I have been a fundamentalist investor for 23 years and my first fundamentals-driven article for Seeking Alpha was about C&C Energia, a Canadian intermediate oil producer in Colombia. I had to debate with the non-believers who did not accept how grossly undervalued C&C Energia was at $5.60 in late July 2012. The comments' section hosts that lengthy debate. A part of C&C Energia was acquired by Pacific Rubiales (PEGFF.PK) for $7.81 just three months later and C&C's total value was estimated at $9.81 by Pacific.
I also take the pride in saying that this was the first publicly released article about C&C Energia. I was trying to find one for months without success in several online publications. Where were the analysts?
My recent article about Surge Energy (ZPTAF.PK) was also based on fundamentals. I believe Surge is a big buying opportunity despite the drop caused by a couple of analysts who showed up at the public media and stated that they did not like the company. The investors just have to be able to separate the herd behavior from the fundamentals.
Actually, Surge Energy reminds me of PetroBakken Energy (PBKEF.PK). I still remember those analysts who trashed publicly Petrobakken at $7 back in September 2011 based on assumptions and hypothetical scenarios. However, the fundamentals were there and I decided to buy PetroBakken at $7,35 in September 2011. The stock rose up to $17 in early 2012.
Several analysts also recommended Apple (AAPL) at $700 a couple of months ago, setting a target at $1,000 or higher. The stock is at $450 currently.
Anyway, this article is not about the analysts who recommend Halcon Resources (HK) as "buy" or "strong buy" at the current levels. This is an article about Halcon itself which has run too much despite the dismal fundamentals. Well, prudent investors had better ignore the analysts and follow "a show me" approach instead. Here is why:
Based on the publicly released information as of today, I have not seen any high impact wells in Halcon's acreage so far. The company is also rather shady with its Woodbine/Eagle Ford horizontal producing wells. The drilling results and the type curve have not been publicly available although it is the company's core area. Should I worry? Are the results below expectations? This reminds me of the Primary Petroleum (OTCQX:PETEF) case which was secretive with its drilling results in Montana until the company disclosed that they were below expectations.
The fact is that Halcon's core Eagle Ford acreage is not located in Gonzales and Lavaca counties where the oil window is. Gonzales County is the best acreage in the Eagle Ford Shale followed by Lavaca county. Magnum Hunter Resources (MHR) has an average IP-30 of 815 boepd as all of Magnum's acreage is located on the oil window.
Penn Virginia (PVA) is also drilling at the oil window of Eagle Ford and its properties are surrounded by Magnum's properties. Penn Virginia has an average IP-30 rate of 657 boepd in its Eagle Ford properties.
So it has to be pointed out that Halcon's core land is primarily located in Madison County with smaller parts in Leon and Grimes counties. All these three counties are at the northeast of Gonzales and Lavaca. Actually Halcon's land is adjacent to Approach Resources' (AREX) acreage which borders the natural gas weighted Cotton Valley.
The company's Eagle Ford wells in Fayette and Gonzales counties have an average IP-30 of 545 boepd (93% oil). This is not a game changer apparently. In addition, due to a non-compete agreement, Halcon plans to divest this 24,000 net acre property whose marketing process is underway. So this acreage will be gone in 2013.
Halcon's Bakken wells have an average IP-30 rate of 347 boepd (91% oil). This is not a game changer rate either. Halcon's Bakken acreage is in Williams, McKenzie and Mountrail counties. Continental Resources (CLR) made a game changer discovery in McKenzie County of North Dakota recently. Continental's Charlotte 3-22H well flowed 953 boepd from the third bench of the Three Fork zone during a one-day test period.
I want Halcon's average IP-30 rate in North Dakota to be higher than 503 boepd which is the average IP-30 rate of the fairly priced Magnum Hunter Resources in the area to justify some premium for Halcon.
The results from the company's acreage in Montana are not encouraging either.
Additionally, both Utica and Tuscaloosa do not give me any reason to rejoice as there is zero production from there. The first results from Utica and Tuscaloosa Marine Shale will be released in Mar 2013 and Feb 2013 respectively.
The Kollatschny-1 well (95% WI) in Austin County of Texas have an initial gross production rate of approximately 595 boepd. To be sincere, I would be excited if it was higher than 2,000 boepd.
