This is a follow-on article to An Introduction to Investing in the Bakken.
Bakken oil producers enjoy some of the highest net income margins of all quoted US E&P companies and, for the most part, their stock price performances have been stunning. A quick glance at 12-month charts is revealing: Stock prices doubled or tripled from the lows of mid-2010 to the highs of spring 2011, only for prices to fall back hard this past two months. What caused the big pull-back and will stock prices move forward strongly again?
These questions are relatively easy to answer. The big pull-back was a combination of general stock market softness since the beginning of May 2011, and the fact that Montana/North Dakota experienced the worst spring snow storms and follow-on floods since 1912, which had a highly disruptive effect on well drilling and oil extraction. Indeed, it is only in the second half of June that the Missouri finally peaked in North Dakota and consequently many drillers had to downgrade guidance.
As to whether or not the related stock prices will advance strongly again, the answer is very probably yes -- at least for companies that roll out aggressive drilling programs in 2012 and forecast good profit growth in 2013. Fortunately, by estimating likely 2012 capex budgets for companies at this early juncture, we are already in a position to get a reasonable view of their 2013 profits.
With E&P stocks now in a mid-2011 slump, and recognizing that the second half of the year typically produces the strongest gains, the scene is set for aggressive investors to pick the best stocks and enjoy outsized gains between now and early 2012, by which time analysts’ official earnings estimates for 2013 will appear. And when E&P stocks are riding high in early 2012, the best advice may be to sell everything and repeat this exercise again in summer 2012. Investors can ill afford to be sentimental in a market likely to remain difficult and volatile until consumers have deleveraged.
Although Continental (CLR) is the single biggest lease owner in the Bakken with 864,559 net acres, it is not a Bakken pure play, with about 50% of sales being generated at other locations in the US – Red River, Niobrara, Anadarko Woodford and Arkoma Woodford. See here for more on each location.
Continental is considered by many to be the leading horizontal driller as well as being the largest land rights owner. It has been responsible for its fair share of firsts in the industry, and there is every reason to believe that management will continue to deliver technical and financial improvements in the next few years.
Sales are currently split 65% oil, 35% natural gas and year on year production growth for 2011 has been guided at 35-37%. Within this, Bakken output is estimated to grow over 60% during 2011 and will become an increasing part of CLR’s business with over 70% of the company’s 2011 capex budget aimed at the Bakken.
- Sales: 2010 $1.03bn, 2011 $1.53bn, and 2012 $1.99bn i.e. plus ~100% over two years.
- EPS: 2010 $1.73, 2011 $2.53 and 2012 $3.35 i.e. plus ~100% over two years.
- Balance sheet: At December 31, 2010, Continental had net debt of $920 million -- $300m notes maturing in 2019, $200m notes maturing in 2020 and $400m notes maturing in 2021, and $30m borrowed under a $2.5bn credit facility that had total borrowing availability of $1.5bn.
During Q1 2011, the company raised $660 million cash by issuing 10 million shares. Retroactively applied, this would have reduced the December 2010 net debt to $260 million, i.e. long term borrowings of $900 million and cash of $640 million.
Shareholders’ equity at December 31, 2010, plus the $660m new equity in Q1 2011, would have been $1.868bn, and net debt of $260 million represents gearing of 14%.
Preliminary 2013 EPS view: During 2011, based on analysts' EPS estimates of $2.50 and adding back non-cash expenses, CLR should generate cash from operations of almost $1 billion. Then, in 2012, using EPS of $3.35, cash from operations would be $1.2 billion. With 2011 starting cash of $640 million (including the share issue), and deducting the 2011 capex budget of $1.75m, this leaves over $1 billion available for capex in 2012, without CLR utilizing any of its $2.5 billion credit facility. In summary, CLR can again put together an aggressive capex budget in 2012, perhaps in the region of $1.5 billion with just modest usage of its credit facility. This capex, together with further efficiency improvements (Eco-Pad, etc.), should result in 2013 EPS being in the $4.00-4.25 range.
Its unrivalled Bakken acreage, reputation as a leading horizontal driller, and proven financial performance mean that CLR stock has traded on a forward p/e of between 15 and 20. In early 2012, the forward EPS will be $4.00-4.25 and this should see the shares trade up to $85, about 25% above the current $67 stock price.
The Q2 earnings announcement is expected the first week of August.
Whiting Petroleum (WLL) owns rights to 678,248 net acres in the Bakken, which it acquired early in the cycle and at an enviably low average cost of just $406 per acre. It generates about 65% of sales from the Bakken with the balance coming from Niobrara, Postle Field in Oklahoma and other smaller fields. Over 90% of Whiting’s sales are oil-generated.
Whiting has wells with some of the best economics in the entire Bakken. Its recent Sanish wells have EUR of 950,000 barrels that cost about $8 million, including land rights and derisking costs. Based on $80 oil, this represents a payback of less than one year. By its own calculations, Whiting’s six-month oil output per well is the highest of all producers in the Bakken. While not all the company’s wells are long laterals with paybacks of less than 12 months, it certainly remains true that Whiting is one of the top drillers in the Bakken. In May of this year, Whiting’s operations were interrupted by floods and related difficult conditions. Consequently, the company moderated its guidance for Q2 and the full year.
- Sales: 2010 $1.52bn, 2011 $1.98bn, and 2012 $2.34bn i.e. plus 55% over two years.
- EPS: 2010 $2.71, 2011 $4.71 and 2012 $5.39 i.e. plus ~100% over two years.
- Balance sheet: At December 31, 2010, Whiting had net debt of $980 million -- cash of $20 million, $350 million notes due in 2018, $250 million notes due in 2014 and $200 million borrowed on a syndicated credit facility of $1.1 billion that had total borrowing availability at that time of $900 million.
