In this article, let's take a look at Cimarex Energy Co. (XEC, Financial), an $11.73 billion market cap company, which is an independent oil and gas exploration and production company with operations in the Mid-Continent, the Permian Basin and the Gulf of Mexico.
Fund's positions
Steven Cohen (Trades, Portfolio) and George Soros (Trades, Portfolio) initiated a new position in Cimarex with 325,600 and 121,622 shares, respectively. Also, Columbia Wanger (Trades, Portfolio) went further and purchased 938,605 shares of the company.
Ken Griffin further increased his position in the stock through Citadel Investment Group by 51% to $274.0 million with 2.38 million shares in the company's latest filing. The opposite direction made Charles De Vaulx, who decreased the position by 57% to 1.44 million shares.
Jim Simons (Trades, Portfolio) and other hedge funds like Pioneer Investments, FPA Capital Fund, First Pacific Advisors and Diamond Hill Capital remain bullish on the company as evidenced by their increased position in the company's shares.
Stock price and downgrades
The stock has returned almost 2% on a year-to-date basis but has dropped 24% over the past 52 weeks, so why have these prominent investors taken long positions?
On June, 4, Deutsche Bank (DB, Financial) downgraded the company from Buy to Hold and lowered the price target to $133 from $145. This means that there exists about a 23% of upside potential from the actual closing price. Moreover, according to Yahoo! (YHOO, Financial) Finance, the estimated one-year target share price is $135.04, reflecting a future price appreciation of 24.5%. In addition, you have to consider any cash flow received by the asset. So for holding the stock one year, you'll be paid a dividend of $0.64 at the end of the year. If we divide this number by current price per share, we obtain the dividend yield, which is the other component of the return on an investment for a stock, and in this case is 0.6%. So the total expected return for investing in Cimarex is 25%, which we believe is an attractive stock return.
Revenues, margins and profitability
Revenue declined by 40% and led earnings per share abruptly decreased in the first quarter compared to the same quarter a year ago (-$4.84 vs $1.59). It is highly probable a 2015 EPS in red numbers, and have to wait until 2016 to see positive results.
Operating margin for the first quarter of its fiscal year 2015 has significantly decreased, but the worst thing is the negative trend for several quarters.
Let´s compare the best measure of performance for a firm's management: the return on equity. The ROE is useful for comparing the profitability of a company to that of other firms in the same industry.
| Ticker | Company | ROE (%) |
| XEC | Cimarex Energy | -1.08 |
| LINE | Linn Energy LLC | -14.49 |
| TLM | Talisman Energy Inc | -11.46 |
| WLL | Whiting Petroleum Corp | -3.04 |
| BTE | Baytex Energy Corp | -15.14 |
| COG | Cabot Oil & Gas Corp. | 1.66 |
| Â | Industry Median | -8.18 |
The company has a current ROE of 15.85% which is higher than the industry median and the ones exhibit by Linn Energy (LINE, Financial), Talisman Energy (TLM, Financial), Whiting Petroleum (WLL, Financial) and Baytex Energy (BTE, Financial). In general, analysts consider ROE ratios in the 15-20% range as representing attractive levels for investment. Cabot (COG, Financial) is among the companies with positive ROE. It is very important to understand this metric before investing and it is important to look at the trend in ROE over time.
Although it is negative, the ROE is ranked higher than 63% of the 536 Companies in the Global Oil & Gas E&P industry.
| Quarter Ended | Dec12 | Mar-13 | Jun-13 | Sep-13 | Dec13 | Mar-14 | Jun-14 | Sep-14 | Dec14 | Mar-15 |
| ROE | 11.58 | 10.23 | 14.33 | 14.77 | 21.11 | 13.56 | 14.10 | 13.25 | 6.79 | -38.66 |
Relative valuation
In terms of valuation, the stock sells at a forward P/E of 97.09. To use another metric, its price-to-book ratio of 2.32x indicates a premium versus the industry median of 0.97x while the price-to-sales ratio of 4.23x is above the industry median of 2.0x.
As we can see in the next chart, the stock price has an upward trend in the five-year period. If you had invested $10.000 five years ago, today you could have $15.151, which represents a 8.7% compound annual growth rate (CAGR).
Final comment
In this industry, a drop in oil or natural gas prices could hurt the company´s profitability. We believe Cimarex has a good position to reach high-growth plays, but the one principal risk is its weak liquidity with a quick ratio which is below 1 and demonstrates a lack of ability to cover short-term cash needs.
Although the company has a good asset quality, I see lower resource potential, which couldl affect production costs and prices. Unfortunately I don’t see the firm that is now well positioned in each of them.
Further, the U.S. Energy Information Administration released its drilling productivity report. It showed that oil production in the seven top shale regions is expected to fall.
The ROE has greatly decreased when compared to its ROE from the same quarter one year prior, and the valuation metrics make me feel bearish on this stock.
The dramatic decline in crude oil prices that started in late 2014 is affecting this company, and I would not recommend it until it demonstrates capacity to generate positive results.
Disclosure: Omar Venerio holds no position in any stocks mentioned
