MGY - Magnolia Oil & Gas

[AugustRain]

Magnolia Oil & Gas Corp

 

Magnolia Oil & Gas is an independent oil producer based out of Texas. The company went public via a reverse merger SPAC deal in 2017. It is run by Stephen Chazen, who acted as CEO of Occidental Petroleum from 2011 to 2016, and as President from 2007-2016. He is well known in the industry and has recently been brought back into Occidental as a board member to help fix the mess they’re currently in. When Mr. Chazen left to create his own company, he brought with him Christopher Stavros, who was the CFO of OXY at the time.  I would just like to note that Mr. Chazen left before Occidental purchased Anadarko, and he was not involved in this purchase.

Magnolia is a small to mid sized player in the Eagle Ford and Austin Chalk region of Texas. They own approximately 23,000 net acres in Karnes county, which is considered one of the crown jewels in shale. This is premium acreage, which is hard to come by. At oil prices of $50-60, return on investment takes approximately 5 to 6 months. Karnes also has one of the lowest breakeven prices in the USA, at approximately $28-32 a barrel.

Magnolia has also purchased 440,000 net acres called the Giddings Field. They have only recently started drilling in this area, but as I will go through later in this writeup, I believe this acreage is significantly undervalued, and as was recently stated on Magnolia’s most recent conference call, is currently outperforming the Karnes field. I will get more into this below.

 

Quick Overview of Financials

 

Magnolia Oil & Gas currently has a market cap of $2.6B. They have very low debt with only $400M senior notes outstanding due in 2026. They currently have $193M in cash, and $450M cash available under their credit facility. In 2020, Magnolia produced 31,722 barrels of oil per day. The company expects 7-10% sequential growth per year in total company production, however, the Giddings field is expected to get 20% or more. In 2020, the company produced a respectable $310M in cash flow from operations, and was able to build cash by $10M this year, despite the oil market conditions in 2020. In 2019, Magnolia threw off $213M in free cash flow. In 2020, despite showing negative earnings due to large write downs on some of their assets due to low oil prices, Magnolia again threw off positive cash flow. Free cash flow from 2019 was $0.88 a share, and there is no reason to believe it will not reach that, and exceed it in 2021 as commodity prices have returned, and Magnolia is still growing production.

 

Business Model

 

Magnolia is committed to staying within cash flow. They spend approximately 60% of operating cash flow on drilling and completions, which has allowed them to grow production 7-10% sequentially each year. Both the Karnes field and Giddings field are funded solely by cash flow from operations. The other 40% of operating cash flow typically goes into acquisitions, share repurchases, and building cash. So far, approximately 8% of cash flow has gone to share repurchases, while 6% has gone into building cash up to the $200M they currently have.

 

The CEO of Magnolia has stated that they have no intention as of this moment of raising more debt, nor do they plan to build cash beyond $200M at this point in time. The majority of cash will be distributed via share buybacks, of which they are predicting share buybacks of 1% of shares bought back each quarter at a minimum. They are also planning on instituting a dividend, paid out semi-annually, starting after the second quarter of 2021.

 

The CEO of Magnolia personally owns 7M shares in the company, and is committed to slowly building the company while rewarding shareholders, exactly as he did while he was the CEO of Occidental. He has also repeatedly said they will institute a dividend because his wife is a big fan of dividends.

 

Giddings Field

Giddings was initially considered a prospective field. Magnolia was able to purchase it for relatively cheap. Until recently, the company was purely in appraisal mode for Giddings, however, they have identified a 70,000 net core acreage in Giddings. This acreage has exceeded expectations in almost every way, and I would consider it a tier 1 oil acreage, comparable to Karnes. In fact, in the most recent conference call, Mr. Chazen stated that they will continue to go heavy into Giddings and light into Karnes due to the fact that over the life of the individual wells, they produce very similar amounts of oil, however, costs are lower in Giddings. As of this moment, Karnes does not compete with the core Giddings acreage. This is quite a surprise considering Giddings was considered more of a speculative acreage. There are potentially decades worth of oil in this area. Giddings has surprised in many ways. Giddings has a lower initial oil output compared to Karnes, however, the decline rate of the wells is much lower than the Karnes wells. The Giddings wells have also produced more oil than expected, as they originally were expected to be gassier.

 

Outside of the core Giddings acreage, the company has also drilled two wells, which they expected to be gassier. These wells have just come online and are producing almost 600 barrels of oil, which is higher than expected. These wells are viable at these prices, and can potentially be used to benefit from higher gas prices should they ever occur, while still producing a good amount of oil. 

 

Conclusion

 

Magnolia has committed to growing within cash flows throughout the (short) history of the company. They have committed to rewarding shareholders through dividends and share buybacks. Reducing share counts by 1% each quarter will have a significant impact on earnings per share over the long run. The company has more than ample free cash flow to achieve this, assuming the price of the company does not significantly increase. They will also institute a dividend in 2021, which will not exceed half of net income. The company is also currently trading at 13x free cash flow for 2019, however, assuming normalized commodity prices in 2021, this number should be significantly higher.

 

Giddings has been a great surprise for the company, with potentially decades of production there. At this point in time, it appears their acreage is of similar quality as their Karnes acreage, which is a premier acreage.

 

Magnolia Oil & Gas has excellent and very experienced management, that has a history of value creation, and of rewarding shareholders. Mr. Chazen is past typical retirement age and has more than enough money to live comfortably in retirement. I think it is safe to say he continues to do this simply due to his love of the business.

 

 

[Williams406]

AugustRain,

 

Thanks for a very nice summary of the MGY proposition and appreciate the Giddings Field update. MGY's capital allocation model has always made sense to me and I think Chazen is near the top in the E&P space. Wish I had added to my miniscule stake back in the $4's and $5's.