In late September 2013, I discussed why Halcon Resources (HK) was one of the most beaten up equities of the energy sector, and why I would not dip my buying toes into it at $4.5, waiting for a better entry point. Once again, I set the speculation and the "Utica hype" aside, trying to see the real thing about this highly leveraged company. My article is here.
The stock rose to $5.5 during October 2013, primarily fueled by Utica's hype, as the company initiated recently its drilling program in the highly publicized Utica. However, the stock fell off the cliff once Q3 2013 report was out. Once Q3 2013 results were out, Halcon could not wow the market once again but it dropped from $5.5 down to $4.5 with big volume. Apparently, some fund managers and institutions were disappointed and dumped the stock.
It really puzzles me when some fund managers and institutions with supposedly good knowledge about the energy sector bite the highly publicized baits (i.e. Utica), and ignore the truly undervalued companies. For instance, these fund managers should buy Arsenal Energy (OTC:AEYIF) and Equal Energy (EQU) which are irrationally cheap instead of buying Halcon. Arsenal Energy is heavily oil-weighted and Equal Energy has a balanced commodity mix. I recommended Arsenal Energy at $4.95 just three days ago, and the stock stands at $6 today. Additionally, Equal Energy's ongoing strategic review for the potential sale of the company will most likely bear fruit by early 2014. The fundamental reasons why both Arsenal and Equal are dirty cheap are shown in my articles here and here.
From Love It To Loathe It
Halcon's vicious plunge did not surprise me at all. Since early 2013 when I wrote the first article about Halcon, this call has worked exactly as planned. Halcon's stock has been a very lucrative bet for all my followers who shared my bearish view, ignoring the analysts' bullish opinions along with the Utica hype that was spread out all over the media. To be more specific on this:
1) In early 2013, I considered Halcon to be analogous to the dot com bubble of 2000. I was wondering why it had such a staggering valuation at $8 in early February 2013. I could not find any fundamental reason to support that valuation, and I made a bearish call back then. I also shorted it, as disclosed. The stock dropped down to ~$6 few weeks later, confirming my bearish call. My article is here.
2) The stock rose again to $8 in early April 2013. However, there was not any fundamental improvement to justify this move from ~$6. I warned all about the company's debt overhang and shorted it again. The stock dropped down to ~6$, confirming again my bearish call. My analysis is here and here.
In these three articles above, the bullish comments were also a study case about the herd behavior, although many of them were deleted because the bulls used derogatory language against me. I know that being a contrarian investor has never been easy.
3) In my recent article about Halcon, I pointed out why I would not touch it with a ten foot pole at ~$6.30. However, I did not short it, as disclosed. I wish I did because the stock has dropped 25% since then. My article is here.
4) In my latest article about Halcon, I discussed why the stock was expensive at $5.45. That was Halcon's price when that article was syndicated. I also noted that Halcon's downside would not stop at $5.45, but I expected it to drop down to $4.5. My article is here.
5) In late August 2013, Stifel showed up finally and downgraded Halcon from Buy to Hold. Stifel was obviously late to this bearish party. Why did Stifel upgrade Halcon from Hold to Buy in early May 2013, when the stock was at $6.5? Where is Stifel's ability to read between the lines and evaluate Halcon correctly?
6) Global Hunter and Canaccord Genuity were even more late than Stifel to Halcon's bearish party. They downgraded Halcon just a few days ago. For Canaccord Genuity, Halcon was a BUY until 5th of November 2013.
Aren't all these analysts paid to be ahead of the average investor? Why did it take them so long to realize the obvious about Halcon?
Utica's Appeal Fades Steeply
Once Q2 2013 report was out, Halcon touted its Kibler 1H (100% WI), located in Trumbull County, Ohio, which was tested at a rate of 2,233 boepd (75% liquids), assuming full ethane recovery. Nevertheless, Kibler's results were not enough to convince me for Halcon's potential in the Utica shale for two reasons:
1) That was just a 24-hour rate which was full of flush production. Actually, this policy reminds me of Gulfport (GPOR) which has also been touting all the 24-hour IP rates from its Utica wells for months now, but it has released only a handful of IP-30, IP-60 and IP-90 rates.
