Pioneer Natural Resources is a Buyout Target: Doing a Deep Dive into the Net Asset Value
Price Objective 2014/2015: $225-$250/304-$338
Trade Recommendation: BUY (M&A Target)
- Long-Term Core Growth Holding with Optionality (Scale into Positions)
4Q13 Earnings Review
Pioneer Natural Resources (PXD) reported earnings Tuesday, February 10th, for FY2013, with consensus estimates at $0.98 EPS, Pioneer reported a fourth quarter net loss attributable to common stockholders of $1.4 billion, or $9.82 per diluted share. Without the effect of non-cash derivative mark-to-market losses and other unusual non-cash items, adjusted income for the fourth quarter was $140 million after tax, or $1.00 per diluted share.
Summary of 4Q13 Results:
- Growing oil production from continuing operations by 22% in 2013 as compared to 2012.
2014-2016 production is expected to increase at 16-21% CAGR; note, this compares with prior guidance of 13%-18% through 2015.
- Expecting to more than double production by 2018 compared to 2013.
- Production growth in 2014 will be second-half weighted: Pioneer is transferring previous vertical activity to Horizontal wells - with a faster acceleration than previous guidance: 16 H rigs are scheduled for the Northern Permian Wolfcamp by the end of March.
- In addition to the proved reserves added in 2013 from the horizontal drilling program in the Spraberry/Wolfcamp play, the appraisal and delineation across Pioneer's extensive northern acreage position and in the southern horizontal Wolfcamp joint venture area increased Pioneer's resource base from 9 billion barrels oil equivalent (BBOE) to 11 BBOE.
- Strong balance sheet with approximately $400 million of cash on hand at year-end 2013, a net debt-to-operating cash flow of 1.1 and a net debt-to-book capitalization of 25%.
Decoding Some Nuances from Pioneer's 4Q13 Conference Call
By far, the most important tidbit coming out of Pioneer's earnings release and conference call was buried deep within its presentation materials and not recognized by many analysts and investors for its underlying implications.
- Pioneer Natural Resources reported that it has successfully appraised 4 of 6 "stacked" intervals of the Spraberry/Wolfcamp with well results and confirmed geologic maps, with the Middle Spraberry Shale interval under appraisal now.
- Management has reiterated repeatedly that they do not want to enter into any transactions with regard to the northern Spraberry/Wolfcamp until it is adequately derisked to maximize shareholder value (more on this later).
Since 3Q13, there have been high expectations for Pioneer's management to update their estimated resource potential for the Spraberry/Wolfcamp reserves ((EURs)). The past two quarters they have released updated data points from its first horizontal wells across the Permian Basin, indicating that total PXD proved reserves + net recoverable resource potential are at least 11 billion barrels of oil equivalents (BBOE). In addition, they did upgrade their estimates to average EURs of 800 MBOE per well for Wolfcamp A and B intervals, 650 MBOE for Wolfcamp D interval and 575 MBOE for Spraberry Shale intervals (Lower Spraberry Shale and Jo Mill Shale). Below are the updated well results and EURs for the northern acreage.
The bear thesis focuses on doubt that management will be able to execute their strategy in the Permian and the argument that most of these assets are priced into the stock at current levels. Recall, management has already delivered near-flawless execution with their production strategy in the Eagle Ford shale, and production is only accelerating. It would also be prudent for bears to observe the following facts and statistics outlined below.
By management's own admission, these estimates "remain conservative" and should highlight for investors that the Wolfcamp B estimated EURs are still too low and are likely to increase to at least 900EURs (+12.5%) from the new revisions of 800 EURs (previously 500-600 EURs).
The potential of the Permian Basin with horizontal versus vertical drilling greatly enhances the resource potential of this shale play. For example, Pioneer's first horizontal well in the DL Hutt area has already produced 190,000 barrels not even a year on production. By comparison, its vertical campaign years ago in these same wells produced only 140,000 barrels over 30 years! This is a demonstration of its exemplary execution, as well as validation that its northern Spraberry/Wolfcamp is extraordinary. Moreover, management is keen on delivering growth for shareholders, and this is reflected in their production strategy by cutting down to only 12 vertical rigs and eventually down to zero over the next several years. At the same time, the company is increasing its number of horizontal rigs to over 80 by 2018.
