What Is Next For The Shareholders Of Carrizo Oil And Gas?

| About: Carrizo Oil (CRZO)


The company sold more than five million shares and paid off its bank line completely.

The company has bids out for small acquisitions that would add to its acreage position and possibly production.

Management has changed this company from primarily a gas producer to primarily an oil producer and increased the company profitability since 2010.

The company has low Eagle Ford costs (its primary acreage and largest production) and can focus on the most profitable part of its acreage for several years.

This management emphasizes cost cutting, profitability, and small well chosen acquisitions. Therefore it has more ways to survive the downturn than many competitors.

Back in October, 2015, the Carrizo Oil & Gas (NASDAQ:CRZO) announced an offering of common stock. The company received $37.80 per share from the offering. That was enough to pay off the revolving credit line of $117 million and put roughly $100 million on the balance sheet. The numbers are approximate because the company never clearly stated whether or not the over-allotment was exercised by the selling agent. The proposed long term debt after the sale of the stock was $1,254 million, shareholder's equity was $1,487 million, and cash $92 million if the over-allotment option was not exercised.

The amount per share received by the company was a discount to the price of the common stock trading at the time, and was net of the expenses of selling that block of stock. It was a bearish statement about the future price of the common stock by company management. Companies usually don't sell stock unless they think that they are getting a good price for their stock at that time, therefore investors should expect the price of the common stock to drop, and indeed it has. At the close of the market on Thursday, January 14, 2016, the price of the company's common stock was $21.87. So the stock price fell about 42% from the $37.80 price that the company received from the offering. With the price of oil hitting one new low after another, maybe its time to look at this stock and see if there is any hope for a recovery.

As a result of the stock offering the borrowing base remained unchanged at $685 million, and it is now unused. The fact that the borrowing base did not decrease and that the covenants were relaxed is a major accomplishment for this company as well as a statement of faith in the company by the lenders. The company also announced a small acquisition at nearly the same time as the offering. Plus it has bids on more properties although there is no guarantees that any of the bids will be accepted. So the company apparently intends to put that cash to work as quickly as possible (as well as the credit line possibly).

Cash flow from operating activities was $118 million for the three month period and $284 million for the nine month period before changes in working capital. The changes in working capital were predictably negative, as companies have a tendency to "pay things off" when they "know" a significant amount of cash is coming in the door. Therefore the figures after the working capital and other operational adjustments are $98 million for the three month period and $290 million for the nine month period. The annualized cash flow figure is roughly $387 million. When the long term debt above (after the offering) is divided by this figure, the ratio is a little more than three-to-one. That is a fairly comfortable figure by anyone's standards. So if this company wants to make acquisitions, at what is likely to be the bottom of the market, it probably has the blessing of its lenders to do so, and it's one of very few companies in a position to make acquisitions.

The company increased its oil production guidance to a 21% growth rate for the year from the previous year. Oil production is expected to increase 3% more (up to 8%) from third quarter. It also added four completions to the fourth quarter, has more non-operated activity than predicted, and its new well performances are exceeding company expectations. This combined with the hedging may well make the annualized cash flow figure reasonable. Plus the third quarter cash flow was about 20% above the cash flow figure from operations of the first two quarters before the company paid some current accounts. The annualized figure takes into account the lower first two quarters and should hold up despite the lower oil and gas prices. At the very worst, should the assumptions be too optimistic, the ratio goes to four-to-one which is still a comfortable figure. That last ratio would represent a cash flow of $300 million which would mean no cash flow in the fourth quarter. While that is highly unlikely it is a good floor figure for 2015.

Also the company has made a small acquisition since the end of the third quarter that added a little bit of production and has bids out for more. Should one of these bids be a winning bid that could also change the outlook for cash flow in 2016.

This management has shown some incredible flexibility. A few years back, this company was focused on gas production. Now the company has a much more liquids weighted production and lower costs. So it is in a much better position to endure the downturn than many of its competitors. Plus the company is more profitable than it was a few years ago by management's own calculations.

Click to enlarge

Source: Goldman Sachs Global Energy Conference Presentation By Carrizo Oil And Gas, January, 2016.

From the presentation, the company shows some of the lowest breakeven points by project out there for the Eagle Ford. Later on, some of the projects that are just getting started and don't have great costs can be put off (or slowed down) until the commodity prices rally a little bit. The company stated that it has several years of prospects on its lowest cost leases and has few commitments to hold its leases.

