Bookkeeping: New Natural Gas Stake in Encore Acquisition (EAC)

In a post earlier this month I mentioned how all things being equal it might make more sense to hedge towards smaller players in both the oil/natural gas exploration and production. [Jun 18: Will Encore Acquisition be Bought Out?]

So all things being equal, we might develop a thesis here, that it might be sensible to build in exposure in smaller E&P companies with the carrot of potential takeouts. The typical market cap of the names above is $1 to $3 Billion.

Many of the (smaller) names mentioned in that post have been absolutely ripping it up the past few weeks, while their big brothers have been going upward slowly or sideways.

Potential takeover targets include Arena Resources (ARD), Brigham Exploration Co (BEXP), Berry Petroleum Co (BRY), Concho Resources Inc (CXO) and Rex Energy Corp (REXX), Tudor Pickering, said.

However, I am going to focus on Encore Acquisition (EAC) because after a tremendous run earlier this year, it has been consolidating this move and more importantly it literally has signaled it is willing to put itself up for sale since the market is not valuing it correctly.

Onshore oil and natural gas exploration company Encore Acquisition Co (EAC) said on Wednesday it was exploring strategic alternatives, including a possible sale.

It is our belief that Encore’s current share price is not reflective of our record operating results and our ability to efficiently fund these projects through our upstream master limited partnership, Encore Energy Partners,” Encore Chief Executive Jon Brumley said in a statement.

At just under $4 Billion in market capitalization (up from $2 Billion earlier this year) it’s a good size fit for many companies. And it’s still cheaper than the other 3 natural gas names I own in the fund for my mini basket of natural gas stocks

• XTO Energy (XTO) forward P/E 16


• Cabot Oil & Gas (COG) forward P/E 22


• EOG Resources (EOG) forward P/E 14

Now, not all companies “should” be valued the same since some have more attractive assets than others, but at a forward P/E of 13 this remains a good “value” and has land in some of the hottest markets in the United States.

With all that said, I’ve been calling for a “correction” in this space so I am not starting with a huge stake. But the stock has begun to pull back (not much, about 10% from recent high) and is sitting at its 20 day moving average of $70. I’d rather buy at the 50 day moving average of $62 (or lower if possible), which we might or might not get. If money rotates out of this group, we will definitely get this price so we’ll hold off on going whole hog for now. So I’m making a starter stake of 1.3% of portfolio, and look to add on larger pullbacks. Keep in mind, if we are so unfortunate to be hit with any major hurricanes this summer/early fall, natural gas would be the group that would spike the most. On the other hand, if oil and natural gas go into a swoon, so will these sort of stocks - hence I feel more secure in other sub-sectors of commodities with longer term contracts in place and not so exposed to spot pricing.

This brings my natural gas “basket” of stocks up to 4 names, and EAC is the smallest of the bunch. Hopefully someone comes knocking on their door in the next 6 months, and we’d be happy to sell out north of $100

As an aside, that rotation I’ve been talking about? It’s officially here - commodities being smashed. “Get in my Belly“

Long Encore Acquisition in fund; no personal position