Additionally, management's new assumptions presume only 7,000' lateral length wells with 100 acre well spacing, but Pioneer has already shown demonstrable success testing only 40-60 acre "staggered" well spacing with nearly the exact same production curves. This tighter drilling scheme increases EURs by 20% to 30%, with minimal increase in drilling and completion capital, as explained in this excerpt from the conference call:
Costs look like they are about $8 million for the South we did have a successful downspacing test we felt like I had mentioned in our third quarter call in the Giddings area. We recall we began testing downspacing down to about 720 feet to 480 feet that's moving down from a 160 acres basin to about 77 acres basin. We're testing those 12 wells and continuing to look at their performance and the important note is that the performance of wells that are 480 feet in terms of spacing the production is compared to the 720 spaced offset wells were essentially identical which is really what you're looking for. So we will continue to monitor those wells and make some evaluations begin of this year including the possibility of looking at further downspacing to perhaps down to 50 acre spacing.
Even assuming this downspacing only applies to 30% of its total acreage, it would still translate into a 10% net increase in total EURs. On the conference call, management said it expects to drill at least 140 wells with average lateral lengths of 8,200', which would correlate with a 900,000 boe type curve (see charts below), not 800M boe curves. Given this evidence, it would increase its total proved reserves + net recoverable resource potential to at least 12.72-13.63 BBOE.
In 2013, the Spraberry/Wolfcamp had production growth of 19%, the Eagle Ford shale grew 35% and overall oil growth up 22%. Pioneer was running only one rig a year ago in the Permian Basin and placed only 21 horizontal wells on production, but will be running 16 rigs by the end of 1Q14 and will have 26 horizontal wells on production in 1Q14. With the increase to 16 rigs, there could be as many as 200 wells, but management guided to about 140 wells in the North, with an average lateral length around 8200 feet. Pioneer will focus new wells on higher-return areas, drilling two-thirds of the new wells in the Wolfcamp B with the remainder across the other intervals. The start to "pop" time requires 145 days, so this will result in the majority of production growth occurring in 2H14. By 2018, Pioneer intends on increasing rig count to 50, which would give it ample capacity to drill over 750 wells in the northern Wolfcamp intervals. Pioneer's guidance assumes only 10 wells per rig will provide at least 600 million barrels of oil equivalent just in the Spraberry/Wolfcamp horizontal reserves from 2014 to 2016, which results in over 40 years of inventory. It is vital for investors to recognize the persistent conservatism in Pioneer's guidance. For example, it noted that all of its models assume only 100 acre spacing, but will get a substantial improvement in production for downspacing. Pioneer's estimated reserves also ignore several other zones in the north which have not even been tested yet, such as the Clearfork, the Middle Spraberry shale, the Atoka, the Woodford and other zones. Consequently, management's guidance to only double production by 2018 understates reality by at least 15-20%. Remember, 2013 was a "science and exploration" year as an E&P company, while 2014 marks the beginning of a transition into a large production company in a perpetual growth cycle that will last for many years.
I assert that Pioneer will grow into its current valuation (see charts below), and should be a long-term core energy holding that will deliver a 65% return, reaching over $300 per share by 2016.
On an EV/DACF basis, Pioneer trades at a 20% discount to Exxon Mobile (XOM) based on 2017 estimates, while only trading at a 30% premium to it on 2014 estimates. Exxon is forecast to grow production by only 3% this year, while Pioneer expects to grow theirs by at least 15-20% per year through 2018. Recent weakness in Exxon's stock has been due to doubt whether Exxon will be able to achieve its growth forecasts. The bottom line is that investors can buy Pioneer at a lower forward valuation than Exxon, which is justified with more than 5x the production growth of Exxon.
- There are some interesting hedging opportunities that could be exploited to mitigate an unexpected decline in WTI prices below $90; however, as a reminder, Pioneer's 3Q13 cost of production was $14.81 and it had an all-in reserve replacement of 87 MMBOE, or 210% of full-year production at an all-in F&D cost of $34.46 per BOE.
There has been poor sentiment toward Pioneer's share price over the past several months, stemming from weather-related production issues and increased commodity price volatility. I expect short-term weakness in the shares to continue until mid 2Q14, when expectations for accelerated production growth in 2H14 become the main focus.
