.63 down from a 52 week high of $8.97.  The MILL fixed to floating 10.50% cumulative preferreds (MILL-D) closed at $13.24 on Friday with a current yield of 19.83%.  The MILL-C 10.75% cumulative preferred closed at $15.61 with a current yield of 17.22%. Both of these are obviously being sold by nervous nellies thinking there could be a dividend suspension in the coming quarters.

Looking at MILL we immediately note that this is a damned small operator–revenues are in the $100 million dollar area. MILL now has all of their operations in Alaska having just completed the sale of their Tennessee operations.  MILL increased revenues by approximately 100% in the last year and showed a hefty loss as measured by net income–but adding back in the depletion charges they had  positive free cash of a few million.  MILL derived 77% of revenue from oil and 23% from natural gas in the quarter ended 7/31/2014.  Last quarter the company received around $100/barrel for their crude and $6.83 for the natural gas.  NOTE that Alaskan crude sells closer to Brent pricing than West Texas.

The company has approximately 60% of their crude hedged for 2015 at approximately $96/barrel.  Today that would put their entire production on pace for an average sale price of approximately $85/barrel.  Approximately 90% of production is hedged for 2016 (at current production rates). There are NO hedges on natural gas for any year (which works well for them as they are contracted to sell most of it at $7 for multiple years).

MILL has quite a lot of debt and unfortunately the lions share is at a current rate of 11.75% (Libor plus 9.75% with a 2% Libor floor).  This is a $175 million 2nd lien credit facility that has been entirely drawn to complete recent acquisitions.  The balance of the debt is a more reasonable 1st lien reserve based revolver with an interest rate of  Libor plus 3%-4% (the more they draw the higher the rate).  Needless to say the $20 million they have to pay on the 2nd lien credit is massive to a company with revenue of $100 million.  Additionally they have around $100 million in preferred shares outstanding with dividend commitments of approximately $10 million.  Total financing cost are about $30 million annually—-around 30% of revenues.

MILL spent $40 million in the quarter ending July 31, 2014 for oil and natural gas properties–which was $15 million more than their total revenue.  As with all of these smaller e&p companies they are spending way too much money to realistically hope to generate net income any time soon–if ever.  That being said MILL has 2 special items that are unusual when compared to other small oil and gas explorers.  These are—

1) The company is reimbursed by the state of Alaska at a rate of 20-40% for their investment in capital expenditures, lease expenditures, seismic etc. The company invoices the state from time to time for the credits and carries the amount under current assets until received.  They receive cold, hard cash for some of these items and others are credited against Alaska production taxes.  These amounts that are reimbursed can be sizable–as much as $10-20 million/quarter.  With these reimbursements the companies net cash spending actually is reduced substantially

2) The company contracts with Enstar (which serves Alaska retail/commercial customers) for multiple years at a contracted price of $7 for their natural gas–Enstar buyS a large portion of their gas production.

These 2 items are HUGE right now as companies are looking to do anything to survive through the next year.

MILL is going to need to do a couple of things right now to survive.  They must cut their capital program significantly–say around 50% for next quarter and then potentially more in ensuing quarters depending on where crude prices head.  We believe that they can do this without dramatically affecting production, at least for a couple of quarters.  Their well decline rates are not as steep as the shale e&p’s so a temporary cutback is likely workable. Additionally the company normally has around $50 million on the balance sheet as a receivable from the state of Alaska which should provide enough cash to get them through the year.

As 2016 arrives and if crude oil prices have not recovered into the $90 area MILL will start to experience issues as well declines would begin to cut into production volumes by then and their receivables from the state will have dried up (because if they are not spending on wells, leases etc they will generate not recoverable expenses) which could put them in a cash bind (although they likely have available cash in their reserve based 1st lien credit facility to constinue to draw it to the maximum is a fools game–but they would do it if backed into a quarter).

To summerize.  We think that MILL we be able to survive 2015 if they do what we have suggested above.  Interest and dividends will be paid.  If they do not execute as suggested above and crude prices do not rebound by mid 2015 then they are toast–they will run out of cash.  In our opinion there really is not any other choice.

We look forward to the new quarterly numbers that are to be released on Tuesday (12/10/2014)–and then we can re-evaluate.