MGY: NYSE

The views expressed below are those of Anchor Capital Advisors, LLC (‘‘Anchor’’) as of the date written and are subject to change at any time. They are based on our proprietary research of the stated company and the following is a summary of the primary factors that support our beliefs and rationale for investing in the company. Please see additional disclosures at the end of this publication.

MGY: NYSE

Magnolia Oil & Gas Corporation (MGY) is an Exploration & Production (E&P) company with assets in south Texas’s Eagle Ford Shale and Austin Chalk formations in Karnes County and in Giddings Field. It was formed in 2018 through the combination of EnerVest’s South Texas Division and TPG PaceEnergy, a special purpose acquisition company (SPAC) formed by TPG Capital. The combined company was named Magnolia Oil & Gas Corporation, is led by Stephen Chazen, former CEO of Occidental Petroleum Corporation (OXY).

MGY’s core asset is approximately 23,500 net acres in Karnes County in the oil windows of Eagle Ford and Austin Chalk. This core asset provides steady production growth while generating free cash which MGY can use to develop its other asset in Giddings Field. MGY has approximately 450,000 net acres in the Giddings Field spread across a number of counties.[1] Current company production is ~45% Oil, 25% Gas, and 30% Natural Gas Liquids (NGLs).[2]

Investment thesis

Today we are seeing many E&Ps focusing on free cash and better returns, a trend some investors have labeled, “Shale 3.0”.[3] Being led by the former CEO and CFO of OXY, we believe MGY was an earlier adopter of this capital disciple and allocation strategy, which was historically more common at large capitalization E&Ps. The management team is looking to reproduce the high return production growth within free cash flow and low leverage strategy from their days with OXY. We believe MGY offers a strong balance sheet, a cash flow and returns focused strategy, a strong management team, and reasonable production growth. Management’s dedication to FCF plus the possible upside from the Giddings Field development are positives in our view.  The production strategy is accompanied by a commitment to returning cash to shareholders via buybacks and dividends.

Confirmation through Research

We believe MGY’s strategy is differentiated relative to many small and mid-cap E&P as it is more in line with large energy companies. The heart of the strategy according to management is: “Our strategy was to establish a company whose characteristics would demonstrate a certain basic set of criteria that would appeal to generalist investors[4]…something that looks like an industrial company and less like an oil company. That is to say, it generates earnings per share that are meaningful and measurable. Which is we have free cash that we can use to enhance value over time, and we have a reasonable amount of growth.”[5] By focusing on free cash, steady organic production growth, and capital reinvestment of 50-60% of EBITDA, we believe MGY should be able to maintain low leverage, avoid the need to raise capital, and insulate it from the commodity price fluctuations. For example, MGY will seek to leverage below 1.0x EBITDA.  According to the CEO, “We don’t believe in debt…Commodities and high debt are concepts that don’t go together well.”[6]

Management compensation aligned with its operating strategy. Among other items, management compensation is based on free cash flow generation and operating margin.[7] Additionally, the CEO owns approximately 4% of shares outstanding which aligns him well.

Finally, MGY recently initiated a semi-annual dividend to go alongside its share repurchase program. The first dividend each year will be fixed. The second payment will include the fixed dividend plus a variable component. The total annual payment would not exceed 50% of the prior year reported net income. MGY expects that dividend will grow annually as it execute its business plan.

Variant Perception

We believe the market underappreciates MGY’s first mover advantage and management experience in navigating the current shale operating environment. MGY was started with a sustainable business model focus. Management’s dedication to FCF plus the possible upside from the Giddings Field development are positives in our view.