(By Mani) Memorial Production Partners LP (NASDAQ:MEMP) has a top tier asset efficiency, leading cost structure and unparalleled long-term growth visibility that are under-appreciated due to the Street's myopic focus on its heavily gas levered production profile.
Texas-based, Memorial Production, which went public in December 2011, engages in the business of acquiring and developing long-lived, mature, oil, and natural gas properties exclusively onshore in two primary areas of operation, East and South Texas.
Memorial Production provides investors with the potential for meaningful capital appreciation over the next 12 months as a material valuation discount to peers ought to erode in the wake of improving sentiment.
The company is most exposed to natural gas prices, and as such, it has traded at a meaningful discount to the group since its IPO, which took place in the midst of the gas market collapse.
"With the floor in the natural gas market having been established, we see MEMP as an attractive risk-reward proposition as, despite what the market seemingly believes, MEMP is not at significant risk of a distribution cut or low coverage if the current price environment persists for the next 24 months," RBC Capital Market analyst John Ragozzino wrote in a note to clients.
In addition, the stage is seemingly set for a continuation of the early stage recovery in gas prices as reduced rig counts and production curtailments begin to return the market towards equilibrium, making the company as an attractive investment at current levels with significant optionality on a potential gas price recovery.
The natural gas market has bottomed, as evidenced by the 45 percent move above its early April 2012 lows, driven by a near-record summer.
"Additionally, we believe that the market's distaste for natural gas-exposed equities, to some degree, is finally subsiding, as the evidence of a 45% rally in gas prices is hard to ignore and certainly constitutes more than a quick head-fake rally along its continued downward trend," Ragozzino added.
Meanwhile, Memorial Production's exposure to low gas prices is muted by the use of fixed-price swaps as well as 2 way collars in its hedging strategy. It has an estimated 81 percent of estimated second-half 2012 natural gas production protected by hedges. More than 50 percent of these gas hedges come in the form of two-way collars or puts, with average floor prices of around $5.00 per million cubic feet (Mcf); the average ceiling price on the collars is just north of $6.00/Mcf.
"We note that even at current prices MEMP is in a position to sustain further weakness for some time, making the current discount to peers unwarranted. With a continuation of solid performance in the current price environment, we expect this discount should soon begin to erode," Ragozzino noted.
Moreover, the company benefits from a peer leading cost structure and exceptionally efficient asset base that are complimented by a robust hedge book which leaves a bit of upside to prices on the table. Despite current gas prices, the company is expected to deliver stronger performance than the Street anticipates, as a result of its efficient asset portfolio and leading cost structure.
"Longer term, we view the high level of growth visibility coming from multiple acquisition channels as a very attractive characteristic and a competitive advantage for MEMP, as is the case with most of the ‘sponsor fed' dropdown-based stories in the peer group," the analyst said.
Further, the company's strategic relationships with former parent Natural Gas Partners as well as Memorial Resource Development provide multiple avenues for long term growth.
In addition, robust activity and diligent execution and a strong freshman year of operations following its IPO should help to remove some of the discount applied by the market to the "show me" stories in the upstream MLP space.
"We believe that the case for an attractive risk-reward profile in MEMP units is clear," Ragozzino added.