The recent weakness in the stock is a long-term buying opportunity for a perpetual growth story and share appreciation. Pioneer has a 3-year EPS average growth rate of ~40%. This persistent growth easily justifies its current PEG ratio of 1.5. With 2013 EPS of $4.44, earnings grew 21% from 2012, and the stock is currently trading at a P/E of 40. Pioneer is expected to grow earnings 28% to $5.71/share in 2014, giving it a forward P/E of 31. My base case price target of $240/share is based on assigning a 1.5x PEG ratio to 2014EPS of $5.25-$6 (1.5x EPS growth rate of 42 x 2014E EPS of $5.71/share=$240/share). Looking ahead further at 2015E EPS of $9.57, Pioneer trades at a P/E of only 18.4x 2015E. Conservatively, even a 20% discount to 2015 estimates still would deliver EPS of $7.66/share, giving it a P/E multiple of 23.5.
On a P/S basis, Pioneer currently trades at 8x 2013 sales, and 6x 2014E sales, which is within its historical range. So at today's price of $185/share, Pioneer is not cheap, nor expensive, just within its historical range on a P/S basis.
Despite Pioneer's favorable growth outlook, shares have been under pressure since announcing 3Q13 results, and have been victim to a wave of "sell the news" across the sector. Sentiment has been negative largely due to disappointment from investors and analysts that management did not increase its energy type curves in the northern Wolfcamp from 500 Mboe EUR to at least 650 Mboe EURs in December at a third-party industry conference. This disappointment was exacerbated by a hailstorm that shut down production during 4Q13; all told, this pessimism drove down shares by 26.67% (peak to trough). Shares have recovered some of the lows, but investors are becoming increasingly cautious toward E&P companies, with oil prices being pressured on several fronts. But it is vital to recognize that Pioneer has the least sensitivity to commodity price risk in the E&P sector, with 88% of 2014E oil production hedged with a weighted average floor of ~$94/b and 76% of 2015E oil production hedged with a weighted average floor of ~$88/b. Not unexpectedly, the above-listed concerns have led to reduced demand for energy-related equities, but I would caution on taking a long-term bearish view on the energy sector. The three underpinnings (discussed below) of potentially lower oil prices all have counter-theses that cannot be ignored.
The longer-term bearish arguments specific to Pioneer center around the skepticism that management can deliver on its significant resource value through successful execution to drive production higher. Recall, Pioneer has already succeeded once; these same skeptics existed in years past with regard to the Eagle Ford shale. Furthermore, management's statements are consistently supported with its actions, and the company is intently focused on accelerating development in the Permian Basin. Pioneer is increasing its northern rig count from 5 rigs currently to 10+ rigs in early 2014 in response to successful well results to date.
Analysts' expectation of Pioneer's resource potential carries wide dispersion, which sets up an informational sensitivity in the stock price and presents an "informational arbitrage" trading opportunity. This sensitivity is embedded into the stock from the dispersion of analysts' estimates of future resource potential, and is reflected in the share price volatility, where investors swing back and forth over how much value to assign to future activities. I anticipate that since management has revised their growth potential in the Wolfcamp, we will see a slow, but rising, wave of analyst estimates on production and NAV.
As a result of the enhanced sensitivity to headlines, depending on what scenarios are laid out by management for development and derisking of its multiple formations in the Permian (Wolfcamp A, Jo Mill, lower/middle Spraberry), these estimates will ultimately drive shareholder sentiment and thus future returns. Merrill Lynch, for instance, models the following scenario for Pioneer based on the current 500-575,000 boe type curve for the northern Wolfcamp, one that would result in multiple compression of over 55% to only ~4.5x EV/DACF, a figure firmly below several larger players' current ratios based on estimated 2014 earnings. The chart below adequately explains the swing in sentiment is conclusively rooted in changes in investor behavior from forward valuations to backward valuations.