Shareholders’ equity at December 2010 was $2.53 billion, and net debt of $980 million represented gearing of 39%.
Preliminary 2013 EPS view: During 2011, based on analysts' EPS estimates of $4.27 and adding back non-cash expenses, Whiting should generate cash from operations of $1.2 billion. In 2012, using EPS estimates of $5.38, cash from operations would be $1.4 billion. The company’s capex budget was $760 million in 2010 and increased sharply to $1.35 billion in 2011. With December 2010 gearing at 39%, it is unlikely that Whiting will want to increase its borrowings much over the next year or two. We may even see the company do a share offering; a 10m share offering at $50 per share would drop the gearing down under 20%, free up more operational flexibility and availability under the $1.1bn credit facility, and enable a bigger capex program in 2012. The improved earnings facilitated by a 10m share offering, which is only 9% dilutive, plus the removal of the existing offering overhang, should do wonders for the stock price after the event. But even without such a share offering, Whiting will be able to roll out another large capex program of about $1.2bn or more in 2012 on the back of strong cash from operations during 2011 and 2012; this should help 2013 EPS to come in well above $6.
As a leading driller with large acreage that was acquired at a highly advantageous cost, Whiting can trade on a forward p/e of 15 or higher if the balance sheet gearing is reduced. In early 2012, the forward EPS will be over $6.00; this should see the shares trade around $90. Whiting’s stock, currently trading at $58, is cheap.
The Q2 earnings announcement is expected July 27. This will enable the company to confirm that the negative effect of the floods is confined to history and provide the shares the springboard to move on.
Brigham Exploration (BEXP) owns rights to 378,100 net acres in Bakken which, like Whiting, it acquired early in the cycle and at attractive prices. Although BEXP also has oil/gas properties in the Anardako Basin and in the West Texas Permian Basin, it generates 85% of its sales from the Bakken. And with Brigham generating 80% of overall sales from oil, the company is largely a pure-play Bakken oil producer.
Brigham is the owner of several IP record breaking wells. While one shouldn’t always place great store on IP data, it must be said that Brigham’s recently drilled wells have gone on to produce industry-leading output data over one week, 30 days, 60 days and longer periods. This trend should extend itself over time as more new data rolls in.
Traditionally, Brigham has been very conservative with guidance and has a record of under-promising and over-delivering. On Brigham’s website, investors can read of the company estimating its wells having EUR of up to 700 Mboe and a payback as short as 1.0 years. Though this is obviously very good, it still doesn’t quite stack with information from other drillers that have somewhat lower oil production figures over the various time horizons but that still cite higher EUR. This situation suggests Brigham's being too conservative, and it appears that, in reality, BEXP is achieving a payback on its latest wells of less than a year. Such a short payback is a tremendous springboard for strong cash generation and continued growth.
- Sales: 2010 $170 million, 2011 $429 million and 2012 $801 million-- up 370% in two years.
- EPS: 2010 $0.60, 2011 $1.43 and 2012 $2.35 i.e. plus 290% in two years.
- Balance sheet: As of December 31, 2010, Brigham had net debt of $53 million -- cash and investments of $247 million and $300 million notes payable in 2018. In May 2011, the company raised $300 million cash by issuing a further $300 million notes due in 2019.
In addition, BEXP has a $600 million senior credit facility with a borrowing base of $325 million, which was unused as of December 2010. Shareholders’ equity at December 2010 was $593 million, and net debt of $53 million represents gearing of 9%. By the end of 2012, shareholders' equity should be greater than $1 billion and would enable higher borrowings and net gearing within comfort.
Preliminary 2013 EPS view: During 2011, based on analysts' EPS estimates of $1.43 and adding back non-cash expenses, Brigham should generate cash from operations of $370 million. Then, in 2012, using EPS estimates of $2.37, cash from operations would be $550-600 million. The company’s capex budget was about $400 million in 2010 and was increased to $693 million for 2011 before being revised up to $835 million in May. With strong cash from operations in 2011 and 2012, plus about $200 million by gearing up the balance sheet to just 20% of shareholders funds by the end of 2012, Brigham should be able to roll out another large capex program of about $800 million or more in 2012. This sizable budget should help 2013 EPS to be in the region of $3.50.
These figures, though admirable, don’t tell the full story. Brigham has recently been beating street estimates by a very wide margin; see here. Even in Q1 2011, with highly disruptive weather conditions, BEXP managed to top street estimates. It looks like the company will at least match if not beat estimates again in Q2 2011, at a time when competitors operating in the Williston have had to pre-announce due to operations suffering at the hands of floods, power outages, road closures, etc.
As already mentioned, well paybacks cited by BEXP appear to be too conservative. Related to this is the fact that Brigham announced in May 2011 that it was accelerating drilling activity and that the company was six months ahead of previously announced guidance. This positive development appears to have been lost amid the May and June newsflow about floods, road closures, etc. With the floods out of the way, Brigham is now free to deliver strongly rising sales and earnings during the remainder of 2011. Presumably analysts will also have to improve their estimates for the balance of 2011 and 2012.
There is every reason to value BEXP on a forward p/e in the 15-20 range. In early 2012, when earnings estimates for 2013 appear, the stock should trade around $60. Currently at $31, BEXP is compellingly cheap for what is an excellent pure-play oil company with large blocks of contiguous Bakken acreage and assured strong growth.
The Q2 earnings announcement is expected the first week of August. While Brigham’s operations were negatively affected by floods in May, the company was still able to confirm that Q2 guidance remained within range. The Q2 earnings event should be positive and investors can anticipate hearing more about the business acceleration.
Disclosure: I am long BEXP.
Additional disclosure: I may also take a position in WLL.