An Undiscovered Gem from Barron's?

Visiting Yahoo! Finance, I saw an article headline from Barron's that intrigued me, "The Best Bank You've Never Heard Of". I was hoping the article might be about some great micro cap bank I'd never heard of, but guessed it would be about a mid cap bank I already knew about, e.g., maybe Hudson City. I guessed wrong though: the bank was the mega cap multinational Santander. Is this is the sort of 'undiscovered gem' readers can expect from Barron's?

This article is my most recent reminder of why I don't read Barron's regularly. The second most recent reminder was this article back in May, which was listed under the "headlines" tab at the time for a stock I own, U.S. Energy Corp (USEG). At the time, this article wasn't available online, so I went to Barnes & Noble and looked for it in the dead tree edition of Barron's. Here was the one sentence that mentioned USEG,

Companies like Cameco (ticker: CCJ), BHP Billiton (BHP), Rio Tinto (RTP) and U.S. Energy (USEG) mine and/or trade uranium, although its value contribution to their shares is overshadowed by the many more popular metals these firms also trade.

Reading that, I thought: Is it too much to expect a Barron's writer to know at least as much about this company as me? U.S. Energy Corp. neither mines nor trades uranium, and, in fact, sold most of its uranium assets to Uranium One two years ago, as I have noted on this blog.

Barron's benefits from the inertia of its brand and of its readership. When I got out of college, I worked for a few months at a tiny, over-the-counter investment bank/brokerage in Manhattan where I was supposed to read Barron's every weekend. So I did. I'd read Alan Ableson's column, which was a little like Louis Rukeyser in print, and then I'd slog through the rest of it. I soon figured out that we weren't actually expected to learn anything useful from Barron's; we were supposed to read it because the affluent investors we were calling on read it, and they might mention something from the most recent issue and expect us to be familiar with it.

When journalists lament the decline of the print business, they ought to consider that the Google- and Craig's List-powered disruption of the advertising model isn't the only reason for print's decline; so is the decline of journalism itself. A lot of what passes for journalism today simply isn't worth paying for in any medium.

U.S. Energy Corp. Update

On Monday, U.S. Energy Corp. (Nasdaq: USEG) filed its 10-K and released its highlights for 2008, most of which we noted here when they were announced individually. Today the company held its conference call. CEO Keith Larsen mentioned that the company's Gillette, WY real estate development was currently 95% occupied, and is generating $225k in rental revenue per month. He also noted that the local economy in Gillette remained strong¹, despite the national downturn. Larsen also noted that the current low oil and natural gas prices offered promising opportunities to sign new exploration and production deals.

If the conference call was any indication, investor interest in USEG, such as it was, appears to have declined significantly. This may have been the shortest quarterly conference call I have listed to, by any company. There was exactly one question (I would have asked a question², but I was listening via streaming audio on the Internet). Other signs of a decline in investor interest:

- The company's Investor Hub message board has four posts in the last four months, all by the moderator.

- The company's Yahoo! message board hasn't had a post since January 27th.

Based on its year-end balance sheet data, USEG is currently trading for less than its net cash.

The photo above comes for U.S. Energy Corp's website. You can read more details on the company's interests in Molybdenum, Oil & Natural Gas, Uranium, Geothermal, and its Gillette, WY real estate project on the projects section of the company's website.

¹As of January, according to the Bureau of Labor Statistics, Wyoming's unemployment rate was 3.7%, the lowest in the nation.

²My question would have been about what cost-cutting plans (if any) the company had in mind to get closer toward profitability from the cost side.

A Conversation with the CEO of U.S. Energy Corp. (USEG)

Keith Larsen, the CEO of U.S. Energy Corp. (USEG), was nice enough to spend 40 minutes on the phone with me Friday answering my questions about his company, and sharing his insights about the natural resources industry. Here are a few notes from our conversation.

- Alternative Energy: T. Boone Pickens's plan came up in our conversation, and Keith Larsen mentioned that he had just seen Pickens speak at an event in Denver. Larsen noted that USEG is considering investments in alternative energy, including wind.

