Lucas Energy (LEI) reported results for the quarter ending June 30, 2013 and the results don't look good.
The most important asset LEI owns (according to LEI bulls) is their Eagle Ford acreage in Gonzales county. Bulls also like to tout how much the company reserves are worth. The problem is that 95% of the company reserves are PUDs and need to be developed still. Besides the obvious problem of Marathon (MRO) being a non-motivated 85% WI operator of these supposedly valuable Eagle Ford properties, another problem is that developing reserves of any nature takes a lot of capital up front. Capital that LEI does not have.
If you have read some of the other articles and comments on Lucas, the bulls would have you believe that Lucas will be able to borrow at reasonable rates in order to finance this development. This is simply not true. Last quarter's disclosure of a 14% six month secured loan with attached stock warrants should have confirmed that. We received another confirmation this quarter. Here is a link to the most recent 10-Q.
On August 13, 2013, Lucas entered into another high interest loan. This time it is a two year 12% loan. This loan is secured by substantially all of Lucas Energy's assets. That wasn't enough for the lender. They are also receiving stock warrants to purchase 279,851 shares at $1.35. With interest rates hovering near all time lows, these are hardly the rates that an asset rich company producing 180 BOE/D would expect to be paying for a two year loan.
The repayment of the Loan is secured by a security interest in substantially all of Lucas's assets which was evidenced by a Security Agreement and a Mortgage, Deed of Trust, Assignment, Security Agreement, Financing Statement and Fixture Filing (the "Deed of Trust"). The Company paid a commitment fee of $150,000 and an advisory fee of $225,000 in connection with its entry into the Letter Loan. Lucas also agreed to pay a quarterly administrative fee in connection with the Loan and grant the administrator a warrant (evidenced by a Common Stock Purchase Warrant) to purchase up to 279,851 shares of Lucas' common stock at an exercise price of $1.35 per share.
It appears Lucas was able to negotiate some favorable payment terms on this loan (such as interest only for the first 6 months and a 50% amortization in the remainder of the term), but that doesn't change the fact that Lucas is being forced to accept these high interest, secured, short term loans rather than more reasonable terms. That alone should tell an investor what the market thinks of company assets and prospects going forward.
Another stipulation of the loan is that within six months, Lucas must raise equity of at least $1MM. More equity dilution is on the way.
A post-closing condition to the funding is that the Company complete an equity funding equal to $1 million on or before the six month anniversary of the closing.
The existing working capital deficit has also widened. Last quarter the WC deficit was roughly $4.9MM. In the most recent quarter, that deficit has expanded to $5.5MM. The working capital deficit will likely turn positive next quarter for the simple fact that the new loan has a term longer than a year and will be considered long term debt.
~$3.25MM of the 12% new loan was used to pay off the existing loan. That leaves proceeds of $4.25MM from the new $7.5MM loan which should put new WC at around $2MM (-$2.25 WC after loan paid off + $4.25MM net loan proceeds) with $7.5MM of long term debt.
The company is still not profitable on the income statement and still not cash flow positive from operations even after new management has had the reins for eight months now. Before balance sheet changes, the company generated -$162M from operations. Oil is $105/bbl. How are they not at least breaking even?! Continued cash burn from current operations and capex (especially what Lucas wants to do extending laterals, deepening wells, etc. Depending on casing size, going in with slimhole tools to attempt these operations can have significant risk.) will chew through $2MM in a hurry.
The new management of Lucas has made a decent attempt to try and reverse this cash burn, but they are not being aggressive enough. LOE and G&A costs are absolutely out of control. Q1 LOE was $466M vs an average daily production of 163 BOE/D (14,670 BOE in the quarter). That's LOE/BOE of $31.76! Take a look around at other oil companies and see what their LOE/BOE costs are. You will find numbers in the single digits to low teens!
G&A costs are sky high as well. Removing one time items and using Lucas' adjusted G&A for the quarter of $900M, current quarter G&A/BOE was $61.35! Do a similar comparison to other oil companies for G&A. This is a company that has 13 employees with only 59 wells! Why do they have G&A of almost $1MM per quarter? No wonder this company can't make money at $105 oil. Simple LOE and G&A alone add up to almost $95/barrel!
Given that the last two loans have been high interest secured, it is obvious that the market will only loan to Lucas in a secured fashion. The latest loan has encumbered all of Lucas' assets. Further debt financing is likely out the window unless it is a refinance of current debt or someone is crazy enough to lend unsecured to Lucas. Equity finance will likely have to support any future development. From the terms of the loan, we already know equity issuance is coming within six months.
My advice to management would be to get out the axe and chop LOE & G&A hard. They already have done a lot to get them down, but they are still astronomically high. More work must be done because not generating cash from operations with WTI at $105 is terrible. Get that fixed ASAP. Also, get rid of the WC deficit. Start with as clean of a balance sheet as possible.
When the equity issuance comes around within the next six months, issue enough to drill a few Austin Chalk laterals. Forget the Gonzales EFS acreage. Marathon already drilled marginal wells there. They have much better fish to fry. The Hagen EFS lease isn't getting drilled for awhile. Three Austin Chalk wells is probably a good number to shoot for which, from my limited research, should cost somewhere around $6MM total. That's a 15% dilution based on the current stock price, but it sure would be better than sitting and floundering losing money on base production. That doesn't even take into account the $2MM they will have from the recent loan after getting rid of the WC deficit. So it could be as small as a $4MM dilution. If that dilution is too much to stomach, go find a JV partner to help develop the Austin Chalk and Buda acreage. It is pretty clear that Lucas will not generate enough cash internally to develop these on their own any time soon. A JV combined with equity financing would likely allow Lucas to keep a large WI in the wells while spreading risk out over multiple wells.
The upcoming equity dilution might be the best thing to happen for Lucas if they take advantage of it and use the opportunity to raise cash to drill a few wells. These wells would significantly raise their cashflows and allow them a chance to organically grow without having to accept continual loan shark deals to stay above water.
I currently have no position, long or short, in Lucas, however if management are able to get expenses under control and end up raising money/entering a JV to drill brand new wells, I would consider a long position in the company.