Energy Prospectus

XEC has taken a beating today. 3rd quarter results came in just 1 cent below my forecast model and production was just below my forecast. I'm working on the model right now, but my initial reaction is that the market has oversold this one. I will have an updated forecast model on the website in a couple hours. - Dan

DENVER, Nov. 3, 2011 /PRNewswire/ -- Cimarex Energy Co. (NYSE:XEC - News) today reported third-quarter 2011 net income of $128.2 million, or $1.49 per diluted share. This compares to third-quarter 2010 earnings of $128.2 million, or $1.50 per diluted share.

Third-quarter 2011 net income includes an unrealized non-cash gain on derivative instruments associated with 2011 oil and gas hedges of $3.4 million after-tax, or $0.04 per share.

Oil, gas and natural gas liquids (NGLs) revenue in the third quarter of 2011 totaled $419.7 million, a 15% increase compared to $366.6 million in the same period of 2010. The increase in third-quarter 2011 revenues is a result of higher realized oil, natural gas liquids (NGL) and gas prices, which were slightly offset by lower production.

Third-quarter 2011 production volumes averaged 592.0 million cubic feet equivalent (MMcfe) per day, a 1% decrease as compared to third-quarter 2010 output of 600.0 MMcfe per day. Third-quarter 2011 Permian and Mid-Continent volumes grew 22% and 15%, respectively over the same period in 2010. Growth in these regions was offset by a 51% decrease in Gulf Coast volumes. Gulf Coast production decreased as a result of declines in wells drilled over the last two years near Beaumont, Texas. Third-quarter 2011 production volumes were 56% gas, 27% oil and 17% NGLs

Production guidance was lowered just a bit, causing today's selloff. Also, their mix shifted more to natural gas, which the analysts did not like. It should be noted that XEC's gas is high btu, so it sells at a premium to NYMEX. They got $4.57/mcf in the 3rd quarter.

I will be lowering my Fair Value estimate but today's selloff is overdone.
> XEC has a very strong Balance Sheet, only $350 in bank debt as of 9-30-2011.
> Debt to total capitalization ratio at quarter-end was 10%
> They remain on-track to generate approximately $15/share in cash flow from operations this year and about the same next year. Trading at just over 4X CFPS is rather ridiculous for a company of this quality. 6X CFPS seems more reasonable to me.
> Most of their production is unhedged, so where do you think oil & gas prices are heading?
> Cimarex has a first class technical team and large inventory of very profitable development drilling locations.

See my updated forecast model under the Sweet 16 tab.

S&P on XEC:

Highlights

XEC's production has begun to reflect a portfolio repositioning over the past two years to focus on higher-margin liquids in response to weak natural gas fundamentals. XEC has 30 rigs running --14 in the Permian Basin (Bone Spring, Paddock,Wolfcamp), 14 in the Mid-Continent (Cana-Woodford, GraniteWash) and two in Yegua/Cook Mountain on the Gulf Coast. XEC has ramped development at Cana-Woodford, where production now accounts for 20% of total volumes. In November, XEC cut production guidance to 589-595 MMcfe/d, reflecting mechanical problems on the Gulf Coast, and we see a decline of less than 1% in 2011 before a 6% boost in 2012, on project development.

Oil and NGLs now represent 45% of XEC's production (previously under 30%). This should allow XEC to mitigate the impact of low gas prices and benefit from better oil fundamentals. XEC sees 2011 capex reaching the high-end of its $1.5 billion-$1.6 billion plan, on additional CanaWoodford capex and higher service costs. About 47% of capex is slated for Permian Basin.

We forecast 2011 and 2012 adjusted EPS of $5.86 and $5.68, respectively.

Investment Rationale/Risk

Exposure to undeveloped acreage at Cana- Woodford and the Permian Basin is expected to drive future production and reserve growth. Development should act as a primary catalyst, although we see more gradual growth than in 2010. We expect over 90% of capex to be spent at Cana-Woodford and the Permian Basin in 2011, given strong returns. Permian Basin drilling is expected to ramp up at XEC's 125,000 acres in the Wolfcamp play; we think XEC will run six rigs there, and eight at Bone Springs, Abo, Cisco/Canyon and Avalon Shale. We now expect XEC to outspend cash flows this year.

Risks to our recommendation and target price include economic and geopolitical impacts on supply, demand and prices; and reserve and production declines.

Our 12-month target price of $73 reflects our NAV estimate of $68 and a target enterprise value of 5X our 2012 EBITDA estimate. We expect the shares to perform in line with E&P peers as production guidance has declined while capex plans and service costs have simultaneously increased. Our hold recommendation is based on slower production growth rates than previously seen (29% in 2010).