- The Gillette, WY project: Currently, it's half built, and the half that is built is 100% occupied and generating $120k in monthly revenue. The other half will be completed by October 1st, and Larsen expects this half to be fully occupied as well, so the completed project should be generating about $240k in monthly revenue for USEG. Gillette has a population of about 50,000, but is growing at about 7% per year and has been benefiting from the secular bull market in commodities -- 40% of America's coal comes from this area (and of course about half of America's electricity is generated by coal-fired power plants).

- Real estate in general: USEG's board has decided not to pursue additional developments, despite the success of the Gillette project, and plans to sell off piecemeal another property it owns -- 25 acres of undeveloped land adjacent to its headquarters. Mr. Larsen expects they will be able to do so at a profit.

- Oil & Gas exploration: The first of three wells being drilled in partnership with Petroquest Energy (NYSE: PQ) is about to be spudded, and the next two are scheduled to be completed this fall. Although Petroquest's website touts an 89% success rate on its wells, Larsen says that figure includes its shale projects, and the more relevant success rate for Petroquest with these sorts of exploratory wells is 70%. If these wells are successful, Larsen estimates they could generate $150k-$250k in monthly revenue per well for USEG. Combined with the revenue from the Gillette, WY development, this could total $1 million in revenue per month, which would be enough to give USEG consistent, positive earnings.

- The Lucky Jack Molybdenum project: Keith Larsen is confident that this project will eventually get completed. He noted that, although our current high energy prices are bad for America unfortunately, they are at least finally increasing public support for natural resource projects such as Lucky Jack (and, of course, oil & gas drilling). Larsen says that despite a small, vocal, minority of environmentalists (who remain unsatisfied by USEG's plans to develop the mine in an environmentally responsible way), the feedback USEG is getting from most locals in the Crested Butte area is that they want the project to go forward, and they are looking forward to the jobs it will create. Larsen also clarified his earlier $10 per pound cost estimate, saying they are working on getting a current engineering cost estimate, and that his $10 figure was a ballpark estimate derived by more than doubling a previous engineering cost estimate. Ten years ago, when molybdenum was trading for about $5 per pound, a previous engineering study estimated that this molybdenum deposit could be mined profitably, at a cost of about $4.50 per pound. Larsen used $10 per pound as a ballpark estimate to take into account the increased cost of mining equipment and labor today.

- Uranium: Larsen explained that the end of our reprocessing treaty with the Russians should put pressure on uranium prices over the next few years. Although Uranium One is not required to give USEG updates on its plans, he estimates that USEG will receive at least $20 million of its $40 million in contingent deferred compensation from Uranium One by 2011. Larsen also noted that USEG also has a 4% interest in any net profits from the Green Mountain uranium deposit, which is estimated to contain 50 million pounds of uranium (uranium currently trades for about $60 per pound). That deposit is currently owned by Rio Tinto which is shopping it around to other mining companies.

- Insider sales: I mentioned the three ~300,000 insider sales listed on Nasdaq in January, and Larsen explained that those were actually shares of a subsidiary that were canceled, and that they are reported as insider sales although they actually aren't. He said that no insider in USEG has sold shares in 10 years.

- Three accounting firms used in the last few years: Larsen said that one of USEG's accounting firms was bought by another, and that also Sarbox required them to change accountants periodically. He noted also that, since they were now actively involved in oil & gas exploration, they might need to switch accountants to a firm more experienced in this area.

U.S. Energy Corp. also recently announced that it has applied for a listing on the Toronto Stock Exchange (TSX), and it expects that application to be approved and that U.S. Energy will start trading on the TSX by the end of October. Since many natural resources companies are listed on the TSX, a listing there should expose U.S. Energy Corp. to a new audience of natural resources investors.

At the current quote ($2.81 per share), USEG trades at less than 60% of its book value. I may add more at these levels.

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.