EXCO Resources (XCO) released earnings yesterday, with a conference call this morning, and by all measures, it was a decent report. While in no way did they "blow the doors off," the mere stabilization of earnings and cash flows, after last year's debacle, is a feat worth recognizing. In addition, they beat expectations, which we believe were set low, and with a strong management team and board in place, it appears capital and liquidity have been properly rationalized. XCO is demonstrating that they can live within their cash flow while they await higher natural gas prices.
XCO had net income of 74c per share, which was high due to a net write-up of $174mn in previously written down assets. The majority of the write-up was due to the sale of their conventional assets into a partnership as the cash they received was greater than its book value. Adjusted for non-recurring items, net income was 13c per share, which included a non-cash tax asset adjustment of about 9c. This tax adjustment was because the sale price of the asset, while higher than current book value, was below where it was originally written down from. The net result is that future tax benefits were lowered by about $19mn, which needed to be recognized this quarter.
EBITDA was a healthy $113mn, including their 50% ownership of the midstream company TGGT. After dividends and capital expenditures, free-free cash flow was $19mn although net receivables increased by $33mn resulting in a lower cash balance at quarter end. It is a welcome sight indeed, after last year, that XCO has covered all their expenses out of current production. They continue to benefit from their hedging program with 65% of the remaining 2013 production hedged at $4.17/mCfe.
Costs have continued to be controlled with lease operating expenses at 33c/mCfe and G&A at 54c (47c cash-based). Gathering costs are still somewhat elevated at 60c/mCfe, the result of fixed costs being spread over lower production. Interest payments are still pretty healthy at about 45c/mCfe as the result of $1.17bn in net debt. Given this debt load (~65c/mCfe reserves), and the associated interest costs, about $2.61 per mCfe of production gets eaten up before capital allocation can occur. It is no wonder that last year's (average) natural gas (NG) price of $2.66 caused such turmoil and that today's NG price only allows for production to stabilize at 2013 levels (140 bCfe). Also, well drilling costs continued to decline with, for example, Haynesville wells costing about $7.8mn; we expect that to decline further over the next few years.
As a side note about Haynesville, we found it interesting on their conference call that Doug Miller (CEO) said that the sweet spot, where they are currently drilling, offers 20% IRRs at $3.5-4 per mCfe given their well cost but that they wouldn't increase drilling there until they hit $5/mCfe. In fact, he was quizzed on that by an astute caller - why wouldn't they drill more at current prices? Based on the work we have done, the reason is two-fold. Yes, Haynesville does offer about a 25% IRR in his quoted NG price range and well cost if, and this is a big IF, one approached it from a clean balance sheet with no vestigial costs (e.g., finding costs). However, with XCO's F&D costs (effectively sunk costs, or net debt, that needs to be repaid out of production), and interest on such, at about $1/mCfe, that implies NG needs to be north of $5 to achieve that 20% target IRR. At current strip pricing, the IRR is about 10%, which is close, if not a bit below, their current cost of capital; hence XCO's motivation to reduce production.
Using guidance for the remainder of the year, we look for adjusted net income to be about 70c/share resulting in the stock trading (~7.5 pps) at just below an 11 forward P/E. EBITDA should come in at $425mn implying a 3.8x multiple for the shares. A more reasonable share price is about $9 in our view. Overall production should be down by about 45 bCfe in 2013 as they've cut back on their drilling program. We expect that production will be stable to slightly down into 2015 as XCO continues to spend within their cash flow as they continue to solidify their balance sheet and look for higher NG prices once demand picks up. The sale of TGGT will probably occur a bit later than expected as EBITDA is improving and we see a $400mn price tag as reasonable for XCO's share. All in all, as we highlighted in our last article, we believe that XCO hit its bottom at $6 per share and look for a steady climb higher.
Additional disclosure: We also own XCO bonds