2) Kibler was just one of Halcon's nine wells in Utica. What about the drilling results from the other 8 wells? The investors were left in the dark because Halcon did not provide any information about those 8 wells, not even the 24-hour rates. Some of these wells were resting but most of them had been tested. If the drilling results were exceptional, I believe the company would release more information about these 8 wells. To me, that was a worrisome signal that Halcon's wells in Utica were at or below industry's average.
This is why, I noted in another article back in May 2013 that I was not convinced about Utica's potential. That article was entitled: "The Utica Shale does not seem to be the ace up Halcon's sleeve". My article is here.
My suspicions came true when Q3 2013 report was out a few days ago. The Kibler 1H produced an average of 358 barrels of condensate per day and 1.6 million cubic feet of gas per day into sales over the first 30 days. This translates into an IP-30 rate of only 625 boepd (57% liquids). More importantly, this result came from the company's most touted well in Utica. What about the other 8 Utica wells? Once again, the company did not provide any results about these 8 wells.
An experienced investor also noticed that Halcon changed its drilling program in Utica after these disheartening results. For instance, let's check out the following excerpt from the Q2 2013 report:
The Company has significant holdings in Trumbull and Mahoning Counties, Ohio and believes there is potential to drill hundreds of wells on its acreage in the area over time. The process of delineating Halcón's Utica/Point Pleasant acreage position is essentially complete. The Company has finished drilling its first nine wells and is evaluating results. There is currently one Utica/Point Pleasant well producing, four wells that have been tested and are shut-in awaiting infrastructure, two wells being tested and two wells resting. Halcón expects to operate a minimum of one rig in the play throughout the remainder of 2013 and anticipates seven of the nine wells drilled to be flowing into sales pipelines by the end of the year.
Once Q3 2013 report was out, Utica was not one of the company's primary targets any more:
1) The CEO did not make any reference about the company's Utica acreage. I quote: "Floyd C. Wilson, Chairman and Chief Executive Officer, commented: "Third quarter results were defined by continued expansion of our activities in the Williston Basin, El Halcón and other areas. We are focused on exploiting the substantial growth potential in our core plays and translating that growth into value for shareholders."
2) From minimum one rig in the play throughout the remainder of 2013, Halcon goes to one rig for the remainder of 2013 and 2014. I quote: "In the near-term, the Company anticipates it will limit drilling in this play to the Southwest portion of its acreage in Trumbull and Mahoning Counties, Ohio. Halcón expects to operate one rig in the play throughout the remainder of 2013 and anticipates six wells to be flowing into sales pipelines by year end. The Company currently expects to operate one rig in the play in 2014".
Murky Production Guidance For 2014
The company guided in November 2012 that it expected to produce 42,500 boepd in 2013 on average. In Q2 2013, Halcon revised its average production guidance for 2013 significantly downwards and did not change it once Q3 2013 was out. Now Halcon guides that 2013 full year average production will be between 30,000 and 34,000 boepd. This is a decline of 20-25% from the initial guidance.
According to the Q3 2013 report, Halcon will hit > 40% pro forma production growth in 2014. Based on the fact that the average production (pro forma) will be between 30,000 boepd and 34,000 boepd for 2013, this rate of 40% translates into minimum production growth of ~13,000 boepd for 2014 (32,000 boepd X 40%). In other words, Halcon will produce 45,000 boepd (32,000 + 13,000 boepd) on average (pro forma) for 2014.
However, Halcon guided at the bottom of its Q3 2013 report that the average pro forma production for 2014 will range between 38,000 boepd and 42,000 boepd (85% oil and liquids). This means an average pro forma production of 40,000 boepd for 2014. After all, the company's production guidance (pro forma) for 2014 is quite murky to me.
The fuzzy production guidance for 2014 deteriorates further as Halcon will continue to strategically divest non-core assets in 2014 but it does not provide any more information (production, reserves) about these assets.
The Balance Sheet And The Peers
What also worries me about Halcon is that the company has not been engaged in any substantial fight to "right size" its balance sheet thus far. The long term debt has been creeping higher for several quarters in a row, reaching $3 billion in Q3 2013. With estimated cash flow from operations for 2013 at approximately $550 million, the net debt to operating cash flow ratio stands at the staggering level of 5.45x.
