A Deeper Look Into Halcon's Earnings

Feb.27.14 | About: Halcon Resources (HK)

Halcon Resources (NYSE:HK) reported earnings last night that missed expectations. In this update I will not dwell on the company's current performance, as it means very little to the long term value of the company.

2014 Woodbine sale a welcomed strategy
Halcon disclosed that they have sold their position in the Woodbine, which was once considered core, for a total of +/- 450 million. I was hoping this sale would take place, as it frees up much needed capital for deployment into growth assets in 2014. By my calculations (which I will share later) HK will burn through about $540 million in FY 2014, assuming $90 oil, a 950m D&C budget and $100m in infrastructure, seismic, etc. This will leave the company negative $100m in 2014. HK will still be in the red next year as well by anywhere from $275m to $300m assuming the same criteria as above. So, another capital raise is likely at the end of 2014, or an asset sale.

Markets will not reward TMS move right away
After completely flopping in the Utica, a huge mishap by Wilson and company, the market will likely take a wait and see approach on Halcon's Tuscaloosa Marine Shale position. Though the TMS play is a little more proven from an oily perspective, it does not remove the fear of another failure on a "new core play". HK was very confident in it's Utica play but it has turned out to be a very costly mishap for shareholders and the company alike.

Drilling inventory points to multi-year growth
Due to down spacing, drilling locations improved to 805 total in North Dakota which implies a drilling inventory of roughly 13-18 years depending on the pace of growth. In El Halcon the numbers are similar at current rig counts, but will likely go up to over 1,200 as down spacing tests come in successful in the future. This is encouraging to me, for any development campaign I like to see a 10+ year inventory. Without the TMS, HK is poised for development growth for at least the next decade.

A look at the financials
Click to enlarge

Assumptions for above financial table:

  • $90 oil, $4.50 gas, $35 NGL
  • Fully diluted shares of 585m in 2020
  • Flat oil prices across the board from 2014-2020
  • Stable CAPEX until 2017 when FCF positive
  • Small land acquisitions yearly growing in the outer years
  • Capping debt overhang @ 3.75 billion

Observations from the table:

  • The biggest question mark, obviously, is commodity prices. The difference for the company just this year alone would be a swing to $.10/shr EPS and $100m reduction in FCF if oil prices stayed where they are now, or around $100/bbl. HK is hedged and capped above $100, so it really doesn't matter how high it goes for them right now, on the downside they are capped from $89 down to $70. Below 70 and they begin to incur more losses. For a company as leveraged as HK, price volatility is a huge factor.
  • If oil prices were to drop significantly, HK would have to drastically reduce its D&C plan more than likely dropping to 1 rig in El Halcon and 1 rig in North Dakota (maybe 2). The point is though, that they can drop CAPEX and easily live within the boundaries of cash flow.
  • The company will likely be sold some time in 2017/2018 for around $20-$25/shr. 2017 will be the first year they really become FCF positive across the board. Floyd wanted to sell around 2015, but due to a couple mishaps, his plans will be pushed back 2-3 years. Make no bones about it, the company will definitely be sold, its just a question of when.
  • As you can see, in the outer years the company really gains a lot of financial leverage. At flat commodity prices, 2017/2018 will see around $1.00 in EPS. If you put a 18-20x multiple on that figure (in line with production forecasts going forward at the time) you arrive at $18-$20 per share at fully diluted and all warrants/converts exercised.
  • They will more than likely plow this surplus in cash flow into development to grow production. I did not account for an increase in production growth and rig counts in the outer years, because I wanted to illustrate the view of what a stable development plan produced over time.
  • Putting a 20x multiple (premium multiple in 2017 due to potential sale, 20%+ production growth and drilling inventory) on HK in 2017 points to a share price of $14.41 at the fully diluted share count. Discount that back 25% (very conservative) and one arrives with a NPV of $6.08 for 2014. This offers upside of nearly 50% for this year.

The street will more than likely be disappointed with the results from the MRQ, and send the stock down as is evident from the -8% drawdown after hours last night. For longer term investors, buying at these levels offers great risk/reward. Debt is not an issue, as most of it is due in 2020+. For starters, the company will likely be sold before then, and even if not, HK will very easily grow into the debt load over the next several years. Halcon is one of the best E&P stocks to own right now for investors with a longer time horizon than 2 quarters out.

Disclosure: I am long HK. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.