Josh Young, a portfolio manager with Los Angeles,
California-based Young Capital Management, is a value investor on
the hunt for undervalued companies in the oil and gas space. He
launched his fund in September, has earned enticing returns so far,
and in this exclusive interview with
The Energy Report,
discusses some of his hedge fund's equity holdings that are
poised to get some love in the market.
The Energy Report:
Josh, What makes your hedge fund different from others?
We're focused on oil and gas investments, and we make those
investments generally through oil and gas (O&G) equities. We
focus on companies that are generally under-followed and find
companies which are trading at a big discount to their intrinsic
value, with identifiable catalysts that are going to unlock that
On the short side, we find companies with some sort of
fraudulent reporting or with very high valuations that are in
fundamentally challenging situations that they are unlikely to work
You're a true value investor.
Yes, I am philosophically a value investor. I focus on the oil and
gas space because there's a lot of volatility and there are lots of
changes and catalysts. With the right approach to managing the
commodity risk, there are regularly opportunities to generate
significant returns and invest at the sort of discount to intrinsic
value that can't be found in other sectors these days because
there's so much investment competition.
You mentioned that you buy companies that are trading at a large
discount to their intrinsic value and that have identifiable
catalysts for further growth. Do you have much trouble finding
those companies in the energy space? And what are some catalysts
you like to see?
The opportunities are there, but it takes a rigorous investment
process to exploit them. It's an incredibly labor-intensive process
to identify those companies, research them and make sure they are,
in fact, undervalued and that the market is missing something. The
risk-adjusted returns from this space, and that I've generated
running the strategy, justify the effort.
I identify catalysts as a part of my investment process. I look
for companies that have already announced that they're going to
sell assets or that they're going to do an equity raise that will
help them finance substantial growth. Those are some examples of
What about drill results? Would you consider those catalysts?
Yes, but those are generally harder to predict and so I don't focus
on them as much. Sometimes it's possible to figure them out before
the market does, and sometimes the market does not immediately
price in meaningful drilling results. But I'm not generally looking
to make investments in anticipation of wildcat exploration drilling
Most of my experience is on the mining side. I noticed when I was
combing through your research, a lot of the companies you follow
have small share floats compared to mining companies at similar
stages of development. Is there a certain range you look for in
terms of the float size? For example, if a company has more than 50
million shares outstanding and isn't as far along the development
path as a comparable company with 30 million shares, is that a red
flag for you?
I'm less concerned with the number of shares outstanding and more
concerned with the percentage of shares outstanding that are in the
free float versus percentage held by one or more major
shareholders, especially when those major holders might have to
liquidate some or all of their holdings. I definitely watch for
that. But I honestly don't care if there's 1,000 shares or a
billion shares outstanding. I care about the fundamentals of the
investment and the liquidity of the stock.
So, you don't like companies that are held largely by a handful of
shareholders? Is that what you're saying?
It depends on the situation. Let me explain. One of the companies I
Gastar Exploration Ltd. (
, had several large shareholders, and the share price suffered as
those large shareholders exited their positions. In 2008, about
20%-25% of Gastar stock was held by a hedge fund that dissolved and
the Gastar stock got dumped into the market as a part of the
dissolution process. That substantially hurt its stock price. More
recently, another investment fund that held more than 10% of Gastar
also dissolved its energy fund. There were a number of other
factors but that, essentially, led to Gastar's stock price falling
from $6. to below $3. even though the company was doing better than
before. That said, it's actually another catalyst in that when a
major shareholder is no longer a shareholder it can create a really
positive environment for the stock and allow it to start
appreciating closer to its fair value.
During a recent conference, Barclays VP of Commodities Biliana
Pehlivanova said the equity markets like seeing gas production
growth from companies because the markets consider it a measure of
success. She added that the market rewards gas producers for the
metric and, further, investors won't punish companies for low
commodity prices because they figure it's beyond any one company's
ability to correct the situation. Do you believe that's what's
responsible for the growing disconnect between share prices and
commodity price in the natural gas space?
I think it's complicated. I'm not sure that's necessarily the
answer. A few big things have been happening. First, companies have
been drilling into a low gas price because they're hedged. They
view their hedges as locking in high prices and, even though gas is
selling at $3.50 or $4, they make another $2 or $3 on their hedge
contract. They're basically producing gas at $7. Investors see the
earnings and cash flow as if the company was actually achieving a
$7 gas price.
