Whiting Petroleum: A High Risk, High Reward Play After Acquisition

Aug.26.14 | About: Whiting Petroleum (WLL)

Summary

Whiting Petroleum will surpass Continental’s production in the Bakken shale region after the acquisition of Kodiak Oil & Gas.

While the acquisition will increase production to more than 100,000 barrels per day, it will also bring a huge debt load of $2.25 billion.

Whiting Petroleum’s financial health will be impacted after the acquisition, with liquidity ratios declining and leverage increasing.

Whiting Petroleum Corp. (WLL) is an oil and gas producer involved in the exploration, acquisition and development of oil and natural gas fields in the U.S. Being limited to one geographical region has not hindered the company's performance as it has reported an almost 75% growth in its share price during the last 52-weeks. On the other hand its competitor Cabot Oil and Gas (NYSE:COG) has followed a very different trend and has reported almost no growth during the same time period as shown below.

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Becoming Number One

Continental Resources Inc. (NYSE: CLR) was considered to be the largest producer in the Bakken shale oil formation. But Whiting seems set to surpass Continental with its acquisition of Kodiak Oil & Gas (NYSE: KOG).

The deal is valued at $6 billion and includes Kodiak's net debt of $2.25 billion. Whiting plans to pay this to its shareholders through the issuance of 0.177 shares of Whiting for every Kodiak share owned. The stock price of Whiting Petroleum was $78.54 at the time of the deal's announcement which means that Kodiak's shareholders will get $13.90 per share of value based on a 0.177:1 share ratio. According to Bloomberg this is a 5.1% premium to the weighted average price of Kodiak's share for the last 60 trading days.

  1. Pros

The combined production of Whiting and Kodiak in the Bakken shale for the first quarter of 2014 was more than 107,000 barrels of oil equivalent per day while Continental Resources produced 97,500 barrels of oil equivalent per day. Whiting's CEO has claimed that the acquisition will increase production by 50% next year. The deal will also increase the company's acreage to 855,000 in the Bakken formation, exceeding Exxon Mobil (NYSE: XOM), and will provide 3,500 new drilling locations. The added acreage will also increase the company's total proven reserves by 167.3 million barrels of oil equivalent.

  1. Cons

Looking at the fundamentals of the two companies we can see that Kodiak had an unfavorable liquidity position. Its current ratio was sitting at 0.81x and quick ratio was 0.71x in the most recent quarter. The quick ratio shows that Kodiak has insufficient cash to pay off its short term obligations. On the other hand Whiting had a strong liquidity position as both its quick and current ratios are greater than 1. After the acquisition Whiting will absorb all of Kodiak's current liabilities as well which means that the new liquidity ratio may fall below 1 as shown below. The reason for expecting this downside is that neither Whiting nor Kodiak have posted strong net cash inflows from operations in the past year. In fact Whiting put on more debt to increase its cash position in the second and third quarter of last year.

Whiting Petroleum

Kodiak Oil & Gas

Post-Acquisition

Current Ratio (MRQ)

1.13

0.81

1.03

Quick Ratio (MRQ)

1.08

0.71

0.99

Debt to Equity Ratio

0.67

1.84

1.21

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The deal is expected to bring a debt of $2.25 billion into Whiting's consideration. The company already has its own massive debt burden of $2.65 billion while its debt to equity ratio is 67%. On the other hand Kodiak has a $2.2 billion debt burden at a debt to equity of 184%. The post-acquisition debt to equity ratio may reach 0.95 or 95% due to Kodiak's high dependence on debt as the total long term debt will reach approx. $4.9 billion (currently Whiting has a long term debt of $2.65 billion and the acquisition will add $2.25 billion). At the same time the total shareholders' equity will increase to $5.16 billion. From this we can calculate the long term debt to equity ratio.

A higher debt to equity ratio will lead to a higher interest rate because the business will be exposed to high risk. This means that we can expect higher interest expenses leading to a weaker bottom line. The acquisition of Kodiak will increase Whiting's production, reserves and acreage but will also put pressure on its financial statements. It remains to be seen whether this deal is in favor of Whiting or Kodiak and time will tell if the financial concerns can be overcome through enhanced operations. From the present scenario it appears that Kodiak shareholders are getting more than Whiting shareholders.

Fundamentals

Currently Whiting Petroleum is strong in terms of liquidity as both current and quick ratios are above 1 but its debt to equity ratio of 0.67 or 67% is of concern as a high debt ratio entails more interest expense and leads to narrow profit margins. This might be one of the reasons why the company's net income fell to $366 million in 2013 from $413 million in 2012 even though revenue grew by 25% year over year.

Upon comparison of these results with its peer and currently largest producer, Continental Resources, we can see that Whiting is better off. Continental's current and quick ratio lags behind at 0.79x and 0.71x respectively. This shows that Continental is short on cash to pay off its short term obligations. Furthermore, its balance sheet holds a greater portion of debt with a debt to equity ratio of 1.21, or 121%, which is not a good sign as it leads to narrow profit margins.

Whiting Petroleum

Continental Resources

Current Ratio

1.31

0.79

Quick Ratio

1.08

0.71

Debt to Equity

0.67

1.21

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Conclusion

Whiting Petroleum has posted better financial results than Continental Resources before the Kodiak acquisition, even though Continental had an edge due to its greater production. As discussed above Kodiak will increase Whiting's production, promoting it to the largest producer in the Bakken formation and also increasing potential reserves. This all sounds promising but the company will have to address financial concerns that can hinder its long term growth if it wants to reap maximum benefits from this acquisition. Its debt level will increase greatly and lead to high business risk. It will also put pressure on Whiting's currently stable liquidity position.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.