Halcon Resources: Q4 2013 Results - Quick Read

Feb.27.14 | About: Halcon Resources (HK)

Strong Results In The Bakken And El Halcón

Operationally, Halcón Resources (NYSE:HK) reported a solid quarter in its two core plays, the Bakken and El Halcón, marked by consistently strong well results, material upward EUR revisions and growing drilling inventories. Production increased sequentially by 15% in the Williston Basin; the highlighted weather-related delays and production impacts in Q4 2013 and Q1 2014 are not a concern, given similar reports by other operators. In El Halcón, production grew by 43% quarter-on-quarter (versus my estimate of 42%), a very strong result.

Sale Of Woodbine Announced

The sale of the Woodbine assets for $450 million is a positive development. Assuming $190 million attributable to existing production (~6.4 MMBoe valued at $30/Boe), the transaction implies ~$3,100 per acre (based on 83,000 total net acres sold). The per-acre valuation is likely similar (and, probably, higher) than the average price that Halcón paid for its Eagle Ford acreage in East Texas. The transaction price is also above the high end of the $300-$400 million divestiture proceeds guidance given by the company in December, most likely in anticipation of the Woodbine sale.

The sale of the Woodbine should not come as a surprise - management gave a clear enough indication of its plans during the company's Q3 2013 conference call. The move is welcome news given the need to focus the company's financial and organizational resources of the most attractive opportunities.

Will Sale of Utica Follow?

Halcón's press release contains the following important comment:

The closing of this sale would essentially conclude Halcón's planned 2014 divestiture program. The Company plans to continue to evaluate all remaining non-core properties for future divestment opportunities.

Given that Halcón's press release and updated corporate presentation are conspicuously free of any mention of the Utica (the play is also not named among Halcón's three "core" operating areas which now include the Bakken, El Halcón and TMS), the comment leads to hypothesize that the Utica may soon follow the Woodbine on the divestiture block and that the marketing process has already started. The question will likely be among the first to be asked on today's conference call.

The fact that management no longer sees the Utica among top strategic priorities for the company became clear already during the previous quarter's conference call and was reflected in the company's capital allocation guidance. However, the strategic "write off" of the Utica may not be fully baked into the stock and may be one of the reasons for the negative share price reaction in the after-hours session following the press release.

If the hypothesis that the Utica might be designated for sale is indeed confirmed during today's conference call, the obvious negative implication is that the assets may not receive a price in the divestiture market high enough to offset the valuation discounted by the stock price (in anticipation of operating success and growth). On the positive side, however, Halcón now has sufficient drilling inventory within its "core" portfolio, and it is only logical that the highest-risk, lowest-return investment opportunity is being eliminated.

In the case of Utica, infrastructure uncertainties and costs, exploration risk and inability to ramp up production are the obvious factors that make this play very challenging (and not just for Halcón).

TMS Acreage Acquisition Confirmed

Halcón's announcement of the acreage acquisition in the Tuscaloosa Marine Shale should not be a surprise to any investor closely watching the company or the TMS. Rumors of Halcón acquiring ~100,000 acres in Wilkinson County, Mississippi and in Louisiana from Encana (NYSE:ECA), on top of leasehold acquisitions in the core of the play from other parties, have been actively discussed in the investor and industry communities for almost three weeks.

Total acquisition price in the TMS was not disclosed. (Although Halcón's press release stated that the company spent ~$201 million for acquisitions primarily in the El Halcón and TMS areas. The TMS likely accounted for the majority of that amount.) Without knowing the structure and terms of lease expirations and specific acreage location relative to what is currently considered the core of the play, it is difficult to assess whether the price paid, whatever turns out to be, was attractive. For reference, Comstock recently paid ~$1,000 per acre for a sizeable block in the Eastern TMS, also with significant exposure to the play's core.