Bringing Pioneer's valuation in line with that of Laredo Petroleum (LPI), currently trading at 9.8x EV/DACF 2014E, would only cause a multiple compression of 20% by 2017E. Based on this model, Laredo would trade at a 30% premium to Pioneer by 2017. Recall, Pioneer has superior growth and costs metrics than all of its peers, and to suggest that it will trade at a lower multiple than Exxon or Chevron (CVX) in 2017 is not rational since Pioneer will deliver high double-digit production growth over that same period. The spread between 2014E and 2017E represents the trade opportunity; if we can buy Pioneer at a forward multiple that is below slow growing peers, with double the production growth, and potential optionality from deal activity such as M&A or asset sales, this is then established as a hallmark asymmetric risk/reward trade. With a healthy correction over 26%, I contend that the downside is limited to another 20% or ~$140/share, with the upside potential of at least 50% or ~$270/share (not including M&A or assets sales), a 2.5:1 risk/reward.
I believe the upside to Pioneer's share price and NAV is skewed substantially higher, stemming from three sources:
- Enhanced guidance of resource potential in excess of 800 EURs for its Wolfcamp B.
- Consistent emphasis by management on bringing forward future NAV through Joint Ventures (JV) and Asset Sales.
- Pioneer possesses the best profile of production growth, cost-efficiency, and least sensitivity to commodity prices with the lowest cost basis per barrel of oil produced in the Permian.
Concerns about energy prices are overblown, and the impact on Pioneer's share prices is likely driven in part by outflows from energy sector ETFs. But it would be remiss to ignore this argument completely, and are briefly summarized in the following section.
Pioneer Exhibits Low Sensitivity to Commodity Prices
Pioneer has attractive oil production hedges in place for 2014, with over 90% hedged at prices above $93 and capped on the upside at $114. This compares to 2013, where revenues were based on an average sales price of $90/bbl oil and $4 gas. Many investors are concerned with commodity price volatility adversely affecting the share price of Pioneer. However, an analysis conducted by Barclays provides direct evidence that any commodity price-related sell-off in Pioneer's shares should be bought.
In their analysis, they surveyed all E&P companies in their coverage universe for commodity price volatility impact on the stability of the companies' balance sheets and operating performance. Specifically, they modeled the impact of large price swings in oil and gas, and how those swings would impact EBITDAX, free cash flow, and leverage. In their model, they expect WTI to average $97/bbl in 2014, Brent to average $105/bbl, and natural gas to average $3.88/mmbtu. On a net debt/EBITDAX basis, the most sensitive companies in their study were Suncor (SUCN), Canadian Natural (CNQCN), and Cenovus (CVECN). The least sensitive companies include Pioneer, Anadarko (APC), and Continental (CLR).
Barclay's commodity price sensitivity analysis demonstrated that Pioneer's business performance is one of the least sensitive E&P companies to commodity price volatility. Specifically, if WTI prices fell from $100/bbl to $75/bbl, Pioneer's EBITDA would only decline from $2.87B to $2.67B, a <9% drop. Consensus EBITDA estimates are currently at $2.705B; this is an important metric because Pioneer's low sensitivity to commodity prices also insulates it from receiving a reactive downgrade by sell-side analysts if WTI prices plunge below $90/bbl. Analyses looking at Net Debt/EBITDA (leverage sensitivities) and free cash flow demonstrated similar levels of resilience. Hence, it is unlikely that an analyst's downgrade would stem from commodity price volatility and immediately change the long-term thesis on Pioneer, but the mitigation of this risk is an important factor when considering a long position.
Three bearish underpinnings on oil prices:
- The U.S./Iran nuclear energy deal, which removed a substantial risk premium of approximately $10/bbl from oil prices.
- Increasing domestic oil production and reduced imports have hurt prices not just from increased supply, but improving the balance of payments for the U.S. This has led to an increasingly bullish U.S. dollar outlook and a proportionate drop in commodity prices.
- Finally, with the Federal Reserve proceeding with its tapering schedule reducing asset purchases by an expected $10B per FOMC meeting, this provides additional resistance to higher oil prices in the form of rising 10-year Treasury rates and a stronger dollar.
Bullish counterarguments on oil prices:
- Geopolitical tensions have abated for now, but there are plenty of other sources to reinvigorate the oil market over the next two years.
- Iran is likely to renege or withdraw completely from its agreement with the U.S. on its nuclear energy agreement. Israel will not hesitate to strike alone if required; when is difficult to ascertain, but a proverbial red line has been reiterated time and time again by Israel.
