Seeking Alpha
Newsletter provider, deep value, long/short equity, commodities
Profile| Send Message| ()  

Introduction

Warren Buffett has said that the markets have a tendency to overshoot at both ends. In my article here back in early February 2013, I analyzed Halcon Resources (HK), explaining why the market boosted Halcon's valuation and why it was a great short candidate at $8. I urge all to have a look at that article to get a more complete idea about this company.

I also noted that the traders and the speculators pushed Halcon to an outrageous overvaluation at $8. This is why I decided to short the stock at $8. Since then, the stock has dropped down to almost $6, confirming my bearish call. I closed my short position at $6.5, because I felt that the new wave of momentum traders and speculators was about to jump on board for the new ride after the severe correction of 22%. The new wave of momentum traders and speculators truly arrived at ~$6.5, and made the stock a roller coaster pushing it back again to ~$8. This rise was short-lived though, and the stock lies at ~$6.7 currently.

Halcon produced 18,348 boepd (81% oil and liquids) in Q4 2012, and it had 108.8 MMboe proved reserves as of December 2012. With Enterprise Value at $5 billion currently (including the recent additional debt), Halcon trades at $273,000 per flowing barrel and $45.96/boe of proved reserves. The company is also highly leveraged, because it has a meaty D/CF (annualized) ratio at 6x.

After all, let's have an update on Halcon, checking out more details about its operations.

The Operations

Going step by step and shale by shale will make things easier:

1) Utica: Do not hold your breath with the company's Utica acreage because the Utica play looks to be overhyped. Four of the biggest stakeholders in the Utica Shale have put up all or part of their acreage for sale, as prices fall by a third in some cases. According to Jerry James, president of Artex Oil:

"Early drilling results showed the oil portion of the Utica isn't as porous as some other shale formations and is shallower than its gas-filled areas, meaning it's harder to get oil to flow through the rock, and there's less natural pressure to help force it out."

In Ohio's Utica formation, drillers frequently found the rock too dense and underground pressures insufficient to produce oil. After all, the rush to buy acreage has reversed.

According to Halcon's presentation, the majority of the acreage is located in the wet gas and dry gas window. On top of that, Halcon's acreage is very close to Chesapeake Energy's (CHK) and EnerVest's acreage.

Chesapeake Energy has decided to leave it to other companies to crack "the code" of the Utica's oil prospects after the company found it wasn't worth trying any longer, Senior Vice President Jeff Mobley said in December at an industry financial conference. Since September, Chesapeake has been seeking a partner to share ownership and costs in the Utica, although Chesapeake had initially boasted Utica would outperform the Eagle Ford.

Meanwhile, Jim Gipson, a spokesman for Chesapeake, declined to comment all this situation, adding to the ominous signs coming from Chesapeake's side.

EnerVest had said the Utica would bring jobs to Ohio and Pennsylvania. Nevertheless, EnerVest in the past year has also tried to sell acreage there and no buyers have emerged.

After putting a portion of its acres into a joint-venture package with Sinopec (SHI) last year, Devon (DVN) also decided to unload its remaining 157,000 net acres in the Utica so it can concentrate on more profitable plays.

Gulfport Energy (GPOR) is another company with acreage in Utica. However, Paul Heerwagen, Gulfport's investor relations director, didn't return phone messages seeking comment about the recent facts coming from the Utica shale as above. Gulfport has touted its Utica wells, despite the facts that:

A) Gulfport has provided only the 24 hour-IP rates, while it has not provided the decline curve and the IP-30, IP-60, IP-90 rates which are way more substantial than the flashy 24 hour-IP rate.

B) Even these 24-hour IP rates are not oil-weighted, but they contain 46% natural gas and 33% natural gas liquids.

After all, Gulfport is grossly overvalued and an excellent short candidate for the reasons I analyzed here.

All these facts weigh heavily on the bearish side, and they do not help me expect overly pleasant results from the company's acreage in Point Pleasant. Halcon holds 125,000 net acres in Ohio and Pennsylvania. Drilling has commenced in this play with first production expected in Q2 2013.

2) Tuscaloosa Marine: The results are not encouraging from Halcon's Tuscaloosa Marine Shale (TMS) either. In late January 2013, Halcon spud a stratigraphic test well, the Lambright, located 16 miles northwest of the Broadway 1H in Rapides Parish. This vertical test found the zone too thin for commercial production.

Furthermore, the company's first horizontal well in TMS, the Broadway H1 in Rapides Parish, was completed recently. However, the well suffered a casing failure while drilling out the plugs. Halcon is currently evaluating an attempt to drill an additional well near the Broadway H1 in 2013. Halcon has 75,000 net acres prospective for the TMS in Louisiana.

These results do not surprise me because Halcon's acreage is at the western limits of the TMS. The results in TMS are poor in general, and the decent ones are coming from Wilkinson and Amite Counties in Mississippi, and St Helena Parish in Louisiana where Encana (ECA) and Devon Energy operate.

Despite the fact that Devon has much better results than Halcon in TMS, Devon decided recently to unload its TMS acreage to focus on more profitable plays.

After all, how can Halcon keep touting its TMS acreage?

3) Bakken/Three Forks: According to the annual results, this is the summary:

A) Halcon does not plan to drill any wells in Eastern Montana in 2013, but the average IP-30 day rate for the two applicable Bakken wells in Eastern Montana put online since October 1, 2012 was 193 boepd (79% oil).

B) Two wells were put online in the Marmon area. The 30 day rates for the Bakken well was 505 boepd (96% oil) and for the Three Forks well was 245 boepd (90% oil), respectively.

