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Drill down and pose for profits in QEP Resources and Rick's Cabaret

Tue Nov 5, 2013


There's more than one way to invest in an energy boom.


  Ashish Kumar
   
By Ashish Kumar

Even with the S&P 500 at an all-time high, there are a number of gems available in the market. Two that we like are QEP Resources (QEP) and Rick’s Cabaret International (RICK).

QEP

Oil and natural gas exploration and production company QEP has traded at around $30 for two years mostly due to its exposure to natural gas price deflation. But the company has done a significant portfolio and balance sheet restructuring. By creating a mid-stream master limited partnership, the company has freed up capital on its balance sheet. It has built a 116,000-acre position in the prolific Bakken formation oil play in North Dakota, with the majority of these acres in the most productive part of the field.

Netting out value of its mid-stream assets, QEP's exploration and production business trades at less than 3.5 times 2014 estimated E&P EBITDA of $1.6 billion. Typically, companies with core Bakken oil assets trade at more than 6 times enterprise value to EBITDA. As oil production grows during the next six quarters, EBITDA should grow at more than 20%, assuming flat oil prices. As the market takes notice of this production growth, the multiple should also expand. Even if the multiple just expands from 3.5 to 4.5, the stock could go up by more than 50%. In a best-case scenario, the multiple could reach a peer-company average and retain significant upside. This stock also provides a free option on natural gas price recovery.

RICK

Nightclub operator Rick's Cabaret is coming out of a rough patch, but the market does not seem to be taking notice. Rick has 37 operating properties and six new ones are in the works. Several of Rick's clubs are in Texas, where the economy (up 4.8% last quarter) is benefiting from the energy boom. RICK is probably best exposed to this booming economy yet trades at 8.35 times its 3Q 2013 annualized non-GAAP earnings. A comparable restaurant and bar company should trade at anywhere 15 to 25 times earnings.

One impediment to stock appreciate is the market's misunderstanding of RICK debt. On the surface, it appears that company has $76.5 million of outstanding debt, but the majority of this debt is backed by its properties. Typically, restaurant companies lease properties with lease expenses of around 11% of revenue. Because adult entertainment licenses are attached to the building, Rick's Cabaret owns its properties. The company's interest expense in 3Q was 6.6% of revenue. RICK’s 2013 cash flow should be around $15 million, which is nearly a 13% cash flow yield. As most of the company's new property construction comes to end soon, RICK could have almost $20 million of cash flow to grow or buy back stocks in 2014. A company with $20 million in cash flow on a market cap of $111mm should be quite attractive.

RICK is also sidestepping into new sports bar concept that is more family friendly. New properties are coming up in oil shale boomtowns like Odessa where profitability should be very high.

As we connects the dot together, we see a business growing revenue at 20%, cash flow generation of north of 15% of market cap, new business strategy to reduce risk and improve capital efficiency, along with a very strong underlying macro tailwind trading at 8.35 times non-GAAP earnings.

RICK stock peaked at $29 in 2007. It closed at $11.20 on Monday. If management executes on its stated plan of achieving 20% revenue growth, it could easily rise into the $20s.

Ashish Kumar is founder and chief investment officer of Maurya Capital, a U.S. long/short equity hedge fund firm in San Francisco.

See also: Capital Group veteran starts long/short equity fund

ISSN: 2151-1845 / CDC10004H