Sometimes when I find an investment I idea I have trouble sleeping. All I want to do is look into the business, do my research, and get to the bottom of whether or not I have a buy on my hands. But of course it usually takes more than a few days to do my research, fully understand the company, and get to the point where I’m comfortable making a decision. So it takes a lot of discipline to shut it down each night, stop my research, and get some sleep. And my recent experience drilling down on Ring Energy had my forcing myself to sleep for the last few nights.
We have to stay humble, and as Mohnish teaches us with commandment number three, thou shall be wrong at least one third of the time. But with that caveat in mind, I believe with Ring Energy I have found a no-brainer investment with hopefully a low downside and a big potential upside.
I recently bought shares of Ring for the After Dinner Investor portfolio at $1.60, and I feel good about the investment. While reviewing Ring Energy it felt like a smack you in the face no-brainer investment. It felt like Mr. Market was serving up a special one to me, so I’ll say as I always also do, thank you Mr. Market, and eventually when I sell Ring Energy I can tell Mr. Market, nice doing business with you again.
In this article I’ll cover how I found Ring Energy, what initially caught my eye, what I found when I drilled down on it, and what the game plan is now that I own it.
How I Found Ring Energy
As I’ve been discussing recently on my podcast, I want to make sure every company listed in the United States has a chance of coming across my desk, and I don’t want to miss out on anything. I want to be like Warren Buffett in the 1950s sifting through the Moody’s manual, page by page, on the treasure hunt for value, and as he says “starting with the A’s.”
In that spirit, I recently created a list of most of the publicly trade stocks in the United States, and the other night I started going through the list, starting with the smallest market caps, and I stumbled upon Ring Energy.
Ring Energy seemed familiar because I had seen the name a few times while I was researching Gulfport Energy.
What Caught My Eye
What caught my eye about Ring Energy were two things. The first was that it was selling for a forward PV of around 2. Ring Energy, when I found it, was around $1.40 or $1.50. And on Seeking Alpha 7 to 8 analysts have them earning about $0.60 a share each of the next two years. And in Value Line they have Ring earning $0.69 and $0.84 over the next two years. So the price was at a near PE of 2.
The other thing that caught my eye was that the chairman of the company, Tim Rochford, was the guy who founded and sold Arena Resources to SandRidge Energy for $1.6 billion in 2010. That was around the time I was a young accountant working at SandRidge Energy trying to figure out how to make money. I was waking up and learning how people got rich in the world, and I was figuring out that some people make exceptional money by creating or gathering business assets and then selling them to other businesses. And an example of that wealth creation process was right in front of me with my employer buying Arena and making their shareholders rich.
I’ll never forget reading about this purchase, sitting there in the accounting department. What stuck with me was that one of my older co-workers told me “yea, that’s it. That’s what this guy does [referring to Tim Rochford]. He builds oil companies and then sells them to other oil companies.” I’ll never forget that. That this is what that guy does line stuck me with. I thought “I don’t want to be this employee guy making $40,000 a year, I want to be that guy, selling businesses for hundreds of millions of dollars and getting rich.”
That’s what that guy does.
So that’s what made Ring Energy stand out to me. I had seen the name recently, I saw that it was at a PE of 2, and the chairman and his story of repeatedly building and selling oil companies and my first-hand experience seeing that process to some extent all peaked my interest and allowed me to put Ring past my one minute filter while I was researching businesses.
Ring was in my circle of competence, it looked like there was potential for a near PE of 1 situation, and the chairman and his success was familiar to me. I knew I had to dig in and figure out what was going on with Ring Energy.
What I Found
The more I dug, the more I liked the situation. I found a company with a plan to grow, some debt but a debt-averse management, a large PV-10 value compared to the price, insider buying, and some additional assets. Let’s break it down.
The stock is up about 10% as I write this, but when I made my initial purchase it was at $1.60. That would put it at the time at a market cap of $108 million. So the price for the entire business was $108 million.
The book value of this oil and gas company is $516 million. So it was selling for about 20% of book valye.
The company recently acquired Wishbone Energy and their earnings have increased since then. 7 analysts on Seeking Alpha have an average 2019 earnings estimate of 60 cents a share, and 8 analysts on Seeking Alpha have an average 2020 earnings estimate of 62 cents a share. Value Line’s estimates are 69 cents and 84 cents, in the two years, respectively.
So the PE at the time of purchase is between 2 and 3.
The company has three areas of acreage in the Permian Basin, specifically in the Central Basin Platform, the Northwest Shelf, and in the Delaware Basin. They have 138,241 net acres.
They have a slide that shows all three areas are break even at $35 per barrel oil. And their San Andres area seems to be their best asset and current focus. In a recent call the CEO said the Delaware is a fine asset, but that the Central Basic Platform and Northwest Shelf take are the priority right now.
Page 24 of an August 2019 presentation really tells the story for me. That is their PV-10 page.
According to Investopedia, PV-10 “is the present value of estimated future oil and gas revenues net of estimated direct expenses and discounted at an annual discount rate of 10%.” It does not include income taxes. And it is a way for investors to value oil and gas reserves.
I’ve learned that PV-10 is not always sold at full value. Just because PV-10 is a certain number it doesn’t mean a seller will get 100% of that number. For example, Ring bought Wishbone for $300 million and Wishbone’s PV-10 was $582 million.