Assuming that Halcón spent $1,000-$1,500 per acre, on average, in the Eastern TMS, the company's total cost to acquire the ~235,500 net acres in this part of the play would be in the $235-$350 million range, or 5%-7% of the company's current Enterprise Value (~$4.8 billion).

Halcón's press release also confirms ongoing discussions with prospective private equity partners regarding a potential JV transaction in the TMS (Apollo Group has been rumored as potential 25% partner in a carried deal). The comment in the press release reads as follows:

The proceeds from the pending sale of non-core assets are expected to provide Halcón the ability to internally fund the TMS program. However, the Company is evaluating joint venture options for its entire TMS position and is engaged in ongoing discussions with several potential partners.

Halcón plans to spend approximately 10% of its drilling and completions budget in the play in 2014, subject to reduction dependent upon ongoing negotiations with potential joint venture partners.

Given that the TMS has been notorious for well execution challenges, Halcón's large-scale entry into the play may be legitimately perceived as an increase of the company's operating risk profile. However, the disclosure in the press release makes it clear that the TMS initiative is being undertaken in conjunction with a high-probability JV transaction which would substantially reduce Halcón's total capital at risk (which includes acreage cost, 2014 evaluation program and geo-science work).

Halcón announced that in aggregate it now has approximately 307,000 net acres leased or under contract in the play. No changes to guidance are being made as a result of this announcement: according to the press release, TMS drilling activity was incorporated into the company's 2014 business plan and budget.

Halcón's decision to make a larger bet on the TMS is understandable: given the company's size, New Venture initiative must be high-impact, scalable and have potential to grow fast, in order to have a chance to move the stock higher. The TMS fits those criteria and provides the advantage of relatively low lease acquisition cost and low competition for land.

2014 Production Guidance Reiterated

Halcón reaffirmed full year 2014 production guidance and provided production guidance for the first quarter. As a reminder, in December Halcón provided its updated budget for 2014 which included $950 million for drilling and completion activity and $100-$125 million for land, infrastructure, seismic and other spending, bringing the total to $1,050-$1,075 million (before including capitalized interest and G&A). While land budget may have to be revised upward due to leasehold acquisitions in the TMS, the higher-than-expected proceeds from the Woodbine sale may provide the necessary funding.

A more balanced rate of spending envisioned by the 2014 drilling plan is a positive change from the break-neck pace seen in 2013. In the third quarter alone, Halcón spent $671 million ($390 million on drilling and completions; $125 million on land, infrastructure, seismic and other; and $156 million on acquisitions and new acreage). The spending compared to $179 million of discretionary cash flow reported during the quarter.

Assuming Halcón generates $700-$800 million in discretionary cash flow during 2014 and adding the $450 million of expected divestiture proceeds, the company may now be able to avoid significant draw-downs on its revolver and should see its credit metrics incrementally improve as a result of stronger cash flow. A JV transaction on the TMS acreage may help fully balance the budget. Still, Halcón's leverage and coverage ratios will remain high at the end of 2014.

Production Guidance

Full Year

1Q14E

2014E

Production (Boe/d)

Low

34,000

38,000

High

36,000

42,000

% Oil

85%

% NGLs

5%

% Gas

10%

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Disclaimer: Opinions expressed herein by the author are not an investment recommendation and are not meant to be relied upon in investment decisions. The author is not acting in an investment advisor capacity. This is not an investment research report. The author's opinions expressed herein address only select aspects of potential investment in securities of the companies mentioned and cannot be a substitute for comprehensive investment analysis. Any analysis presented herein is illustrative in nature, limited in scope, based on an incomplete set of information, and has limitations to its accuracy. The author recommends that potential and existing investors conduct thorough investment research of their own, including detailed review of the companies' SEC filings, and consult a qualified investment advisor. The information upon which this material is based was obtained from sources believed to be reliable, but has not been independently verified. Therefore, the author cannot guarantee its accuracy. Any opinions or estimates constitute the author's best judgment as of the date of publication, and are subject to change without notice.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.