- Pioneer Natural Resources posted disappointing second-quarter results.
- While results are typically volatile, hedging losses appear quite large, bigger than should be expected.
- While I see the long-term potential, I am still left with many valuation questions to be answered.
Investors in Pioneer Natural Resources (NYSE:PXD) were not happy at all with the soft second-quarter sales and unexpected high hedging losses.
Shares have lost some 5% on the back of the earnings report on what has generally been a down day for energy names amidst a continued correction in oil prices. Despite the near-term pullback, long-term returns remain unmatched given continued production growth and further growth appeal going forward.
Having some questions regarding the lower profitability at the moment and the firm's hedging practices, I remain a bit cautious rather than simply buying on the most recent dip.
Second Quarter Highlights
Pioneer Natural Resources posted second-quarter revenues of $953 million, a 17.8% decline compared to the same period last year. This shortfall in revenues came as a shock to the market with sales for the first six months of the year being roughly equal to the comparable period last year.
On the bottom line, the firm posted earnings of merely a million which compared to last year's earnings of $337 million, which were aided by a $183 million gain on the disposition of assets.
The company posted adjusted earnings as well. Adjusted earnings exclude unusual items, including mark-to-market derivative losses, and came in at $195 million, or $1.35 per share. Analysts were anticipating adjusted earnings of about $1.28 per share, yet the lack of GAAP earnings triggered quite a disappointment among investors.
Looking Into The Numbers
A lot of items impacted the results over the past quarter, making the headline results quite deceiving. Revenues derived from sales of oil and gas were up by nearly 23% to $959 million. Sales were furthermore aided by the sale of purchased oil and gas from other companies which resulted in revenues of $205 million versus just $56 million last year.
Offsetting have been sizable hedging losses of $218 million versus a $144 million contribution last year. Gains on the sale of assets came in at just $4 million compared to a $183 million gain as reported last year.
All of this resulted in income from operations before tax of just $92 million versus a $523 million gain recorded last year. Even adjusting for the sizable asset gains on sales last year, earnings would be down significantly. Now, subtract losses of $57 million from discontinued operations and earnings are essentially breaking even. Discontinued operations for the quarter encompassed the operations in Alaska and the Barnett Shale which the company sold for a combined value of $495 million.
On the operational side, production came in at 183,000 barrels of oil-equivalent per day, an increase of about 11,000 barrels compared to last year. Based on the current growth trajectory, full-year production growth is now seen between 16 and 19%. This comes at an expense, as this year's capital budget is pegged at $3.3 billion, a very sizable amount for the company the size of Pioneer.
Combined with anticipated future growth, this should allow for 2018 production to be doubled compared to annual production being realized in 2013.
Looking Into The Next Quarter
For the current third quarter, Pioneer sees production between 181,000 and 186,000 barrels of oil-equivalent per day, excluding the Barnett Shale and Hugoton contribution which are now classified as discontinued operations.
At the end of the quarter, Pioneer held about $445 million in cash and equivalents, while its larger debt position results in a net debt position of about $2.2 billion.
With some 143 million shares outstanding, and shares trading around $210 per share, equity in the business is now valued at roughly $30 billion. On a trailing basis, the firm has now posted revenues of about $3.9 billion while incidental items caused it to post a loss.
Shares trade at 7-8 times annual revenues at the current rate and the lack of topline growth has been disappointing for investors, combined with the disastrous developments on the bottom line.
A History Of Growth
Long-term investors in Pioneer have hit the jackpot. The high cost of production and expected long-term growth creates quite volatile returns, but long-term investors have been doing great.
Shares have peaked at around $75 in 2008 before the financial crisis hit after which shares fell to lows of $10-15 a year later. From this moment onwards, shares have seen a steady move upwards to highs of $235 in recent weeks after which a recent 10% correction has occurred.
Underlying this spectacular price movement has been a relatively modest increase in topline sales which rose from $1.8 billion in 2004 to roughly $4 billion per annum by now. The company has demonstrated real earnings power in the past, yet one-time items and depreciation charges have hit the bottom line more recently. Most of these items have been non-cash items, resulting in still very healthy operating cash flows of over $2 billion.
Yet more cash is needed to allow production to double again by 2018 with the company having set a $3.3 billion capital expenditures budget for this year. In the Spraberry/Wolfcamp area alone, more than $2 billion will be invested this year.
I have a few problems with the valuation and the latest earnings report. For starters is the real issue of sustainable earnings growth. While I acknowledge that the company is very valuable if it can increase production to 350-400 thousands barrels in a year or four down the road, it is already valued at $30 billion. In optimistic scenarios, Pioneer actually sees production to total a million of barrels of oil equivalent a decade from now, driven by the increased adoption of horizontal drilling.
The reason why the market attributes such a large valuation to the company undoubtedly has to do with the company's estimates of 10 billion barrels in oil-equivalent of recoverable resource potential in the Spraberry/Wolfcamp area. This values the company's estimated reserves at just $3-$4 per barrel, a huge discount compared to some of its competitors. Yet this is based on ¨promises¨ and future potential not by the current performance or cash flows.
The other and more urgent issue are the huge derivative losses for the quarter. Given the production of 183k of barrels of oil-equivalent per day, total production for the quarter was about 16-17 million barrels. Yet the company posted pre-tax hedging losses of $218 million for the quarter, corresponding to losses of $13-$14 per barrel of oil-equivalent. This is quite a lot especially in the light of the limited volatility of oil in recent times.
As such I am in doubt. Growth potential is here and the reserve estimates are simply astonishing. Yet growth will be very capital intensive, even as the balance sheet is still in reasonable shape. On the other hand, I wonder what the true earnings potential of the company is. The recent decision to be more tolerant for US condensates exports would be helpful for a start. This could allow for oil markets to potentially narrow the discount of WTI versus Brent, which largely has been the result of the US energy revolution. Pioneer would be one of the most prominent potential beneficiaries of such a move.
So based on the historical performance, Pioneer has always been valued a bit rich, while the huge resource potential does continue to create appeal to investors. Yet I am worried a bit about current growth, volatile and lower recent earnings and the company's hedging practices. As such I have no compelling arguments to either operate on the long or short side, continuing to watch the action from the sidelines for now.