In today's market it is difficult to find attractive yields above 7% or even 6% without extending maturities beyond 8 to 10 years. The bonds of Exco Resources (XCO) appear attractive (7.50% of 9/15/2018, CUSIP 269279AD7), especially given their maturity date in September 2018, a bit more than 4 ½ years away. Based on the most recent ask price of 98.5 (as of the end of trading January 21, 2014), the Yield-to-Maturity (YTM) is approximately 7.9%. The bonds are callable as of 9/15/14 at 103.75, then on 9/15/15 at 101.875, and finally at par anytime after 9/15/16. Since the bonds now trade below par, a call event would be a positive for bondholders, increasing the realized YTM.
Let's review the company from a credit perspective. We find that bonds often are analyzed from an equity perspective (i.e. will the company create more value for shareholders resulting in a stock price increase), when the real question to ask is if the company can service its debt and is there a reasonable chance of bankruptcy. It appears that Exco can easily service its debt, has a negligible chance of bankruptcy, and has an asset value far exceeding its debt balance.
An overview of the company and its business can be found elsewhere, but here is a summary of recent key events which bolsters the credit profile of Exco:
- The company just closed on a $272 million cash equity raise in a rights offering, all of which was used to repay senior debt (the new equity represented about 14% of debt outstanding). While dilutive to stockholders, it's a big win for bond holders.
- WL Ross & Co. further demonstrated its support for the company by subscribing to about $98 million of the rights offering. They now own 18.7% of the company. There is also institutional support from Oaktree Capital (16.6% ownership) and Fairfax/Hamblin Watsa Investment Counsel (6.4% ownership).
- In November 2013 the company sold its portion of a 50/50 joint venture that owned and operated natural gas and processing systems for $240 million - with all proceeds again used to repay debt.
- In October 2013, S&P upgraded its outlook on Exco from B "Negative" to B "Stable." This positive action was taken based on the expectation that Exco will "keep capital spending within cash flow" and that "debt to EBITDA should remain in the 3.5x to 4x range."
- In July 2013, Exco completed a $973 million acquisition of producing and undeveloped acreage in the Eagle Ford shale and Haynesville from Chesapeake Energy (CHK), and entered into a participation agreement with Kohlberg Kravis Roberts (KKR) (who paid $131 million for their interest, with proceeds used by Exco to reduce the debt used for the acquisition) to jointly fund future development costs of the undeveloped Eagle Ford acreage. While the outlook for the KKR arrangement are uncertain, the assets appear to be attractive, and the KKR investment is a positive for a credit perspective.
Pro forma for the rights offering, approximately $492 million is outstanding under the company's $900 million revolver, leaving about $401 million available according to the unused borrowing base. Total pro forma debt as 9/30/13 comes to about $1,478 million ($791 million of senior bank loans including the revolver, $750 million of the unsecured bonds, less $63 million of cash) versus approximately $415 million of EBITDA (excluding adjusted EBITDA of equity investments which would results in lower net leverage). Total leverage comes to about 3.6x, and is likely to remain flat in 2014 based on the company's 2014 EBITDA guidance (basically flat with 2013 actual EBITDA) and the fact that operating cash flow will be used for capital expenditures (the company indicated a capital budget of $368 million for 2014), not debt reduction. 2015 EBITDA is anticipated to grow 10-15%. Interest coverage comes to a healthy 4.77x based on approximately $87 million of pro forma interest expense (L+2.75% on revolver, 5% on term loans, 7.5% on bonds).
Based on the closing stock price of $5.18 and the new share count, the market cap is approximately $1.4 billion, resulting in an enterprise value of about $2.9 billion, or nearly 7x EBITDA. Debt to equity is about 1:1, or we can look at total value of the company covering total debt by about 2x.
Note that the corporate rating for Exco by S&P is B, with the secured bank loans "notched up" to B+ while the unsecured bonds are "notched down" to CCC+. The corporate rating is the key rating (taking into account in general the severe limitations of credit ratings) since this measures the borrower's capacity to service debt. The notching is helpful but simply reflects the various positions of debt tranches in the capital structure. Moody's has a more favorable B1 corporate rating (stable) which was affirmed recently (August 2013).
The key credit negative for Exco is its concentration in natural gas, which due to weak prices has been the key reason the stock has declined in the past few years. While prices have improved and are off 2012 lows (and the Chesapeake acquisition added some more oil into the mix), they are still expected to be weak and pressure margins. We note, however, that Q3 2013 EBITDA was $108 million, up sequentially from Q2 2013 of $90 million, and down, but within range, of Q3 2012 of $123 million. The $400 million level of EBITDA appears to be a figure that the company can consistently hit, important from a credit perspective (equity holders would want to see more growth). Also note that Exco's Chairman and CEO unexpectedly resigned in November 2013, but this change does not appear to be an issue.
With all of the various moving parts, including asset sales, a major acquisition, a KKR joint venture, rights offerings, etc. we cannot predict if these events are already reflected in the stock price or if the equity value is poised to go up or down. But these events are indicative of a company that can service its debt, with bankruptcy a highly remote possibility in the next 4 ½ years. An 8% yield through 2018, for a company with a nearly $3 billion value, 50/50 debt-to-equity ratio, 3.6x leverage, 4.7x interest coverage, a recent equity raise and material deleveraging (rewarded by a small upgrade by S&P) seems like a good value relative to other bond offerings today. With all that being said, Exco is clearly not "investment grade" and investors should be willing to accept the higher volatility of a high yield bond issue like XCO.
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Additional disclosure: I personally have a position in XCO bonds and in client accounts.