Kenneth Peak on Bloomberg: Contango's CEO Discusses the Importance of Low Costs and Value Creation Per Share

Contango Oil and Gas (MCF) is a houston-based exploration and production business with a ~ $ 920 million market value. Kenneth Peak, the founder, CEO, and chairman of Contango, was recently interviewed on Bloomberg. In the interview, he talks about the importance of being among the lowest cost producers in the natural gas and oil exploration business.

Contango, in many ways, operates in what is an inherently tough environment.

Bloomberg Interviews Contango CEO

In a commodity business where (by definition) you have no control over price, being at or near the lowest cost becomes all-important. Being at least among the lowest cost producers is a crucial factor for survival during the bad times (low prices) and excess returns during the good times (high prices) for any commodity business.
(For banks it's similarly about having the lowest cost money.)

A durable low cost position, balance sheet strength, and management that allocates capital wisely is at or near the top of the list of those things an investor should attempt to gauge before putting capital at risk.

Well, at least that's what I'd look for before investing a penny in any commodity-based business.

Mr. Peak also explains why he chose to eliminate stock options at every level. He first eliminated his own stock options four years ago then later moved to do the same at the board level and for employees. He emphasizes the importance of value creation per share saying "there's no point in getting big, the object is to get rich". Stock options have a tendency to quietly dilute shareholders (and in some cases not so quietly...actually rather blatantly).

He makes the point that a buyback done just to offset dilution from options isn't really a buyback. In other words, the buying back of shares in order to offset that dilution is hardly a brilliant reason for a buyback (though some companies seem to behave as if it is).

Speaking generally, buybacks can make sense in my view if a business is financially strong, is comfortable in its competitive position, there's no clearly superior alternative use for the available funds, and the shares are selling at a plain discount to value.

So buybacks work well under the right set of very specific circumstances; inevitably the right course of action will be different for each business and industry.

It's worth noting that Contango doesn't bother to hedge, has plenty of cash, and no debt.

Contango may not be my favorite type of business but I do think some useful lessons can be learned from this interview.

Adam

No position in MCF
---
This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.