I think the speculation and the CEO's resume have sent Halcon soaring lately. After a series of acquisitions and the recent notes of $600 million the company has accumulated a debt of $2.6 billion, producing 26,500 boepd (77% oil and liquids) currently. Adding the last shares from the Canadian Pension Plan Investment Board and the recent financing, the company has 366 million outstanding shares and an Enterprise Value ((EV)) of $5,5 billion. This results in a staggering $207,500 per flowing barrel valuation.
The company has also 115 MMBoe (79% oil) proved reserves so it is priced for $47.8 per boe of proved reserves. This is obviously another generous metric.
What about the operating cash flows? Halcon has $16 million in operating cash flows in Q3 2012 with 11,000 boepd production. Add on this the recent Williston Basin acquisition of 10,500 boepd and the operating cash flow in Q4 2012 will be around $45 million at its best. This results in a D/CF ratio (annualized) of 14 and a EV/CF ratio (annualized) of 30. Both ratios make me sweat. Why? Because even Kodiak Oil and Gas (KOG), one of the most richly priced oil producers, trades for $129,600/boepd (86% oil and liquids) with EV/CF ratio at 11, based on the current production of 27,000 boepd and EV of $3,5 billion. This Denver-based producer has not been selected accidentally. Kodiak and Halcon have the same production but Kodiak is more oil-weighted than Halcon. Despite this, Kodiak has $2 billion value less than Halcon. Another common characteristic between them is that Kodiak is an acquisition target in the overcrowded Williston Basin according to the rumors.
The M&A Activity
The CEO Mr. Wilson has already said publicly that Halcon will be sold in 3 years. Based on its current valuation, the CEO has to work very hard to make Halcon an appealing acquisition target. Why? Because the transaction metrics for all the recent oil-weighted deals are much lower than Halcon's. I follow all the Canadian and US-based energy companies and I keep track on all the transactions made in the energy patch. So let's have a closer look on some of them:
1) Bonterra Energy (BNEFF.PK) acquired Spartan Oil (SRTNF.PK) a few weeks ago for $420 million, buying 4,000 boepd (82% oil and liquids) production and 2P reserves of 21.4 MMboe. Bonterra paid 105K/boepd and $19.6/boe.
3) In Nov 2012, Crescent Point Energy (OTCPK:CSCTF) acquired the privately held Ute Energy for $861 million. Ute had 7,800 boepd (88% oil and liquids) production in Uinta Basin. That is $110K/boepd and $20/boe of Proved Reserves.
4) In June 2012, Forestar Group (FOR) acquired Credo (CRED) for $146 million. Credo had a production of 1,000 boepd (61% oil and liquids) and Proved Reserves of 4.1 MMBoe (50% oil as of Dec 2011). Thus Forester paid $146K/boepd and $35/boe.
5) In June 2012, the most acquisitive Canadian oil player, Crescent Point acquired 2,500 boepd (90% oil) of Shaunavon production for $343 million from an undisclosed senior oil producer. That is $137K/boepd.
6) In Feb 2012, once again Crescent Point made another deal and bought 2,900 boepd (90% oil) of Bakken production from PetroBakken Energy for $427 million. That is $147K/boepd.
7) In Jan 2012, Crescent Point also bought Wild Stream for $611 million, adding 5,400 boepd (90% oil) production. That was a 113K/boepd deal.
Two significant purchases took place recently. However I consider them as a move that sugarcoats the current overly rich valuation of Halcon:
2) The hedge fund Citadel bought 2 million shares in Q4 2012 according to a 13G filed with the SEC. Citadel now owns 5.2% of Halcon.
I will debate on this with the fact that the insiders' purchases is not a concrete indication of a company's undervaluation. There have been many cases where the insiders have lost a lot of money. The latest unfortunate case of ATP Oil and Gas is always there to remind us about such damaging insider purchases. The insiders of ATP were buying shares from $5 to $10 even a few months before the company's bankruptcy.
As a former shareholder of GeoResources, I will keep monitoring Halcon closely as I am very curious to see how this play evolves. I wish Mr. Wilson success but I want him to show me consistently exciting results on the top and the bottom line first before I jump on board. Anything less than that will not convince me to become a buyer.