Michael Melby of Gate City Capital Management presented his investment thesis on Unit Corporation (US: UNTC) at Best Ideas 2023.
Thesis summary:
Unit Corp. is Mike’s top pick for the second consecutive year (access last year’s presentation). Unit’s stock price increased over 90% in 2022, but due to robust FCF growth, non-core asset sales, and opportunistic share repurchases, the company’s enterprise value increased by just 22% over the same period.
Unit recently had a market cap of ~$540 million and, with ~$180 million of net cash, has an enterprise value of ~$360 million. Mike’s price target of $88 per share provides investors with ~57% upside with limited downside risk.
Unit operates as an integrated oil and natural gas company with two segments: (1) oil and natural gas and (2) contract drilling. The oil and natural gas segment, operating as Unit Petroleum Company, develops and produces oil and natural gas primarily in Oklahoma and Texas. Unit Petroleum should continue to generate significant FCF in the years ahead, benefiting from low operating costs, relatively low decline rates, and the runoff of below-market hedges.
The contract drilling segment, operating as Unit Drilling Company, owns and operates 21 drilling rigs. Unit Drilling’s prospects have improved dramatically as tightness in the onshore drilling rig market has caused dayrates and profitability to increase substantially.
Unit also owns 50% of Superior Pipeline Company, which owns and operates pipeline infrastructure assets used to gather, process, and treat natural gas.
Since declaring bankruptcy in May 2020, Unit shed over $650 million in debt, installed an experienced management team focused on FCF, cut costs and capital spending, and divested non-core assets. In 2021 and through the first three quarters of 2022, Unit generated almost $300 million in operating cash flow, sold almost $150 million in non-core assets, and spent only $55 million on capital expenditures. The robust cash flow generation has allowed Unit to grow the net cash balance to ~$180 million while repurchasing over $75 million of stock at attractive prices. Mike expects Unit to generate robust profitability and FCF for the foreseeable future.
Unit recently traded at less than 2.5x EV/EBITDA and has an unlevered FCF yield of nearly 25%. Mike also expects Unit to continue to return capital to shareholders. Unit has opportunistically repurchased stock and also announced that it is conducting a tax earnings and profits analysis to determine whether cash distributions can be made to shareholders in a tax-efficient way.
Unit is traded OTC, has no sell-side coverage, and does not conduct investor conference calls. An uplisting to an exchange or the initiation of additional investor relations functions could attract new investors to the company.
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About the instructor:
Michael Melby is the founder and portfolio manager of Gate City Capital Management, a micro-cap value focused investment firm. Before starting Gate City Capital, Michael worked as a research analyst at Crystal Rock Capital Management where he covered the consumer, restaurant, retail, and gaming sectors. Michael previously worked at Deutsche Bank Securities in their Debt Capital Markets group and at the University of Notre Dame Investment Office where he focused on natural resources, fixed income, and risk management. Michael earned an MBA from the University of Chicago Booth School of Business where he graduated with Honors and a BBA in Finance from the University of Notre Dame where he graduated Summa Cum Laude. Michael is a CFA Charterholder and has earned the Financial Risk Manager designation.
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