In other cases, companies spent a significant amount of capital
on leases in the Haynesville Shale or elsewhere and they're
drilling to hold those leases and retain some of the value in
relation to the high prices they paid for them. In those cases,
companies are growing their gas production by default. I think a
lot of the current oversupply in natural gas is actually coming
from those first two factors.
The third factor is that the general market wants to be long on
natural gas. Retail investors believe in natural gas. They believe
in commodities. They're concerned about quantitative easing 2
(QE2), and the general growth of the money supply. People want to
be long on natural gas but they've lost money on the natural gas
ETF, UNG, so they've been buying natural gas companies. One of the
only ways a retail investor can access natural gas is by buying
these natural gas companies through either ETFs or directly owning
shares. I think that's where some of the disconnect comes from. The
people trading natural gas futures aren't necessarily the same
people as the people buying the stocks.
Do you think investors should just ignore the low gas price and
invest in companies with good balance sheets and solid management,
or are there better places for their capital right now?
I'm not sure I should be telling investors what they should and
shouldn't do. What I'm doing is finding companies that are trading
at a discount to their intrinsic value at the current gas price and
on the current forward curve. I intend to benefit both from the
undervalued stock price of the company, as well as any uplift they
might get from rising gas prices. So I'm not ignoring the gas price
completely, but I'm not letting it drive my investment decisions.
It's been a headwind and it will be a tailwind at some point going
forward, driving additional return for some of my investments.
Let's talk about some of your fund's equity holdings. One company
in your hedge fund is
Cabot Oil & Gas Corp. (
. It's trading at around $35, which already exceeded a target price
set by Macquarie Equities Research. J.P. Morgan has a target of
$50, but Oppenheimer has mixed opinions about Cabot. What do you
see in the company, and how high do you think it could go?
Cabot has traded down a lot over the past few months, after
receiving a lot of negative press about its operating activities in
Pennsylvania. My understanding is that the company's operations are
not substantially different from other Pennsylvania operators.
Cabot just happens to be in Susquehanna County, an area with a very
high visibility, and the people there are concerned about the water
supply. I think that negative news about Cabot has scared
investors. Large investors are reducing their positions or not
increasing their positions as much as they would have relative to
Cabot's intrinsic value.
Cabot is really in the core of the dry gas window in the
northeast. It's in an area of the Marcellus Shale where it and the
operators around it have achieved some of the highest and most
impressive initial production rates on their wells. Cabot is highly
economic even at current gas prices. It has high-quality
management, too. I think it's attractive just because it's been
picked on so much. To be able to buy a low-cost natural gas
producer in the U.S. at a discount to its intrinsic value is
Are there some catalysts there that you're eyeing?
There are a few things going on. First, there's industry
Atlas Energy, Inc. (
recently got bought out by
Chevron Corporation (
EXCO Resources Inc. (NYSE:EXCO)
is in the midst of a take-private transaction that may not close
but is priced much higher than Cabot's current market valuation.
There have been a number of deals in the Marcellus, joint ventures
(JVs) and acquisitions over the last few years at generally
increasing prices. Cabot hasn't done a JV yet in the Marcellus, but
it may at some point. The company may even get bought out-it's in
the core of the Marcellus. If I were a big multinational oil
company and I wanted a large position in the core of the Marcellus,
I would buy Cabot or go to the company and make a really attractive
JV offer. That's a harder to predict catalyst from a timing
perspective; it's something I think may happen over the next couple
Nearer term, it looks as though Cabot is going to monetize a
portion or all of its Haynesville acreage. Based on other
transactions happening there, I think that would be very positive
and provide the company with additional liquidity.
Cabot's acreage is in great locations in the Eagle Ford Shale,
and it looks like the company should expect some high return wells
there. They are also in the Heath Shale in Montana and the things
I'm seeing in the Heath Shale are positive so far. But I don't
attribute a lot of value to Cabot's Heath positions right now. Like
I said, I don't really invest based on exploration prospects; but
it's always nice to have the upside. It's possible that the company
could pull in a few good wells in the Heath and that would
significantly differentiate it and possibly lead to positive
movement in the stock.
You mentioned Gastar earlier. That's an exploration and production
(E&P) company with a market cap of about $200 million. A recent
Canaccord Adams research report said, "Gastar is an attractively
priced Marcellus producer given its relative growth potential."
