In late 2012 Halcon Resources (NYSE:HK) closed some game-changing transactions that were not reflected in financial web sites such as Yahoo Finance, Seeking Alpha or Bloomberg until after the company filed its 2012 10K report on February 28, 2013. This didn't help investors gain a clear appreciation of Halcón's outlook and investment potential. Now that the 10K filings are done and analysts' estimates for 2013 and 2014 have been published on financial web sites, I believe a clearer understanding of Halcón as both a buyout and value play will soon emerge.
Halcón - A Buyout Play
It is no secret that Halcón is building a scaled-up shale oil business that is planned to be sold, probably in 2015. Realistically, a salable business package would include production of over 100,000 Boed and would be generating robust sales, profits and cash flows. Additionally, there should be excellent potential for continuing growth in production, sales, profits and proved reserves coming from a large inventory of drilling locations sitting on comfortably more than 1 million top quality shale acres in large contiguous units.
An example of such a business already exists today - it's called Continental Resources (NYSE:CLR). Continental recorded production of almost 100,000 Boed in 2012 and anticipates growth of 35% to 40% in 2013. In 2012 it registered sales of $2.6 billion, net income of $740 million and generated cash from operations of $1.6 billion. Continental ended 2012 with 785 million barrels proved reserves. All of this stemming from its 1.1 million acres in the Williston basin and ~200,000 acres in South Central Oklahoma Oil Provence (SCOOP).
The Continental example highlights that proven expertise and scaled-up efficient operations warrant a reasonably good valuation. That is not to suggest that Continental stock is richly valued, it is not. The company has a market cap of $15.8 billion, an enterprise value of $19.3 billion and the shares, currently $86, trade on a 2014 p/e of 13.
Considering that Halcón is already on track to have a similar asset base as Continental, can it expect to achieve an exit price in 2015 in the same ball-park as Continental's current valuation? Valid arguments can be made to support a higher or a lower valuation but, in general, Halcón's exit valuation can easily be similar to Continental's valuation today.
What would an exit valuation of $19 billion be worth to Halcón shareholders? From the $19 billion deduct a high-side estimate of $4 billion for debt leaving $15 billion for shareholders. Divide this by the fully-diluted share count of say 500 million (rounded up from the current 468 million) and you get $30 per share. This explains why there was such widespread insider buying at Halcón during the latter part of 2012 at prices ranging from $5.50 to $7.50. They didn't do it for a just a few dollars profit. They did it because they know this is a potential multi-bagger investment with a high chance of success.
Will Halcón achieve its goal of major success by 2015?
Floyd Wilson and his team at Halcón are highly regarded and rightly so given his lifetime of experience in the industry and of course his record of delivery at Petrohawk. For more about Wilson, his achievements at Petrohawk and his goals for Halcón, read the following two press articles from June 2012 - WSJ and OGFJ - and watch this brief interview on CNBC from October 2012.
When you look at Halcón's shale acreage - especially where it has already captured 90% of its three primary plays (Woodbine/Eagle Ford, Bakken, Utica), it owns rights to 1 million acres and it is on target to achieve its goal of 1.5 million total acres - you can conclude that this prime asset base will not be a stumbling block to the company achieving Continental-like success.
The key to Halcón achieving breakout success rests primarily within 2013. The final and most immediate question to be asked here is: Can they achieve sufficiently strong production growth in 2013 to propel the company towards 100,000 Boed in early 2015? I highlight the importance of 2013 because, following a robust 2013, the company then only requires production growth at a moderated pace during 2014 in order to hit the 100,000 Boed target.
In November 2012, Halcón issued production guidance of 17,000-20,000 Boed for Q4 2012 and 40,000-45,000 Boed for full year 2013. The year-end 2012 earnings announcement of February 28, 2013 showed that Q4 production came in at 18,348 Boed, in the middle of guidance. Good though this is it still doesn't negate the fact that the 2013 full-year guidance remains aggressive. Accordingly, and in the interest of being conservative, only the lowest point of the 2013 guidance i.e. 40,000 Boed, will be used in this note.
