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Summary

  • Penn Virginia has shifted its strategy from a natural gas weighted company to an Eagle Ford play.
  • Thanks to this transition, the company's stock has risen more than 200% over the last 12 months.
  • The company's current valuation is not a compelling buying opportunity.
  • There are currently other E&P companies to invest that combine much less risk with much higher potential reward than Penn Virginia.

Introduction

One of the E&P companies that got the message early and shifted its investment and production focus away from natural gas and toward higher-margin oil and NGLs, is Penn Virginia (NYSE:PVA). During this process that started in mid-2010, Penn Virginia cut a years-long dividend and transformed itself from a predominantly natural gas producer to an oil and NGL weighted producer.

This transition has been fueled by the Eagle Ford Shale. 2013 was a successful year for the company, not only with a sizeable Eagle Ford Shale position that added a significant number of drilling locations, but also with a drilling program that has generated attractive rates of return. This success has been reflected at the stock performance which has risen approximately 300% since May 2013, as shown below:

(click to enlarge)

This performance was also supported recently by the fact that Soros Fund Management revealed a 9.18% ownership stake in the company. The stake was increased from the 5,829,845 shares that were disclosed in another filing in February 2014. Penn Virginia accounted for a 0.47% position in the fund's Q4 2013 portfolio. According to that filing, the fund believes Penn Virginia "should explore strategic alternatives as a means to enhance or maximize shareholder value."

Has this rally legs? Is there any significant upside left? Can Soros unlock further value from the current levels? This is what I will try to figure out in the next paragraphs.

Balance Sheet Concerns Will Remain By Year End

After acquiring approximately 40,000 gross acres from Magnum Hunter (NYSE:MHR) in April of 2013, Penn Virginia has built up a position of approximately 84,300 net acres (as of today) in the Eagle Ford shale, which has been fueling the company's growth over the last 12 months.

This expansion in conjunction with successful downspaced drilling have helped the company increase its estimated drilling inventory by about 26% from 895 just a few months ago to the current estimate of approximately 1,100 gross drilling locations. The company's goal is to increase acreage position to approximately 100,000 net acres by year‐end.

The increased frac intensity is also another factor that has increased the company's oil production, helping both the gross profit margin and revenues grow over the last two years.

Nevertheless, Penn Virginia has been losing a lot of money over the last 5 years and is still in the red zone. It lost $143.1 million in 2013, and the impairments is the primary reason behind these significant losses. Since the company still holds a considerable position in natural gas weighted properties, the impairments will continue to weigh heavily on the balance sheet, assuming the natural gas price does not recover significantly over the next couple of years.

In fact, I do not expect the natural gas price to rise substantially by 2015. When the natural gas price hit $6/MMbtu in February 2014, I wrote an article and presented the 12 fundamental reasons why that sky high natural gas price was not there to stay. Several opinion makers were very bullish on the natural gas price back then, including Dennis Gartman who said publicly that the natural gas price could even rise to $10/MMbtu. I put my money where my mouth was and shorted the natural gas at ~$6.1/MMbtu. Nat gas price currently stands at approximately $4.3/MMbtu and my bearish article is here.

Penn Virginia's operating cash flow was only $36.7 million in Q4 2013. Since the company's CF for 2013 was $261.5 million, the Debt to Cash Flow ratio (pro forma the latest disposition) is also high and stands at approximately 4.5 times. It is clear that the company is not out of the woods and Penn Virginia remains a debt-heavy company, as it used debt to fuel its buying spree in the Eagle Ford Shale.

The preliminary 2014 guidance range for capital expenditures was $510 to $540 million. 2014 CapEx is now expected to be $575-$640 million, which is approximately $90 million higher than the preliminary 2014 guidance provided earlier. 86% of 2014 budget is for drilling and completion and 98% of capital investment for 2014 is in Eagle Ford development.

Thanks to this business plan and with IRR of >50% (at $90 WTI price), Penn Virginia expects to grow its 2014 oil production by approximately 70% and hit approximately 27,500 boepd (75% oil/liquids) by year end.