Canaccord has a buy rating of $4.50 on it. Meanwhile, Rodman &
Renshaw has a target of $5.50 on Gastar. What are some of the
Well, Gastar just did an acquisition but the stock doesn't seem to
have priced in the value creation from that acquisition. The
company hasn't announced the metrics on the transaction; but, based
on the understanding of some of the research analysts that I've
spoken with and some back-of-the-envelope math, Gastar just bought
north of 50,000 acres at $1,000 an acre or less in the Marcellus.
They bought it in the dry gas area, but in a very good area of West
Virginia. That's tremendously positive for the company. There are
some big questions, though. What is the exact price Gastar paid?
How will they finance the acreage acquisition and development? And
did their existing JV partner decide to participate with it in the
acquisition, or will they seek an additional JV partner?
Gastar recently sold acreage to its joint venture partner at
more than $4,000 an acre, and here it is buying similarly
high-quality acreage at $1,000 an acre or even less. That's huge,
especially for a company as small as Gastar. Gastar is now likely
the most levered company in the Marcellus by enterprise value, at
least among those that are publicly traded.
Gastar has really transformed itself to a certain extent into a
Marcellus acreage play, and an extremely attractively priced one at
that. This catalyst has already played out and it's just a question
of the price the company is paying. I think the market will be
further surprised by other additional upcoming catalysts, such as
the results from their oily Eagle Ford and Glen Rose wells in East
Texas-you could see upside to the $5.50 price target that Rodman
& Renshaw put out, and I really respect the analysts at both
Rodman and Canaccord. Rodman recently upgraded RAME and raised
their price target, and I suspect that could happen for Gastar as
these catalysts play out.
You mentioned earlier that Chevron took out Atlas. The deal hasn't
closed yet, but it's all but done. Atlas has a huge position in the
Marcellus. Is that transaction affecting companies like Gastar? Are
people adding a little extra value to such companies given the
I think they should. I think it has affected companies like Cabot
Range Resources Corporation (
, but I don't think it's affected companies like Gastar yet. I
think it's important, even if I don't expect Chevron to buy Gastar
or any major oil company to come in and buy a company like Gastar.
It is important because Chevron's Atlas takeover is a validation of
the play. I think it will give private equity firms and domestic
and international oil companies more confidence in doing JVs in the
area and buying companies to access their assets. I think it helps
highlight Gastar's intrinsic value in the asset market even if it
hasn't yet translated into a higher share price.
Another company in your fund is
GMX Resources Inc. (
. GMX increased proven reserves by about a quarter in fiscal year
2010 (FY10). And it recently subleased a number of drills to cut
back on drilling in the Haynesville in order to reduce its capital
costs. C.K. Cooper & Company has a hold rating on GMX, whereas
both MKM Partners LLC and Stifel Nicolaus have buy ratings with a
$6. target. Tell us about your outlook for GMX.
GMX is interesting to me because it has a tremendous amount of
proven natural gas reserves on its books and is in the process of
reducing the cost of adding additional reserves. Relative to the
company's enterprise value, you pay less than $1. per 1,000 cubic
feet of proven natural gas reserves. A large portion of those
proven reserves are developed and producing. The company is
profitable right now-primarily because of its hedges-but it is
GMX has done a couple of things that have substantially
increased the company's value and the value of its assets. First,
it has significantly increased the amount of reserves it accesses
per Haynesville well drilled. At some point couple of years ago,
GMX was booking 3-4 billion cubic feet (bcf) of reserves per well.
Now it's up to somewhere around 6-6.5 bcf per well in reserves,
with associated higher production. Based on the type of
improvements the company is achieving, it could get reserves as
high as 7-8 bcf per well, comparable to some other places in the
Haynesville historically considered more "core" than GMX's area.
These are $9 million wells, so GMX's finding costs are pretty low.
It's not the lowest-cost producer, but the company has definitely
improved its cost structure. That's one really big positive.
Another big positive is that it did a deal with
Kinder Morgan Energy Partners, L.P. (
, one of the big pipeline companies. GMX sold a minority interest
in its gathering system in East Texas for more than $40 million. I
think it was a 40% stake or somewhere in that range. GMX still has
the majority ownership in that system. Valuations on mainstream and
gathering assets have gone up a lot in since that transaction. So
GMX has what's probably a $60-$70 million asset that no one seems
to be giving them credit for. The company's valuation is very low
because people are worried it will outspend its cash flow. Yet, it
has this asset that it will be able to sell to fund its
development, increasing expected future reserves and cash flow.
