In my last article, I analyzed PDC Energy (PDCE), a natural gas weighted company whose stock has run too much lately. PDC's core area is the Wattenberg field where Bonanza Creek Energy (BCEI) also operates. In my opinion, Bonanza is another grossly overvalued company of the Wattenberg field but please do not get me wrong because I have nothing against this field. I just believe that some Wattenberg players are great short candidates due to their current valuations.
In general, my followers know that I do not recommend overvalued or hyped stocks. All my picks are undervalued stocks where the numbers speak volumes. If my picks are not favored by the market temporarily, the buying opportunity becomes even more appealing for me. This may remind you of Warren Buffet who says : "The best thing that happens to us is when a great company gets into temporary trouble. We want to buy them when they're on the operating table."
Based on these criteria, I recommended Rock Energy (RENFF.PK) at $1 and Surge Energy (ZPTAF.PK) below $4. Especially Surge is a grossly undervalued oil-weighted producer of 11,500 boepd (73% oil and liquids) with operations in North Dakota and Canada.
The more choices an investor has, the more successful he can be. This is why, I also thought to capture at the bottom of my article some other oil-weighted companies of North America whose key metrics are much lower than Bonanza's. The numbers always speak volumes.
Bonanza Creek Energy sold 10 million shares of common stock at $17 per share in late 2011, raising gross proceeds of $170 million in the offering. The deal was priced below the expected range of $20 to $22 per share. The company also reduced the number of shares being offered from the original level of 14.3 million shares.
After selling the Californian assets, the company is focused on the Wattenberg Field, the North Park Basin and the Cotton Valley sands of Southern Arkansas. In August 2012, Bonanza won the leases and expanded its position in Colorado by 5,638 acres of oil and gas rights in Weld County. It is de-risking the horizontal Niobrara "B" Bench currently and it plans to expand its drilling inventory into the Niobrara "C" Bench and Codell formation of the Wattenberg field.
The typical Niobrara horizontal well is drilled on 80 acre spacing and cost approximately $4 million to drill and complete. These wells have an estimated ultimate recovery (EUR) of 312,000 BOE and have approximately 65% oil.
In the Wattenberg field, the company has provided IP-30 average production rates on 31 wells and IP-60 average production rates on 25 wells, which have averaged 503 boepd (76% oil) and 394 boepd (74% oil) respectively. During Q2 2012, Bonanza Creek also drilled and completed the North Platte J-F-24HZ, its first horizontal Codell well. The well delivered an IP-30 average rate of 370 boepd (81% oil).
Anadarko Petroleum (APC) is also operating in the Wattenberg field and it estimates its Wattenberg HZ program contains net resources of 1.0 billion to 1.5 billion barrels of oil equivalent. Actually, the Wattenberg field is one of the core fields for Anadarko who holds 350,000 net acres there and its wells hit rates of return (ROR) exceeding 100%.
PDC's Wattenberg wells have average IRR=65%-70%, average peak 24-hour IP=517 boepd and average IP-30=403 boepd. Thus, Bonanza's wells in the Wattenberg field show better results than PDCE's and it seems they can compete with Anadarko's.
The Key Metrics
The average production in Q3 2012 was 9,545 boepd (74% oil and liquids). Most of this production is coming from the Rocky Mountain region which contributed approximately 5,063 boepd (72% oil). The company has also proved reserves 43,7 MMboe (December 2011).
Bonanza has 40 million outstanding shares and its Enterprise Value (EV) is $1,5 billion. Thus, it trades at $156,000 per flowing barrel and $34.3/boe of proved reserves. Both these key metrics are obviously sky high. The proved reserves ratio will most likely go lower once the new independent report for 2012 reserves is out but I estimate it will not go lower than 25.
Unfortunately, the company does not provide its probable reserves. I am not talking for the possible or prospective reserves which are rather theoretical and there is no certainty that any portion of these reserves will be discovered. However, the probable reserves is a key metric for the evaluation of any E&P company, and I do not get why the company does not disclose this number.
The company also trades well above its book value (PBV=2.4) and the PE is higher than 30. The operating cash flow for 2012 is approximately $120 million. Thus, the D/CF ratio (annualized) is 1 currently and obviously this is not low enough to offset the current premium valuation. Actually, even if Bonanza was debt free, its current valuation would be very generous. I guess this staggering valuation is the reason why a major stockholder decided to exit recently.