Nevertheless, the company's long term debt does not seem to drop any time soon. The company estimates that the outstanding debt will be approximately $1.43 billion by Q4 2014, because it will keep borrowing money during the remainder of the year. According to the CEO: "We expect to fund our capital programs over the next three years with increasing operating cash flows, net proceeds from asset sales and borrowings under our revolver, with the ongoing goals of decreasing our leverage ratio and, therefore, increasing our liquidity over this same timeframe." In other words, the company expects to reduce its leverage ratio by increasing its operating cash flow, but this remains to be seen.

The "New Play" And The Asset Sales

As mentioned above, the company has shifted away from a gas-dominated acreage portfolio to a liquids player, and will continue its efforts to increase its oil production over the next couple of years. However, there is a significant funding gap for 2014 and Penn Virginia has to sell assets to close it in order to fund its drilling program in 2014. The first sale has already been completed, and Penn Virginia sold its Eagle Ford gas gathering and gas lift systems for $94 million in January 2014.

According to the corporate presentation, the Selma Chalk and Granite Wash assets will most likely be sold by this summer. Selma Chalk/Mississippi assets have proved reserves of 14.2 MMboe and production of 2,000 boepd (Q4 2013). Granite Wash assets have proved reserves of 10.6 MMboe and production of 2,200 boepd (Q4 2013). In total, these two assets include proved reserves of approximately 26 MMboe (~20% oil/liquids) and produce approximately 4,200 boepd (~26% oil/liquids). I estimate Penn Virginia will not raise more than $150 million from these two assets.

Penn Virginia also expects to monetize the rights to construct oil gathering system for its Eagle Ford properties in 2014, but the estimated proceeds from this sale are currently unknown.

Last but not least, Penn Virginia's exploration strategy has not changed and the company continues to look for the next "new play". According to the latest presentation, Penn Virginia keeps looking for new opportunities, with an early entry into a new play at modest lease acquisition cost. Potential opportunities would include resource and unconventional play types with a horizontal drilling application. Assuming this expansion takes place by the end of 2014, the company's debt will most likely rise further and the D/CF ratio will deteriorate.

The Valuation

After this rally, let's see now where Penn Virginia stands from a valuation perspective. If nothing else, the calculations below serve as a reality check and help any investor realize the big picture. And this is why those investors who really want to maximize their returns take these calculations very seriously and act accordingly. But those investors who are in denial will most likely record significant losses or end up holding stocks that will under-perform over the coming months.

Here are the peers:

1) Halcon Resources (NYSE:HK) whose core assets are in the Williston Basin (Bakken/Three Forks), in East Texas (Eagle Ford Shale) and in Mississippi/Louisiana (Tuscaloosa Marine Shale).

2) Kodiak Oil (NYSE:KOG) has its core producing properties in the Williston Basin of North Dakota. Kodiak Oil is a pure Bakken/Three Forks play.

3) Bonanza Creek Energy (NYSE:BCEI) whose assets and operations are concentrated primarily in the Rocky Mountains in the Wattenberg Field, focused on the Niobrara oil shale, and in southern Arkansas, focused on the oily Cotton Valley sands.

4) Sanchez Energy (NYSE:SN) whose core assets are in Texas (Eagle Ford Shale) and in Mississippi/Louisiana (Tuscaloosa Marine Shale).

These peers have not been selected accidentally of course. All of them are intermediate and oil-weighted producers whose the producing assets are located onshore US.

1) Per EV/Production: Here is the table with the first key metric:

Company

EV

($ million)

2014

Production (*)

(boepd)

EV

---------

2014 Production (*)

($/boepd)

Penn Virginia

2,300

26,000

(75% oil/liquids)

88,462

Bonanza Creek

Energy

2,180

24,000

(72% oil/liquids)

90,833

Sanchez Energy

2,340

22,000

(86% oil/liquids)

106,364

Halcon Resources

4,960

40,000

(90% oil/liquids)

124,000

Kodiak Oil

5,710

43,000

(90% oil/liquids)

132,791

(*): Based on the latest corporate guidance.