- Terrorist groups have reclaimed Western Iraq and could lead to intervention with U.S. forces.
- While the domestic energy renaissance is likely to continue to improve the balance of payments, the direct effect over the long term on oil prices may not be as impactful as believed.
- The Fed's tapering is premised on the notion that the U.S. economy is able to stand on its own merit again, without the need for support from the Fed. However, I remain skeptical that tapering will proceed as fast as anticipated, or the Fed rate will rise as quickly as forecast (late 2015).
- If the Fed proves to be correct that the economy is strong enough without stimulus, then that implicitly says that there should be growing economic activity, and with that, growing demand for energy resources.
- As a result, there will likely be increased sensitivity of asset prices to global economic data.
As Pioneer characterizes its Wolfcamp energy type curves, current and pending well results (see charts below) could materially increase Pioneer's resource and production outlook 20-40% above management's current guidance of 11 BBOEs. Critical to the bullish thesis is that these estimates are based on conservative assumptions of only 800 MBOE per well. Any significant revisions to these curves would act as a significant catalyst for the stock. Based on the chart below, thus far all wells are running well at or above these estimates, and all evidence supports an upward revision to this guidance.
The second component to this bullish view is that Pioneer's assets are extraordinary in both size and quality of its resources. The Spraberry/Wolfcamp is a superior asset (see charts below) relative to all North American shale plays, and Pioneer has over 600,000 continuous acres in this opportunity (the largest of any player in the space).
The Permian Basin versus Other Shale Plays
>70% liquids contributing to its resource potential brands it as the most attractive Permian Basin play. Among all its competitors, Pioneer not only has the lowest cost of production in the Northern Spraberry/Wolfcamps, but also would be enticing to any potential bidders for these reasons:
Longevity of resources (40 years) and high composition of liquid resources.
Technological leader in the Permian Basin, with sophisticated geologic maps from >70,000 logs, >2,600 square miles of 3-D seismic and >14,500 feet of core.
Cost-efficient production of assets (charts below) driven by a 20% reduction in costs, 17.6% reduction in drilling time per well, and a 25% gain in drilling feet per day. These efficiencies were driven primarily through improvements in Frac design.
Based on production curves would generate high returns on invested capital (ROIC), with pre-tax investment rate of return of 60-125% depending on pricing assumptions (chart below).
Pioneer has ~18 years of Proven Reserves & Production.
Energy reserve replacement of 211% in 2013.
Pioneer has a consistent history with deal making in the form of Joint Ventures or asset sales:
In a JV with Sinochem, Pioneer sold 40% of PXD interest in 207,000 acres; and sold Wolfcamp and deeper horizons (retained Spraberry/Dean and shallower horizons) for $1.7B total consideration; or ~$21,000/acre
Pioneer raised $8 billion of capital during the company's transformation period to accelerate development in unconventional plays: $3B from the sale of conventional assets, $5B from 2 JVs and equity issuance.
While Pioneer only operates 28 of the 272 rigs in the Spraberry, it remains the largest single producer in the Permian, which isolates Pioneer as the most attractive pure play in the Permian, which is an otherwise fractured shale play. This supports the notion of a potential acquisition in the future. Because the Permian Basin is such a fractured market, potential bidders would have to do a series of at least 3-4 acquisitions to replicate the resource potential of Pioneer. In addition, doing multiple acquisitions would not replicate the high margins Pioneer has because it has the largest contiguous acreage, which delivers cost synergies. Critically, with horizontal wells only recently coming online for production (see chart below), 16 rigs are scheduled for production by end of 1Q14! This represents a much faster ramp in production than anticipated.
Merrill Lynch conducted a scenario analysis showing that an increase in the well curves from the current 500 EURs to 750 EURs would increase Pioneer's 5-year CAGR to 22%, which is ahead of guidance by 10-20%. This would increase NAV by $80/share or ~42% of its most recent close price of $180/share. Importantly, by the end of 2015, Pioneer could be operating on a neutral cash flow basis.
Production Curves of Pioneer's Wells in the Spraberry/Wolfcamp
Management has now revised their guidance to more accurately reflect reality; two things are likely to transpire in 2014:
First, this guidance should cause a quick rerating on the stock, propelling shares back above $200-220/share. It is likely that these assets are likely to deliver EURs of at least 800Mboe, which would increase the 3-year CAGR in production toward 30% annually.