Assuming that all the proceeds from the sale of the conventional assets (~$300 million), go to the debt line, the long-term debt will drop to $2.7 billion, which is where it was in Q2 2013. So Halcon will have to sell more producing assets during the coming months to lower its debt substantially, bringing its D/CF ratio in line with the peer group. This makes me doubt about the company's guidance for 2014, and I believe that the production guidance above will be revised downwards in the next quarters.
Pro forma the sale of the conventional assets (4,500 boepd, 21.2 MMboe of proved reserves), Halcon currently produces approximately 33,207 boepd (37,707 boepd - 4,500 boepd) on average and owns 85.5 MMboe of proved reserves (106.7 MMboe - 21.2 MMboe).
After all, let's check out the following tables. To make these calculations below, I assumed that all the proceeds from the sale of the conventional assets will go to Halcon's revolving credit facility, reducing the net long term debt to $2.7 billion. All the peers below have heavily oil-weighted production and reserves, while they operate close to Halcon's properties.
Halcon Resources, Kodiak Oil (KOG) and Oasis Petroleum (OAS) are intermediate producers while Continental Resources (CLR) and Whiting Petroleum (WLL) are major ones. Arsenal Energy is a growing junior producer and even if an investor discounts its key metrics below by a huge 50%, Arsenal's key metrics are still absurdly low compared to the other Bakken intermediate players.
Not to forget that Arsenal has a strong balance sheet, a low D/CF ratio and pays a 5% dividend that none of the other Bakken (intermediate or major) players pay. So Arsenal is the cheapest publicly traded producer in the Williston Basin currently, and this is why I believe that either an intermediate or a major Bakken player will acquire it sooner or later. However, this is a speculative scenario, and an investor had better not make his investment decisions based on such scenarios.
1) Per Production and Proved Reserves:
* Assuming that all the proceeds ($300 million) from the sale of the conventional assets, go to debt reduction.
2) Per Debt To Cash Flow Ratio:
Long Term Debt (Net)
Cash Flow (2013)
In late October 2013, Jim Cramer ranked Halcon's stock a Buy. In early November 2013, Jim Cramer ranked Halcon's stock a Sell. I do not know what made Cramer change his opinion 100% in just two weeks.
The thing is that I am not going to change my bearish opinion about Halcon now. I have been consistently bearish on Halcon since early 2013, and I'll remain bearish at the current levels of $4.78. I do believe that the stock still has room on the downside.
Meanwhile, Whiting Petroleum is the cheapest and best play among all the aforementioned intermediate and major producers. Whiting Petroleum has also land diversification, a very low D/CF ratio and ample cash on hand to fund new growth initiatives. Whiting Petroleum had $1.03 billion cash as of September 2013, and this cash increased recently after the sale of its Big Tex assets for $150 million. Meanwhile, Whiting's production remained unchanged because these assets were producing only 200 boepd.
However, I do not have Whiting Petroleum in my buying list currently, because I prefer other stocks that are way more undervalued than Whiting. I turn over lots of rocks and more about my stock picks will be disclosed in my next articles.
Even after the latest sale of its conventional assets, Halcon has still a significant debt burden to face in 2014. Apart from the debt challenge, Utica's productivity is highly questionable and this is why Halcon downplayed its Utica operations, once Q3 2013 report was released. It is apparent now to all doubting Thomas that Utica is not one of the drilling opportunities with the highest returns, and Halcon can not maximize the efficiency of its capital by drilling there.
As I have also noted in my previous articles, Halcon has arrived late in the shale game, and it does not own top quality acreage. Halcon has just a small position within the best portion of the Bakken play which is not enough to offset the current staggering valuation or handle the debt.
After all, Halcon is at a dangerous juncture right now and has to face several challenges in 2014. The stock will continue to move like a roller coaster, and another down leg is written on the wall which will most likely lead to new lows during the next months. Since I am not really excited by such rides, I'll avoid buying Halcon once again.
Additional disclosure: I may initiate a short position in HK over the next 72 hours.