2) Per EV/1P Reserves: Here is the table with the second key metric:

Company

EV

($ million)

Proved Reserves

(MMboe)

EV/1P

($/boe)

Penn Virginia

2,300

136.3

(61% oil/liquids)

16.87

Bonanza Creek

Energy

2,180

69.8

(66% oil/liquids)

31.23

Kodiak Oil

5,710

167.3

(83% oil)

34.13

Halcon Resources

4,960

136

(91% oil/liquids)

36.47

Sanchez Energy

2,340

58.7

(88% oil/liquids)

39.86

3) Per EV/EBITDA: Let's check out the table below with another key metric:

Company

EV

($ million)

2014 EBITDA (*)

($ million)

EV

---------

2014 EBITDA (*)

Bonanza Creek

Energy

2,180

460

4.74

Sanchez Energy

2,340

460

5.09

Penn Virginia

2,300

450

5.11

Kodiak Oil

5,710

870

6.56

Halcon Resources

4,960

650

7.63

(*): Estimate, based on the company's production guidance.

4) Per D/CF Ratio: The higher this ratio is, the weaker the balance sheet is. To find the net debt of the companies mentioned, I will take into account the working capital deficiency, if any. From this perspective, Bonanza Creek has the strongest balance sheet while Halcon Resources has the weakest balance sheet, as shown below:

Company

Net Debt

($ million)

(as of Dec 2013)

2014 CF (*)

($ million)

Net Debt

---------

2014 CF (*)

Bonanza Creek

Energy

420

550

0.76

Sanchez Energy

845 (***)

370

2.28

Kodiak Oil

2,320

740

3.14

Penn Virginia

1,200 (**)

340

3.53

Halcon Resources

3,100

550

5.64

(*): Estimate, based on the company's production guidance.

(**): Pro forma the sale of the gas gathering and gas lift systems.

(***): Net Debt (as of today), based on the company's latest presentation.

From a debt perspective, Penn Virginia is not in an enviable position. Penn Virginia has the second worst balance sheet after Halcon Resources which made a very risky bet recently, as I analyzed in my article here.

Based also on the calculations above, it is obvious that Halcon Resources trades at very high key metrics ($/boepd, $/boe, EV/EBITDA) at the current price of $4.48, although it has the weakest balance sheet among its aforementioned peers.

My Takeaway

After the rally of the last 12 months, Penn Virginia's current valuation is not "a low hanging fruit" any more. Actually, the stock has already run too much although the company's weaknesses can be seen in multiple areas, such as its continuing losses, its high debt to CF ratio, its high debt to equity ratio, compared to the peers above.

As such, do not let some relatively low key metrics ($/boepd, $/boe) fool you, because the competitors' production and 2P reserves are more oil-weighted than Penn Virginia's.

Furthermore, Penn Virginia is losing money while most of the aforementioned peers are profitable and have a much healthier balance sheet (Bonanza Creek, Sanchez Energy, Kodiak Oil). This is the big picture. And based on this big picture, Penn Virginia is not a compelling opportunity at the current levels compared to its peers above.

I do not know whether Penn Virginia will "explore strategic alternatives as a means to enhance or maximize shareholder value". But I do know very well that there are currently other companies to invest in the oil and gas sector. These companies combine much less risk with much higher potential rewards than Penn Virginia.

For instance, a grossly undervalued growth producer is Nighthawk Energy (OTCQX:NHEGY) that operates close to Bonanza Creek Energy in the Denver-Julesburg Basin in Colorado. Thanks to its oily wells (100% light oil) that have very short payouts (3 months), Nighthawk Energy has been growing as fast as Kodiak Oil and Sanchez Energy were growing during 2010-2012 and 2012-2013 respectively. As a result, an investor can say that Nighthawk Energy is a Kodiak Oil or a Sanchez Energy in the making. There is a detailed analysis about Nighthawk Energy in my yesterday's article that was selected as a "Top Idea" by SA's PRO Editors, as shown here.

After all, I believe Penn Virginia's rally will not continue over the next months, but I expect it to be a very bumpy ride instead.

Disclaimer: The opinions expressed here are solely my opinion and should not be construed in any way, shape, or form as a formal investment recommendation. Investors are reminded that before making any securities and/or derivatives transaction, you should perform your own due diligence. Investors should also consider consulting with their broker and/or a financial adviser before making any investment decisions.

Source: Penn Virginia Corporation: Has George Soros Arrived Too Late To The Party ?