So it’s not a perfect number, it doesn’t include income taxes, I’m not going to ever think a company will get the full PV-10 value, and it does include a lot of assumptions like what oil and gas prices will be (PV-10 uses the average of the prices on the first day of the month for the previous 12 months), what expenses will be, and of course a discount rate of 10% is higher than the risk free rate you could put those earnings into, so it might understate the true present value (lower discount rate = higher present value). But it does do a good job of letting investors know information about the quantity of assets an oil and gas company has in the ground.
It should be noted that PV-10 includes proven reserves, but not probable or possible. He’s another useful guide on PV-10.
Ring’s most recent 10-Q from the second quarter of 2019 shows $961 million of assets, which includes $912 million of net property and equipment. And on their Q2 2019 earnings call slides they report PV-10 of $1.1 billion on page 24.
The company owes a little bit over $360 million on its line of credit, and I believe the maturity date is 2024.
Beyond that there’s another $85 million of liabilities, most of it being accounts payable.
On the second quarter 2019 earnings call, the CEO said in regards to a water disposal system they’ve built up in the Delaware asset that they own, “A couple of years ago people were tossing around $20 million, $30 million and $40 million numbers. I couldn’t guess at what it would be today, but I do believe it would be additive to the concept of the oil and gas sale.” So besides the Delaware asset which they’re not focused on right now, they also have this water disposal system that could be sold at some point.
On OpenInsider I saw that insiders have been buying at recent prices. This is a good sign.
Put It All Together
So what do we have here?
Mr. Market offered me a growing oil and gas company, run by experienced management that’s done it before (grown and sold) and is buying at similar prices, at a price that’s a PE of under 3 , for $108 million, while the company has a PV-10 of $1.1 billion, debt of $360.5 million, a book value of $516 million made up of hard assets, and oil well assets that breakeven at $35 a barrel.
Twist my arm, I’ll take it.
Say the $1.1 billion of PV-10 is actually worth 50% today at market (I doubt that, but let’s say it is), that’d be $550 million, three quarters of that is $412 million after tax, minus the $360 million of debt, and you’ve got $52 million left. And oh yea, the water disposal assets are another $20 million. $70 million of fire sale worth. And then take away the net current liabilities of $30 million, and I’ve still got $40 million of worth.
I’m just spitballing here, but let’s say that’s the fire sale scenario, and my downside is down two-thirds. And of course the worst case scenario is a really bad recession, depression, or somehow a massive over-supply of oil, oil prices go south of $40 and that’s a wrap, it’s a bust.
I don’t know the odds of an extended period of oil below $40 and a bust here, but they don’t seem high.
Additionally, my PV-10 worth 50% and fire sale basement net worth of $40 million doesn’t seem likely either, although it’s nice having this basement. Who knows what the odds are of this scenario.
I’m aware of all the risks. I know oil could go low and stay low. I know interest rates could rise. I know $35 a barrel break even probably doesn’t include a bunch of expenses, and I know PV-10 might not sell for 100%. But given all the risks, I like the situation as an opportunity to invest and go for a multi-bagger.
If things go right they’ll make their interest payments, they’ll pay down the debt, the get cash flow positive by the end of this year, they’ll earn their PE of under 3 for the next couple years, and sooner or later Mr. Market will wake up and say “hey you know what, why is this company valued at a PE of under 3? Why is this company selling for a fifth of its book value? Why is this company selling for a fraction of its net asset value? This company is worth more!” And then the stock price will go up, we’ll sell, and lock in our profits.
The Game Plan
I always like to have an all-options game plan when I make an investment. All I can do from here is buy more, sell, or hold. Those are the options.
One thing I’ll be looking for is the interest coverage. In the second quarter of this year the income from operations was $17.6 million and the interest expense was $4.3 million. That interest expense was up from $800,000 in the first quarter, and this reflects the additional debt they took out from their credit facility. I’ll be watching to see if this interest expense stays the stay in the third quarter so we can know that’s what to expect going forward, assuming they don’t add debt.
I’ll be watching for more insider buying if the price stays near where it is now.
I’ll be watching oil prices.
And I’ll be watching how the company performs. How is production, how is cash flow, do they find more acquisitions, do they start paying down debt once they reach cash flow at the end of this year? I’ll be watching.
If the price stays near where it is or drops, I’ll probably buy more. And we’ll see what happens if it goes up. Do I sell and lock in my profit? Or do I stay with the Ring Energy team and see how big they can grow the company?
I like that I got to parter with Tim Rochford and his team, and I got to buy in for a PE of under 3 and for a price of $1.60 when their PV-10 net of debt asset value is around $10 or $11.
Thank you Mr. Market.
At the end of the first quarter 2019 earnings call, on May 9, 2019, Rochford said, “Look, there’s no question in our opinion. Everyone on this team realizes that — and I think a whole lot of you folks realize that right now these shares are grossly undervalued. No question about that. I don’t care what model you want to use — you take a look and you can argue whether it’s the EBITDA side or NAV side or maybe a couple of others. There is no question that it’s undervalued.”
I’m betting he’s right. On May 9 the stock price was $4.48. I bought in at $1.60. And hopefully in a few years from now we’ve got a nice multi-bagger investment that put us one step closer to being that guy.