CRGY - Epsilon Energy: Waiting For Strategic Direction

Summary

• Epsilon Energy has cash almost equal to the nine-month sales figure.
• There is no long-term debt.
• The new CEO needs to completely understand company operations and then state a strategy (and get moving).
• The status of Oklahoma operations appears to be undecided.
• An expansion of the Marcellus holdings appears to be a good possibility.

Epsilon Energy ( EPSN ) remains a company with a lot of cash and an excellent balance sheet. But the person who got the company in such great shape has now left. There is a brand-new CEO who was talking about getting his hands on the situation. So far so good. But some shareholders are worried that all that cash will be spent on poor acquisitions to put the company back in debt as it was more than a decade ago before the last CEO straightened things out. Therefore, it is going to be important to see what the new CEO does with the company's assets.

The company has long had a major interest in the Marcellus as shown above. This is a dry gas area where the company reports the majority of the production each quarter. The operator has long been Chesapeake Energy ( CHK ). This is probably one of the more profitable areas of the basin.

With really no long-term debt and plenty of cash, the company has no fear of a commodity price downturn. This is a company that simply lives off the cash balance during times of weak commodity prices if production needs to be shut-in until prices recover. Note that such a situation has yet to happen despite the years of weak commodity prices.

The company reported roughly $40 million in cash at the end of the third quarter. This is an impressive amount for a company with about $44 million in sales in the first nine months of the fiscal year.

The company purchased some acreage in Oklahoma as a potential growth avenue during the previous administration. As management noted during the conference call, there is some capital allocated to this acreage. Currently this acreage is in the exploration stage as the profit potential appears to not have been conclusively established. Therefore, the new CEO somewhat hedged about the potential of this acreage.

For the new CEO, this acreage is so far away from the main income source, that there was some question as to the wisdom of establishing some operations in a new basin. Now, like the acreage in Pennsylvania, there is an operator for the acreage. So, the company always has the option of participating or not participating in any project.

The previous administration seemed to be fairly excited about the few wells that had been drilled and were producing. But it is only natural that a new administrator reviews the whole portfolio before coming to a decision as to future strategy. Obviously, had the partners made a decision to develop the acreage, that would have been carried out in this environment. So the current neutral opinion needs to be considered in that context.

What management did state is that they are interested in more participation in the Marcellus and have let the operator know about that interest. My own suspicion is that management needs to do a fair amount more than that.

A larger company, Antero Resources ( AR ) has been reporting a steady stream of small acreage acquisitions for some time. Similarly, down in the Eagle Ford, Ranger Oil ( ROCC ) has been executing this acreage strategy of purchasing subpar holdings and then piecing them together into more marketable (as in profitable) positions for some time. Possibly the hardest part of this strategy is to get started. But I suspect once Epsilon does and properly executes the strategy, they can do it as cash becomes available.

There has been a widespread attitude throughout the industry that production is cheaper to purchase than drill. Some companies like Crescent Energy ( CRGY ) have been formed specifically to take advantage of that belief. This company has mentioned this idea "on-and-off" for some time. But has really not gotten the process underway. With natural gas prices considerably off the recent high points, one would think a few small deals could be executed by doing due diligence and knowing the market.

Management has initiated a dividend and does repurchase stock from time to time. But the current environment appears to be one in which either drilling or purchases of acreage should produce an adequate return when compared to returning the money to shareholders. I do like the conservative management that is shown by this small company. But management may be erring a bit much on the conservative side. Therefore, a deliberate change in direction appears to be indicated.

The Future

Management appears to have the company well positioned to go in any one of several directions. The new CEO should by now have had the time to study the company operations enough to "get going". Probably the key here is to do something both deliberately and with proper due diligence.

Cash has been building up for a while. That cash either needs to be put to work in company operations or it needs to go back to shareholders. The current environment appears to favor reinvesting the cash in the company operations.

Unlike many upstream companies, this company has an interest in a midstream operation that provides steady cash flow during a commodity price downturn. An expansion into this part of the industry should not be out of the question either if an opportunity arises. Because of the midstream operations, there is less earnings volatility than is the case with a pure upstream operator.

This small company has a balance sheet that "is a rock". That reduces the risk of stock price downside and long-term loss of principal. The debt free balance sheet with a large cash balance is a highly desirable characteristic that probably needs to be at least somewhat maintained once management decides upon a future strategy.

Similarly, despite the new CEO, this board is likely very active in company affairs. So, there are other people besides the new CEO that are familiar with the industry, company history, and of course operations. There appears to be enough personnel to guide a new key officer in getting started in a new position. But it is probably wise for the company to state a strategy for the new fiscal year and future and then get moving on it. The current uncertainty is likely to leave the stock price in "limbo" until that happens.

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