U.S. Energy Corp. (USEG)

I started a position in U.S. Energy Corp. (USEG) last month at $2.85. Today it closed at $2.81. Below is a write-up of the company I initially posted on GuruFocus.com a few days after I bought the stock. I am re-posting it here now because I spoke with the CEO of USEG today, and before I post my notes on our conversation, I wanted to provide some background on his company, for those who may be unfamiliar with it.

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U.S. Energy Corp. (USEG) is an energy and natural resources exploration and development company currently trading for a third less than its book value (it was trading for .57x book when I bought it a few days ago). The management of USEG has a demonstrated track record of acquiring natural resource assets and selling them at opportune times for significant gains; the most recent example of such a successful sale occurred last year, and was the source of most of the company’s current cash hoard. USEG is a compelling value on its discount to book value alone, but four potential catalysts present opportunities for significant additional appreciation.


Valuation


USEG has a market cap of $75,470,000 and an enterprise value of $10,687,000 (subtracting both the company’s cash and its Treasury securities from the sum of its market cap and interest-bearing debt). It currently trades with P/B ratio of .66 and an EBIT/EV ratio of 82% (using trailing twelve-month data). The reason why the company trades at such a high earnings yield is because up until now it has generated its income through occasional deals rather than through consistent earnings. The company’s strategy going forward is to invest in assets that will produce recurring revenues while still pursuing large deals with windfall potential. The catalysts I describe below include examples of both. Note that the data above do not reflect the results of U.S. Energy’s sale, announced today, June 13th, 2008, of 39,062,072 shares of Sutter Gold Mining Inc. (SGM on the TSX Venture Exchange) for approximately $5,281,200 (in U.S. dollars).



Examples of USEG Management’s Timely Sale of Natural Resources Assets


Last year, U.S. Energy sold uranium properties that it had staked claims on during the 1990s, and had held onto as uranium prices dropped from the $ mid-teens per pound to $6.40 per pound in 2001. With uranium prices at uneconomical levels, U.S. Energy turned its focus to developing prospects for coal bed methane, but held onto its uranium properties. Through a subsidiary, Rocky Mountain Gas, U.S. Energy invested $15 million in the exploration and production of coal bed methane assets. Through a series of transactions, by the end of 2005, U.S. Energy had sold these assets for a total of $27.7 million.


Last April, when uranium prices were about $110 per pound, USEG sold its uranium properties to Uranium One Inc. (which trades under the symbol UUU.TO on the TSX) in exchange for 6.6 million shares in Uranium One, plus additional consideration, which I will expand on below. Uranium prices peaked in the mid-$130s a few months later, in the summer of 2007, and around that time USEG sold all of its shares of Uranium One Inc. for an average price of $13.68. Today, uranium is trading for less than $60 per pound, and shares of Uranium One Inc. are trading at about $4.30. This is an example of near-virtuosic timing and prudence on the part of USEG management, and one that bodes well for its handling of its current and future natural resource projects.


Catalysts


USEG has four potential catalysts to unlock additional value: One in the near-term (most likely this year), two in the medium term (within the next five years), and another in the longer-term (five years from now).


Near-Term Catalyst

· The Completion of a 216 Unit Residential Real Estate Project in Gillette, WY. Demand for housing in this part of Wyoming has been high recently because of the natural resources boom – the Gillette area produces about 40% of America’s coal, and the town’s population is growing by 7%-10% annually. Of the 216 units, 207 have been pre-leased. If USEG holds onto this property, its CEO Keith Larsen estimates it will generate about $250,000 in monthly revenue. Although USEG management sees promise in targeted real estate developments in regions participating in the natural resources boom, they have decided not to pursue any additional real estate projects, to assuage investor demand that they focus exclusively on energy and natural resource projects.

Medium-Term Catalysts

· Oil and Gas Exploration and Production. U.S. Energy has entered into separate partnership agreements with a private Houston-based oil and gas company and with Lafayette, LA-based Petroquest Energy (PQ on the NYSE). Drilling of the first three natural gas wells with Petroquest is expected to begin in June of 2008, and the drilling program with the private company is expected to begin in 2009. According to a presentation by Petroquest management dated June 2nd, 2008, Petroquest’s drilling success rate over the last 9 years has been 89%. U.S. Energy’s CEO has estimated that his company’s interest in these three wells alone could generate $250,000 in monthly revenue (the CEO estimates that USEG may be able to generate a total of approximately $750,000 in monthly revenue between interest income, income from the Gillette real estate development, and the potential revenue from these initial wells). USEG is evaluating other oil and gas investment opportunities to pursue in partnership with exploration & production companies that have proven, successful track records.
· Additional Payments from Uranium One. The largest part of the additional consideration that USEG received from Uranium One last year was $40 million to be paid contingent on the former USEG uranium properties meeting certain production targets; USEG management expects to receive this $40 million in the next few years as these production targets are met. Since USEG is such a small, little-followed stock, these windfall payments may act as catalysts for the share price as market participants see them appear in USEG’s quarterly filings. More importantly, USEG will be able to reinvest these moneys in energy and natural resource projects with promising returns.


Long-Term Catalyst


· Molybdenum Claims in Colorado. USEG’s patented “Lucky Jack” molybdenum claims near Crested Butte, Colorado, represent its most challenging project and also potentially its most lucrative one. USEG management estimates that a mine here could produce 15-20 million lbs of high-grade molybdenum per year, at a cost of about $10 per lb, and that the mine could have a 50-year life. Molybdenum, the demand for which has been driven partly by the global infrastructure boom, currently trades at over $33 per lb, so the potential profits from a Lucky Jack mine at current prices hold would be over $345 million per year. Currently, USEG has commissioned an engineering study of the project, and intends to submit a plan of operation to the U.S. Forestry Service by the end of 2008. If all obstacles are surmounted, and USEG can build a mine here, it would first start producing molybdenum in 2013. USEG may be able to monetize part of its interest in this project before then though, since it plans to sell a stake in its claim to an established mining company and have that company help develop the project.