Canaccord Downgrades Magnum Hunter, Cuts Target To $2/Share

In a report published Thursday, Canaccord Genuity analyst Karl Chalabala downgraded the rating on

from Buy to Hold. The price target was lowered from $3 to $2. "We like Magnum Hunter's two core assets, the ~202,000 net Marcellus and Utica acres, and its stake in the Eureka Hunter pipeline. However, we believe the current capital structure, which is highly levered with onerous terms, will deliver little value to the equity holder when taken in consideration of our view that natural gas prices continue to be challenged at main Southwest Appalachia pricing points through 2016," Chalabala explained. The company's balance sheet appears stretched with total debt of $966 million. Although Magnum Hunter has several options to increase liquidity, the analyst believes that exercising these options would dilute the company's core assets. According to the Canaccord report, "The Ohio Utica JV would give an interest in 8,000 undeveloped acres to a financial entity, thus reducing working interest slightly in what we view as core dry gas acreage. We also believe stated goal of $450-$500 million in liquidity proceeds is optimistic for an 8,000 acre JV, which equates to 30 wells on 640-acre spacing at six wells/section." The company has already decreased its majority interest in the Eureka Hunter pipeline, which is a key midstream asset. Magnum Hunter intends to sell of more of its total interest to reduce its stake to 43 percent. Proceeds from recent and future sales are expected to be used to pay down the company's 2nd lien loan. "This limits what Magnum needs, which is cash, as paying down the loan will allow the borrowing base to expand and increase liquidity, it does not change the net debt," Chalabala stated. In addition, the company is also facing natural gas pricing challenges in SouthWest Appalachia, and the analyst believes that "the challenged pricing would equate to a longer JV and thus longer time before Magnum captures more EBITDA. That said, the drill & carry would offset capex needs and generate EBITDA to help satisfy interest payments/covenants."