Second, the process of de-risking Pioneer's assets and resource potential is almost complete and should be completed "later this year", which could provide the impetus for a takeover bid in 2015.
Is it too late or still early? Judging Pioneer's past corporate activities will likely reveal its future
Several scenarios in the Wolfcamp are possible. For example, an incremental increase of only 6 rigs annually through 2018 would increase NAV attributed to the Wolfcamp to at least $90/share. Pioneer's estimates assume 140-acre spacing between well sites, but it is testing 40-60 acre spacing in the northern acreage. Management believes it has 6-stacked sections across the bulk of its northern acreage that could theoretically multiply potential drilling locations by 5-6x.
Pioneer's management has earned a reputation for its readiness to bring forward NAV for shareholders. With an estimated resource potential of 11-14 BBOE and an accommodative management team focused on shareholder returns, I propose that Pioneer will deliver multi-billion dollar assets sales or JVs, which will greatly accelerate its production plans; or will be acquired for more than $270-330/share within the next two years.
According to Merrill Lynch, after discussions with management, "it is clear that it does not want to prematurely sacrifice any value through an early JV in the north until it has fully appraised the full resource potential." However, as noted already, a critical tidbit was buried within its recent FY2013 conference call presentation, that in my humble assessment provides us with the precise timing for key catalysts ahead.
From its 4Q13 earnings release, "Based on these production results and the extensive 'science' that was performed on these wells, the company's geologic maps are being confirmed and four of the six 'stacked' shale intervals are now considered successfully appraised. Appraisal of the Jo Mill Shale and Middle Spraberry Shale intervals is currently underway, with results expected later this year."
My interpretation of its appraisal timeline is that this represents the critical endpoint when Pioneer will be seeking bidders for an acquisition and can truly maximize its value for shareholders. My hypothesis is supported in light of management's shareholder-oriented business objectives to bring forward NAV.
One important issue associated with all resource-rich companies is translating implied NAV into shareholder returns. The primary methods through which this is achieved are asset sales, partnering with a larger player on attractive terms, M&A, or a rapid pace of cash flow growth, while maintaining a strong balance sheet. As shown in the 4Q13 earnings release, Pioneer's liquidity of a net debt-to-operating cash flow of 1.1 and a net debt-to-book capitalization of 25% remains well below its 35% net debt/cap target.
Representative of all high-growth companies, Pioneer appears to be "expensive" with an elevated 2014 EV/DACF, but recall this multiple falls quickly based on conservative assumptions on production growth. Importantly, the only impediment to higher rates of growth for Pioneer is the drilling activity it can achieve with its current balance sheet. Another key distinguishing factor of Pioneer's assets is resource visibility, which is lacking with its competitors. Even if an acquisition does not come to fruition, there are many alternatives to unlock shareholder value, and Pioneer remains a very attractive long-term core holding. It is truly a demonstration of a perpetual growth story with long-term visibility into its resource potential.
Informational Arbitrage: The Bear Case may turn out to be the Bull Case
The bears will argue Pioneer is expensive at today's market valuations and multiples.
I take particular issue with the bearish on valuation thesis. If you compared Pioneer to growth stocks in other sectors, it would become abundantly clear that Pioneer is comparable to other growth stocks on a P/E, PEG, or P/S basis, but has higher 3-year growth rates than many other favored growth stocks. It is clear that resource-rich companies carry risk, but arguably at least both the resources and the risk associated with them are measurable. Whereas, in other sectors, it is difficult to determine if and when a product will become obsolete or no longer popular.
Bears will argue that a lot of the future success resides in management's execution ability to extract the resource potential in the Permian in a cost-efficient manner. And that today's valuations reflect the majority of future NAV.
However, I would argue that it is undeniable that Pioneer's resource potential is significantly greater than its proven reserves of 1.1 BBOE, and that its current estimated total resource potential of 11 BBOE remains conservative as described previously.
Management has achieved quality execution in the Eagle Ford shale previously; it is reasonable to believe they can repeat their performance in the Permian.
To bears, strong share price performance already reflects strong results from the Wolfcamp.
