Founded in 2002, Cimarex was born as the E&P spin out of Helmerich & Payne. It was the land before shale and the conventional oil and gas business was in decline in the United States. It was the time before horizontal Wolfcamp wells, before STACK cubes and before casual Friday’s became “If you bring your brain to work, you can wear pajamas.” Flash forward, tie on, to 18 years later and the founding principles (and principals) of the company remain intact and that’s the reason Cimarex ended up in the cross-hairs today.

To read their conference call transcripts over the past 5 years is to know that this is a conservatively managed company. Focused on long term share holder value, plodding along, and not one to be forced into knee jerk reactions, nothing says “Leave us alone” more than this sentence on the conference call.

“I know that many of you’re wondering what we will do with this cash. First off, I need to say that we would like to generate the cash before we get too drawn into speculation and what we’ll do it.”

Appropriately focused on the balance sheet and slowly embracing technology through their digital innovation and machine learning initiatives, it would be hard to find too many people who wouldn’t say Cimarex isn’t a solid, well run company. (Doesn’t this feel like a horror movie? Like… what’s he up to… that was a pretty glowing review… when does the bad guy show up?)

Let’s start with a visit to the SMOG table from their 8-K (will will need to wait to see the full 10-K breakdown). $3.629 billion is the PV-10.

Net debt is $1.985 billion (roughly 1.5x debt to EBITDA, reflecting the conservative balance sheet). SMOG – debt = $16.10/share. Current share price is….$39.39 (239% of SMOG PV10). Pause and think about that. Great company. Great asset. Stock has fallen 72% since the beginning of 2017 and I’m proposing it has 58% to go before I would buy it.

Now, defenders of Cimarex would say “But they are conservative and they don’t believe in booking PUDs.” True, at YE2019 they had only 88 mmboe of PUDs and 531 mmboe of PDP. The first question is obviously “Your stock has fallen 72%, the same management team is in place, if you have data that should make me want to buy you…. why the hell aren’t you telling me??”

More importantly, if 86% of the reserves are PDP and don’t require ANY capital (so are what 90, 95% of the NAV?), what does that imply to the valuation of the PUDs anyway? Who knows. They, and others, don’t disclose.

I have been saying “95% of E&P companies are overvalued or have a balance sheet that makes it so you can’t own them, or both.” THIS is what I’m talking about. This isn’t about ESG. This is about valuation. Which is a nice transition to the second part of the post. E. S. G. Here is a clip from Tom Jordan on the Q4 conference call.

I am 100% in favor of all these initiatives. Companies need to do the right thing, even when nobody is looking, and recycling more water, reducing emissions and reducing flaring separate and apart from regulations is the right thing to do. But, is that going to bring investors back? No.

Let’s go to hypothetical land: I want to introduce you to “Tammy”, my investment banker friend. She just graduated from Harvard or Princeton or Stanford and has $150,000 of student loans. Tammy landed a job at a top investment bank and was put on the energy desk (poor her). Her boss “Sandra” says…. “go find me a stock I can buy.“

Tammy, who follows the #hottakeoftheday, knows that SMOG isn’t perfect, but it’s not bad. She screens every E&P stock and finds that most of them look like Cimarex (in that they trade at multiples of their PV-10). But, Tammy is smarter that DRW.

So Tammy goes to Sandra and says…. “We can’t own any E&P stocks because I’m worried about climate change.” Sandra says “But you drive a car, buy plastics, fly on planes, it’s YOU who makes the CO2… not fossil fuel companies.”

Undeterred Tammy continues…. “Yes, that’s true, but the social pressure is just too great. I know that Cimarex just reported how interested they are in “E” in ESG but we need to see them execute.”

Then a missile hits a tank somewhere in the Middle East, oil goes to $68/bbl and Cimarex stock goes to $65. Sandra says… “Tammy…. thank goodness we took an ESG stance on this….. we would look like idiots if you told me that the stock should trade at $16.47 and was trading at $65 and I would have to fire you and you couldn’t pay your student debt.” Phew.

So, here’s the uplifting part of the post: What is Cimarex to do? It’s time to kick conservatism to the curb. They have the balance sheet, they have the premium stock valuation, and they have to do something to pivot away from the mid continent and not surprisingly…. I have a suggestion!! Buy someone who trades below SMOG and who’s CEO retired yesterday…

Bottom line (and this will be a theme for every Technical Tuesday we do): ESG isn’t the reason E&P isn’t investable. Valuation is. And, when you understand that and when you have a stock that trades at a premium, you can afford to pay a premium equity valuation when you use your equity.

We are an NAV business. Get used to it. And that’s why I’m not long (but I don’t short).