C) In the New Home II area, the average IP-30 day rate for the ten applicable wells was 282 boepd (88% oil).

D) Of the 17 wells put online in the Fort Berthold area, 8 of them were Bakken completions and 9 of them were Three Forks completions. The average IP-30 day rate for the applicable Bakken wells was 780 boepd (84% oil). The average IP-30 day rate for the applicable Three Forks wells was 823 boepd (82% oil).

After all, the following tables help us visualize these results:

Bakken

Montana

(2 wells)

Marmon

(1 well)

New Home

(10 wells)

Fort Berthold

(8 wells)

Total

Average

(21 wells)

IP-30

193 boepd

(79% oil)

505 boepd

(96% oil)

282 boepd

(88% oil)

780 boepd

(84% oil)

473.86 boepd

(86% oil)

Apparently, this IP-30 is not exciting to justify Halcon's lofty valuation. Actually, this IP-30 is mediocre because it is much lower than Magnum Hunter's (MHR) results from its Bakken acreage in North Dakota. Add on this that Magnum's acreage is not considered top-quality. Magnum Hunter Resources has an average IP-30 at 552 boepd from its Bakken wells in North Dakota.

To prove this, Kodiak Oil and Gas (KOG) has an average IP-30 at 945 boepd from its Bakken wells according to the corporate presentation. I found this by calculating the respective numbers from Kodiak's sixty four Bakken wells drilled and completed in 2012.

Obviously, Kodiak's acreage is a top-quality acreage and this is why this company enjoys a premium valuation in comparison to its peers, despite that Kodiak is a one-Basin play without any land diversification. To be more specific, Kodiak trades at $152,000/boepd and $34.81/boe of proved reserves, based on its current EV of $3.3 billion. Kodiak produces 21,700 boepd (~85% oil and liquids) and has 94.8 MMboe of proved reserves. A comparison with Halcon's valuation above, speak volumes.

On top of that, Kodiak's D/CF ratio (annualized) is 3x which shows that Kodiak is much less leveraged than Halcon.

Three Forks

Montana

Marmon

(1 well)

New Home

Fort Berthold

(9 wells)

Total

Average

IP-30

-

245 boepd

(90% oil)

-

823 boepd

(82% oil)

765.2 boepd

(83% oil)

Regarding Three Forks, this sample above is not enough for me to make a fair judgement. This is why, I will wait for more results before I make my call on Halcon's Three Forks acreage.

4) Woodbine: Halcon has an average IP-30 day rate at 388 boepd for the six applicable wells located in Leon and Northern Madison Counties. In Brazos County, one well has an IP-30 day rate of 724 boepd.

Woodbine

Leon & N. Madison

(6 wells)

Brazos

(1 well)

Total Average

IP-30

388 boepd (90% oil)

724 boepd (90% oil)

436 boepd (90% oil)

It is also worth noting that Halcon had some underperforming Woodbine wells in Q1 2013 that negatively impacted production by approximately 1,000 boepd in the first quarter of 2013.

Crimson Exploration (CXPO) is a primary player of this play. According to the company's presentation, the average IP-30 for its Woodbine (Eaglebine) wells is 748 boepd, which is significantly higher the average IP-30 rate for Halcon's wells in the area. Actually, Halcon's wells are quite poor in comparison to Crimson's.

5) New East Texas Eagle Ford: This new East Texas Eagle Ford Shale play has been established as Halcon's fourth core area. The play extends across several counties in East Texas. Halcón currently has in excess of 50,000 net acres leased or under contract. The average IP-30 day rate for the seven producing Eagle Ford wells has been 694 boepd (94% oil).

To evaluate the quality of these assets better, we can have a look at Penn Virginia Corporation (PVA). Penn Virginia has significant exposure to the Eagle Ford Shale.

According to Penn's presentation, its legacy assets have average IP -30 rate of 621 boepd in Gonzales County, and average IP-30 rate of 644 boepd in Lavaca County.

Penn Virginia acquired Magnum Hunter's Eagle Ford assets few days ago, paying $400 million for 19,000 net acres in Gonzales and Lavaca Counties. The acquired acreage is in the oil window. The acquired assets have average IP-30 rate of 678 boepd in Gonzales County and average IP-30 rate of 849 boepd in Lavaca County. After all, the total average IP-30 for all the Eagle Ford assets of Penn Virginia is 698 boepd.

The following table helps us visualize Penn's Eagle Ford assets better:

Eagle Ford

Gonzales

(Legacy)

Lavaca

(Legacy)

Gonzales

(Acquired)

Lavaca

(Acquired)

Total

Average

IP-30

621 boepd

(93% oil & liquids)

644 boepd

(93% oil & liquids)

678 boepd

(94% oil & liquids)

849 boepd

(94% oil & liquids)

698 boepd

(94% oil & liquids)

It is quite clear that Halcon's acreage is not at all superior to Penn's and Magnum's acreage in Eagle Ford Shale. Neither Penn nor Magnum enjoy a superior valuation currently. Why should Halcon do?

Conclusion

Halcon is another stock that shines like gold at the current levels but it is like hay to me. I will definitely stay away from it. In the meantime, I will keep monitoring and evaluating this company. Those who buy Halcon just because they trust the CEO have to reevaluate their position. "In The CEO We Trust" does not mean much to me. "One Swallow does not make a Summer" either. The fundamentals have always been the primary drivers for my investments, and I have never bought any hype during the last 24 years.

Source: Halcon Resources: Why I Steer Clear Of The Current Staggering Valuation