This is true; however, management has consistently guided low and remains low, as previously described. But in 2014 and 2015, Pioneer moves into execution mode with great potential to exceed production estimates in 2H14, FY2015, and beyond.
Management has also suggested 800,000 EURs for Wolfcamp B as a reasonable resource estimate for the Wolfcamp 'A', which covers most of Pioneer's ~600,000 net acres in the Permian.
Price Objectives and Model
According to Bloomberg's analysis of energy-related acquisitions, "Suitors would have to offer at least a 30 percent premium, or in the range of $275 a share. That would value that company at about $40 billion, approaching Exxon Mobil Corp. 's record North American bid for XTO Energy Inc." However, an energy analyst at Oppenheimer said Pioneer may demand at least 50 percent. Adjusting for current share prices, those premiums would imply a takeover bid between $287- $315 per share. Assuming net debt includes the full drawdown of Pioneer's unsecured credit facility, that would value any takeover approximately at $273-$287 per share net of debt.
Interestingly, these market valuations are supported by a model that I constructed immediately after 4Q13/FY2013 results reported on February 10 that included a dramatic acceleration in horizontal drilling activity described previously in this report. Essentially, the impact of this accelerated program will not trickle down to shares until 2H14, in accordance with management's new guidance. But what is interesting is that the implied production increase with 16 new rigs drilling in the northern horizontal Wolfcamp by end of 1Q14 brings forward estimated production levels from 2016-2017 to 2015-2016. Even more surprising is that these production estimates are drawn from the most bullish sell-side analyst on the Street. This implies that other sell-side analysts will have to play catch-up during the second half of 2014.
As mentioned previously, the most important data point coming from the 4Q13 earnings release was a definitive endpoint for "derisking" Pioneer's assets, which should be done "later this year". This was the critical piece missing from my thesis of a future buyout; now, with a known endpoint where management feels comfortable with its resource potential characterized enough to not leave substantial value on the table, it clearly opens the discussion to bringing forward future NAV sooner through value-unlocking transactions. Bearing this in mind increased my level of confidence for this trade recommendation.
Northern Wolfcamp Pre-Tax NAV Model 750 EURs vs. 900 EURs
- PXD has found solid support at $163-$165, which coincides with the 200-day moving average.
- Critically, it's formed a double-bottom formation on expanding volume, while finally breaking its downward trendline that has acted as resistance from its all-time highs.
- Maximum downside resides with a break below the double-bottom formation at $163, with some support at $154 as final support before a move down to the suggested short Puts at $140, which coincides with a major trendline at ~$135 from 2010 to present and a Fibonacci extension at $140 as final support.
- Upside resistance was met with recent highs at $187-188(100 day moving average), with cloud resistance residing between $192-$200 projecting out to March 14th a range of consolidation between $176-$200.
Possible Trading Strategies
- Initiate small options position now, and accumulate on any sustained weakness dollar-cost averaging into position over 1H2014 (recall major production growth is likely to come in 2H14).
- Wait for a pullback to the 50 or 200-day moving averages at $171-$175/share before initiating first position.
- Wait for a breakout signaled by a 10-day moving average crossing above the 50-day moving average, which could occur within the next 2 weeks if PXD can hold its current trading range.
- Wait for a major breakout above $200/share on heavy volume.
- Wait for more clarity on timing the trade, I foresee several weeks of consolidation in price action, and do not see any immediate catalyst that demands this trade be put on immediately. However, the stock is cheap relative to where it's going, and could break out as we approach the end of March to April (based on the charts).
- Fundamentally, I would recommend implementing the trade no later than May, as investor expectations are going to be focused on enhanced production levels going into 2H14.
Key risks to this trade
- Obviously, commodity price risk will affect sentiment on the sector.
- Production problems; for example in 4Q13 an ice storm in Midland, Texas halted production, leading to a reduction in production by 6 Mboepd.
- Actual 4Q production was at 173Mboepd (guidance was 179-184 Mboepd).
- Issues such as these are likely to recur in 2014, which may create a seasonality pattern of weakness in the shares during the winter.
- Consequently, there may be peaks and valleys throughout the duration of the trade (Jan 2016) and it would be prudent to initiate positions small with intent to build into full-size position over the year.