Plus the company did some additional hedging this summer that resulted in a significant amount of its production hedged at $60 per barrel of oil (roughly). Click to enlarge

Source: Goldman Sachs Global Energy Conference Presentation By Carrizo Oil And Gas, January, 2016.

From the presentation, thanks to the moves made this summer the company has a significant amount of protection from the currently very low commodity pricing. It does not have the best hedging program by a long shot, but the company still has significant cash flow protection with the hedging it has done. That amount of protection will allow for a fair amount of cash flow despite the fact that the commodity prices are currently below the Eagle Ford breakeven amount. Plus the company is working to lower its costs still further both by increasing recovery amounts (initial flow rates higher and more oil sooner with lower decline rates), and decreasing the drilling costs and times (and any other operational costs it can decrease). There is a very good chance that the costs on the first slide will be lowering significantly throughout the current year.

While the company has more than 60% of its oil production hedged for the year, in 2017, it currently has less than 10% of its production hedged. Should prices remain low into 2017, then the company will have to rely on operating cost reductions, well chosen acquisitions, and its line of credit to survive. While 2017 does not currently present a pretty picture, there is still a year to go through before that has to be faced. This past summer prices rallied enough for the company to put hedges in place for more than half of its production for this year and that could happen again in the current year.

The lower commodity prices will definitely decrease cash flow, however, the operating results will offset some of the effect, and a few carefully chosen acquisitions could change the ratios dramatically. A lot of distressed property is coming on the market and this company has the credit line to take advantage of those distressed sales. The company will reduce its capital expenditures in the current year until commodity pricing improves, and its cash flow can decrease quite a bit because the ratio above was very comfortable, so there is absolutely no need to panic about the currently low commodity pricing. Capital expenditures to maintain production are a small fraction of what they were just a few years back and still declining. If anything the company is posed to benefit from the current low pricing. If operations manage to cut costs to the point where new wells make money, then the company has the choice of ramping up production if it chooses to do so.

Click to enlarge

Source: Goldman Sachs Global Energy Conference Presentation By Carrizo Oil And Gas, January, 2016.

From the presentation, the company got a relatively late start in the lease acquisition game (started around 2010 in earnest) because it was primarily a gas producer until a few years ago. Despite that late transition, it finds itself with some relatively good leases in decent low cost places to be. That is definitely a tribute to management. Plus as noted on the slide, the company has a lower breakeven on the Eagle Ford leases than is shown for the average breakeven on the slide. That is another sign of both good and tight fisted management. There is a long list of companies that acquired acreage late, and then had second best leases (or worse), and terrible costs or low recovery rates.

The company currently shows a breakeven cost in the Niobra of $49 WTI range. This is currently fairly high when compared with other operators in other articles, nonetheless, the company is just getting started on this acreage, and will probably drill very slowly until it is satisfied with the cost (that will probably be a lot lower and match the competition).

Similarly, the company has significant acreage in the Delaware Basin, but again was just getting started developing the leases when oil prices dropped. So expect the company to proceed slowly if at all until it finds a profitable cost. It has very few lease commitments and can therefore emphasize the Eagle Ford (which it knows the best) for the next few years if it needs to do that, and allow the other leases to wait until it can drill profitably. The Eagle Ford well costs have decreased from $7.5 million a year ago to a current cost of $4.6 million, and investors can expect more savings in the future. So it makes sense for the company to concentrate on this acreage, and manage the other leases opportunistically.

At the Capital One Securities Conference, the presenter stated that the company could hold production flat for about $250 million (very roughly) or so. With a capital budget of $400 million the company would grow production more than 10%, but the current low commodity prices make this budget very unlikely right now. These are numbers that were dreamed about just a few years ago.

The company increased oil production, which it is emphasizing, 18% over the previous year and six percent over the previous quarter, despite reducing the capital budget throughout the year as commodity prices declined. Total production increased seven percent over the previous year in the third quarter. Most of the growth came from the Eagle Ford which more than offset declines in the Marcellus shale. This is exactly what an investor would expect given the company's emphasis on oil production.


The company has enough locations in the Eagle Ford with low breakeven costs for it to be able to maintain its production for at least a couple of years. Further it has the hedging and liquidity to survive the current downturn. While further cost cutting and operational improvements are needed to make the Eagle Ford wells profitable at current pricing, it is significantly possible for that to happen. However, if prices remain below breakeven, the company has at least one year of significant hedging protection and a robust credit line to help it get through the current downturn.