When GMX sells that gathering asset, it's really going to unlock
value there. It will highlight how discounted the stock is relative
to its fundamental value. And this is the kind of discount I look
for and the kind of misunderstanding I take advantage of for my
What are some of your other holdings that you'd like to talk about,
One of my largest positions that has done fairly well recently, but
still has a lot of upside potential, is
RAM Energy Resources (
. RAME has a number of more mature oil assets, primarily in Texas
and Oklahoma. They also have an oil field that they recently did
some exploration work on and achieved some really positive results.
Their stock is attractive because it is trading at a large discount
to its proven reserve value, at a low cash flow multiple, while
benefiting substantially from the above $80 price of oil. RAME's
enterprise value/BOE is effectively ~$11/BOE, or $11 per barrel
equivalent of energy in its proved reserves, which is substantially
lower than the going rate for other oil stocks and in the asset
On the surface, RAM appears to be overleveraged, but it recently
did an asset sale for more than $40 million. The asset they sold
appears to have been one of the company's weakest assets. It was a
high-percentage natural gas field that was providing a relatively
small amount of cash flow to its value. Even though RAM announced
positive exploration results on a trend where
SandRidge Energy, Inc. (
Chesapeake Energy Corp. (
have been very successful a couple of counties west in Oklahoma,
RAM's stock has not received much credit for the substantially
improved liquidity position nor the recent exploration success. And
given that the majority of RAM's reserves are in oil, the company
continues to trade at a substantial discount to its proven reserve
value, which was calculated at a lower oil price. So, there's even
more value there that should be recognized in the market at some
One more is
Lucas Energy, Inc. (NYSE.A:LEI)
, a micro-cap company. It's a small position for me, partly because
it is not the most liquid stock and is a small company, but it's
definitely one of the more interesting oil and gas companies. The
company is entirely in the Austin Chalk formation and the Eagle
Ford Shale. Lucas did a JV with Hilcorp Energy Company, a private
company, whereby Hilcorp is going to drill a number of Eagle Ford
oil shale wells. Lucas is getting carried on the first couple of
wells, and they are going to maintain a 15% interest.
Lucas is currently producing 120 barrels of oil per day (bpd),
so it's a very small amount of production. These Eagle Ford oil
wells are coming on at anywhere from 500-1,000 bpd, so the company
should have one well in production before the end of the year; and
it should have a couple additional wells in the first quarter of
next year. Lucas could more than double its oil production just
from these first wells that Hilcorp is bringing on. And it has a
number of other locations that Hilcorp will be drilling over the
next several years, and has recently acquired additional Eagle Ford
acreage at prices that were likely compelling. At oil prices north
of $80, Lucas' oily Austin Chalk wells should be highly economic.
You could expect the company to accelerate drilling there and
increase production at very attractive margins in a play that was
less attractive at that lower oil prices. Even though it's still
very small, it's still an interesting company.
As you can see, my investment process entails finding value and
taking advantage misunderstood opportunities, and there are a
number of attractive opportunities that I've found recently in the
oil and gas space. It takes a lot of research and involves
developing an understanding of the companies, but it is worthwhile
in terms of the opportunities it generates for attractive
risk-adjusted return investments like some of the ones I've
Thank you, Josh for your time today.
Joshua Young is the founder and portfolio manager of
Young Capital Management, LLC
, which launched Young Capital Partners, LP in September 2010. He
previously served as an analyst at a multibillion-dollar
single-family office in Los Angeles, which was nominated for
single-family office of the year by
magazine in 2008. At the family office, he was involved in the
sourcing, evaluation, purchase and sale of primarily public equity
investments in a value-oriented long/short equity strategy. He also
led the energy investment effort, evaluated third-party investment
managers and assisted in the development of this relatively new,
multibillion-dollar family office. Prior to that, he was an
investment analyst at Triton Pacific Capital Partners in Los
Angeles, a middle-market private equity firm. Prior to that, he was
a corporate strategy consultant at Mercer Management Consulting and
DiamondCluster in Chicago. He graduated with honors from the
University of Chicago with a BA in economics. Josh can be reached
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1) Brian Sylvester of
The Energy Report
conducted this interview. He personally and/or his family own
shares of the following companies mentioned in this interview:
2) The following companies mentioned in the interview are sponsors
The Energy Report:
Atlas and Ram.
3) Josh Young: I personally and/or my family own shares of the
following companies mentioned in this interview: Cabot, Gastar, RAM
Energy, GMX Resources and Lucas. I personally and/or my family am
paid by the following companies mentioned in this interview: None.
I reserve the right to buy or sell any stocks I have mentioned here
at any time.
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