Starting with the analysts' estimated production of approximately 29,000 Boed in Q1, the company would need to grow production each successive quarter of 2013 by about 22% in order to hit the full-year target of 40,000 Boed. Dropping the pace of quarterly growth to a more manageable 12% in 2014 and then to 10% in 2015 would have Halcón hitting the magic 100,000 Boed figure in Q2 2015. Here is a tabular view (all figures '000):
Halcón Boed estimates
Full-year Average Boed
Although the 29,000 and 35,000 figures in Q1 and Q2 2013 tie into analysts' sales estimates of $195 million and $246 million, in practice production growth will not straight-line each quarter. Still, the data is useful in helping to understand how an aggressive ramp-up in 2013 makes it much easier for Halcón to reach the 100,000 mark in early 2015. We don't yet know if Halcón will achieve the 40,000 Boed number in 2013 but by upping production from Q4 2012 to Q1 2013 by over 50% they are off to a tremendous start and the overall view for 2013 is already looking bright.
At the start of this note key points about Continental Resources were highlighted; production 100,000 Boed, sales $2.6 billion, net income $740 million, cash from operations $1.6 billion and proved reserves of 785 million barrels. In 2015, Halcón may publish data along the following lines; production 100,000+ Boed, sales ~$2.5bn, net income ~$650 million and cash from operations ~$1.6 billion. Halcón's total proved reserves won't catch up with Continental's for a further couple of years because of the late start but the drill bit will take care of this in due course. Nonetheless, the two sets of data are remarkably similar and this comparison highlights the magnitude of upside that exists at Halcón without even thinking of an exit premium.
Halcón - A Value Play
It's all very well dreaming about a possible exit price for a company if and when it might be sold. I would keep this possibility in mind for stocks in a portfolio but I wouldn't advocate making investment decisions based on buy-out expectations. Invariably, it is better to buy stocks based on value with due regard to the specific growth outlook. Ultimately this comes down to a company's ability to generate profits and cash flows. Analysts most recent estimates for 2013 and 2014 shows that Halcón stock now trades on a forward p/e of 6.6 - this is the cheapest stock in the universe of shale companies that I follow. Nearly all are trading on next year p/es around 10, examples being Kodiak (NYSE:KOG) 9, Northern (NYSEMKT:NOG) 9.6, Oasis (NYSE:OAS) 10.9 and Whiting (NYSE:WLL) 11. Continental is on a next year p/e of 13 - twice that of HK.
Some investors consider HK stock to be more fully valued using the economic value per flowing barrel metric. On a look-back basis to Q4 2012, and working off a fully diluted economic value figure of $5.2 billion ($6.65 share price), the EV per flowing barrel figure was a meaty $280,000. However, investment is about the present and the future. On a full year 2013 basis this metric falls to $130,000 and next year it will be $78,000. In comparison, Continental anticipates production of 136,000 Boed in 2013 rising to 170,000 in 2014 giving EV per flowing barrel figures of $140,000 for 2013 and $113,000 next year. Halcón is substantially cheaper whereas in fact it should be more expensive given its better growth prospects. The key again is production growth and, as mentioned, Halcón's outlook for 2013 is already looking good.
In attempting to value Halcón others have wondered if the company has a high level of debt. At year-end 2012 it had an unadjusted debt/equity ratio of 100%, both debt and equity being about $2.1 billion. This is perfectly acceptable especially when considering that in January 2013 the company had $1.2 billion available liquidity, enough to fund its entire 2013 drilling capex budget. In any event this is lower than many (respected) shale companies such as Continental at 112%, Kodiak at 110% and Oasis at 150%. But the underlying reality is actually better. On a fully diluted basis, $275 million of debt converts to equity with an additional $165 million equity paid in via the associated warrants; the total adjustment being $440 million. Thus, on a fully diluted basis, the y/end 2012 equity becomes $2.54 billion and debt drops to $1.66 billion giving a fully diluted debt/equity ratio of just 65%.
Considering the enormous growth in production, sales, profits and cash flows Halcón will surely generate from its already acquired 1 million acres, allied to proven management expertise and a well managed balance sheet, one would expect Halcón stock to trade at a premium valuation. In fact it's the opposite - Halcón stock is trading at a significant discount to other shale players despite the company having superior prospects.
Ultimately, this situation is understandable. It has happened because Halcón underwent a number of game-changing transactions in late 2012 that the investment world needs time to catch up with. I suspect a good deal of catch up will occur around the time of Halcón's Q1 2013 earnings report. A solid earnings report showing that production increased an eye-catching 50%+ from Q4 2012 will help investors appreciate the attainability of Halcón's growth trajectory. With that on the table the stock price should be able to look after itself.
I believe that Halcón's recent weakness represents a very good buying opportunity, particularly now that we have seen the stock drift lower in last few days as we approached 'sequester time' and oil prices softened. Working off the lowest point of the company's 2013 production guidance, the shares are a compelling value play with excellent multi-year growth potential. Further down the road, any take-out premium that may arrive is icing on the cake.