The company has made one small acquisition, and is on the prowl for other acquisitions that are near acreage it currently owns. Given the number of financially stressed firms, the ability to grow in this fashion is very likely. A few well chosen acquisitions could easily enhance the future of the company. In the current environment, its lenders may even bring a few proposals to the company of leases they do not want to operate. While the current ratio is below one-to-one, the company has the revolving credit line to use should it need to pay some accounts payable. So the weak current ratio is probably not a concern.

In any event, this company is in a far better position than many of its competitors. The cash flow ratio is not bad for 2015, and the hedging should keep the ratio reasonable in 2016. The hedging program should reduce the effects of lower commodity pricing, it has a position in some of the lowest cost regions of the country, and it has a vigorous cost cutting (and production enhancing program in place). Now admittedly, if lower prices persist through 2017, the company will have problems unless it gets its costs low enough to make decent money with low pricing. The company still has the gas properties so should gas prices rally first the company can shift its drilling to the Marcellus Shale properties.

Management has shown the ability to shift the company to greater profitability in the past when the company shifted from mostly gas production to mostly oil production, so expect management to be nimble in the future (and very focused on cost cutting and profitability).

Click to enlarge

Source: Goldman Sachs Global Energy Conference Presentation By Carrizo Oil And Gas, January, 2016.

From the presentation, the company liquidity is quite good, even with the financial leverage from the long term debt, and the company has no significant payment requirements for the next few years. The banks appear satisfied with the company performance and they relaxed the restrictive covenants for two years.

The bank debt is not due for several years and therefore decisions about paying off the debt or refinancing it can be put off. Most likely the company would wait for a favorable time between now and 2019 to pay off the debt. The company has a lower "B" rating which does make it speculative according to the rating agencies.

Right now there is a lot of concern about world economic growth which has contributed to the current weak oil price environment. China is making the news with its problems about its weak economic activity, and an economic downturn would prolong low oil and gas prices. However, the latest downturn, in 2008, depressed prices for a year, and despite all the bad news, the economies don't show the signs of the current growth problems being anywhere nearly as bad. However, should there be a prolonged and severe downturn, it would have dire consequences for the company and the industry. The company is hedged for this year, but that hedging drops to 10% of production next year, and the credit line would help them make it to eighteen months. After that the company would definitely struggle.

Expect the company management to continue to wisely steer the company through this downturn with more financial options than many of its competitors. This management has already proven its financial savvy through the financial structure shown above so investors can expect more deft handling in the future. The financial structure and the low cost operating structure have given this company several options to survive in the immediate term and prosper in the long term. This management is definitely above average.

This company could grow by acquisition, like Cardinal Energy LTD. (OTC:CRLFF). Or maybe operations will come through with enough improvements to make production expansion a profitable possibility. In the worst case scenario, the company hunkers down, and maintains production until commodity prices improve. It is in a far better position to do that than many of its competitors, although an extended downturn of more than eighteen months could hurt it. That sale of stock in October, may have been more important to this company than many realize. Clearing the revolving credit line is usually a wise move in a downturn and so is increasing the cash balance. The company will provide some guidance within the next month or so to deal with the recent price volatility. Investors should expect a flexible budget that starts out pretty lean but will probably be revised as the year progresses.

The current market cap of the company is $1.2 billion and the total long term debt was projected to be $1.3 billion after the offering. The annualized cash flow of $387 million divides into the total of those two figures to give a ratio of roughly 6.44:1. While that figure is fairly cheap, keep in mind that cash flow is likely to be lower next year, but with the hedging is highly unlikely to drop below $250 million. Also, the company has a fair amount of long term debt that is currently not burdensome, but could be in a worst case scenario, however, there are many competitors in far worse shape and a fair amount of the industry would go bankrupt first. That ratio is a little low even given the amount of long term debt. With the current cost cutting, cash flow is likely to be much better, especially if commodity prices rally in the second half of the year as some expect. The company did obtain relaxed covenants when the bank made its redetermination, and that is a sign of faith in the management of this company.

Disclaimer: I am not an investment advisor and this is not a recommendation to buy or sell a security. Investors are recommended to read all of the company's filings and press releases as well as do their own research to determine if the company fits their own investment objectives and risk portfolios.

Disclosure: I/we 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.