Projections For 2013
The company guides for an average production ~15,000 boepd in 2013. It also plans to spend $394 million, allocated 80% to the Wattenberg Field and 20% to southern Arkansas.
In the Wattenberg Field, it expects to invest $282 million to drill 72 gross (64.5 net) operated horizontal wells. It will begin the year with two operated rigs and increase to four by Q2 2013.
In Arkansas, it plans to spend approximately $60 million to drill 36 gross (30.6 net) wells and recomplete 114 gross (98.2 net) wells. It will also spend $10 million for the company's gas processing plant which is expected to be online in Q1 2013, bringing total processing capacity to approximately 40 million cubic feet per day.
The remaining CapEx will be allocated to two net non-operated wells, seismic and other maintenance capital.
To me, it should allocate 95% of its CapEx in the Wattenberg field where the average IRR is higher than 50%, with 5% of its CapEx allocated in Cotton Valley where the average IRR is as low as 23%. In Arkansas, the company should spend money only to complete its gas processing plant in my opinion.
The potential buyers also need to know that if the company does not announce a dilutive offering soon, the CapEx for 2013 will be funded by the operating cash flow and new debt (bank or notes). The operating cash flow itself is not enough to fully cover the CapEx.
Although the market is often irrational, it becomes rational sooner or later, adjusting the valuations accordingly. This is something that the investors should always bear in mind. The following oil-weighted companies have compelling valuations and significant upside potential, proving how grossly overvalued Bonanza is:
1) Bonanza's EV is $1,5 billion and Surge Energy's EV is as low as $440 million currently. The valuation gap is just huge although Surge has bigger production than Bonanza. Additionally, the two companies are equally oil and liquids weighted.
Surge produces 11,000 boepd (73% oil and liquids) currently, the debt is very controllable (D/CF=2) and it owns much more prospective oily land to sell than Bonanza, if necessary. It is also worth noting that one of Surge's core formations is Spearfish which is a highly economical formation with IRR exceeding 100%, low cost per well ($1.5 million/well) and a payout period less than one year. In short, Surge trades at $39,000 per flowing barrel and $15.7/boe of proved reserves.
Barrett trades well below its book value (PBV=0.7) and it is one of PDC's neighbors in the Rocky Mountain region targeting the Niobrara shale. The company has continued DJ Basin success with 82% growth in proved reserves and nearly four-fold increase in resource drilling locations. With a production at 36,700 boepd (30% oil and liquids) and EV=$1.9 billion, the company trades for $51,800/boepd (30% oil and liquids). Barrett has 173.3 MMboe (December 2012) proved reserves (29% oil) that results in $10.96/boe of proved reserves.
Barrett has also zero drawn on the $825 million borrowing base available from the company's credit facility and it has a D/CF (annualized) ratio at 3x which is concerning. However, the company is committed to maintaining total debt at the current levels. The debt consists of convertible and senior notes due in 2016 the earliest. Barrett has projected total capital expenditures of $475-$525 million for 2013 and it will ~95% focused on oil development properties. It will be financed through cash flow and further non-core asset sales.
3) The income investors can buy Penn West Petroleum (PWE) which is also oil-weighted and produces 161,000 boepd (65% oil and liquids) having exposure to 7 different plays in USA and Canada. Penn West has also 334 MMboe proved reserves (71% oil and liquids) as of December 2012 and the EV is $7.4 billion currently. This gives $46,000/boepd and $22.15/boe of oil-weighted proved reserves. Until the share price rises, Penn West's shareholders can collect a 10% dividend.
4) Northern Oil and Gas (NOG) is a pure Bakken company with a heavily oil-weighted production. Northern produces 10,800 boepd (95% oil and liquids), it has 57 MMboe (June 2012) proved reserves and the EV is $1,2 billion currently. This means that the company trades at $111,100 per flowing barrel and $21/boe of proved reserves.
It is said that: "The enemy of a cheap thing is the same thing cheaper". In other words, there are many oil-weighted companies out there, that offer a significant upside potential. A prudent investor reduces his winning odds substantially when he buys an overvalued one.
Disclosure: I am long ZPTAF.PK.