Why The Murphy Oil Deals Are So Good

| About: Murphy Oil (MUR)


The company only had to pay half an acquisition price up front. Management hopes to pay the rest from the joint venture profits.

The deal could lower company breakeven costs.

The sale and then the purchases added C$285 to the balance sheet current assets. In addition, long-term debt rose but is still very manageable.

The company still expects significant cost savings in the current fiscal year.

The latest company break even point appears to be near $30 BOE and dropping.

Murphy Oil (NYSE:MUR) announced the diverstiture of some midstream assets and the purchase into a joint venture. The announcement was significant on a number of levels, and shows some long term thinking and planning on the part of management.

First was the divestiture of gas pipeline and gas processing units that serviced Murphy's Montney fields in the Tupper and Tupper West of British Columbia for C$538 million.

Then the company turned around and purchased a joint venture interest in the Kaybob Duvernay lands and the liquids rich Montney lands in Alberta for $C250 million at closing and another C$225 with a carry period of five years. Interestingly, the company wants to make sure that the projects pays for itself. So the main idea is to get production to the point where it can pay for the remaining principal and maintain or grow production. Since the project already has some production, it will be interesting to see if the company can achieve its goal for this project. So this transaction immediately placed C$285 million into the cash balance on the balance sheet (which will be converted to US dollars when reported). That cash offset the long term liability increase. The current ratio and quick ratio instantly became materially better and the long term debt, though higher, is still manageable.

Click to enlarge Click to enlarge

Source: Murphy Oil 2015 Fourth Quarter Presentation

From the presentation (click on the fourth quarter 2015 presentation), one can get some sense of the increasing recoveries of resource from these wells. On the cost side, the conference call noted wells used to cost up in the eight to ten million range (and a few years back the costs were higher still). Now the aim is as low as $3.5 million for each well. The big savings appear to come from reduced drilling time. This gives the company a big advantage when planning a reduced capital budget as less drilling time means less capital needed to achieve production goals.

Plus when investors wonder how much the company will save from the purchase price by making enough of an investment to make the project self-funding, the answer is that those savings are a moving target. The cost of wells is dropping very rapidly, and the well design, including increasing the number of stages, is improving recovery rates dramatically. So the savings will actually improve over time from both of these factors. Even if the company does not achieve the self-funding goal completely, any progress made would be a cash flow help.

The company does consider this "savings" in that corporate cash is not required (hopefully at all) to make the second payment. In the current commodity pricing environment where the company has made the balance sheet important, this is a very important consideration because the company will not have to use precious cash already on the balance sheet to pay off the investment. Instead the money will come from the joint venture earnings. Liquidity may not be enhanced, but it also won't get worse from this course of action.

Click to enlarge

Source: Murphy Oil 2015 Fourth Quarter Presentation

From the presentation (click on the fourth quarter 2015 presentation), here is one slide that does show the possibilities of the lower cost wells. But also notice that the joint venture partner is running behind some of these great costs and has some catching up to do. Murphy Oil management did mention that for at least one of the plays they would be taking over the management, however, the partner had enough experience that the taking over the operations part was expected to be fairly smooth, and the well costs were expected to decrease faster because of that experience. Expect Murphy to lead an enhanced cost cutting drive.

Click to enlarge

Click to enlarge

Source: Murphy Oil 2015 Fourth Quarter Presentation

From the presentation (click on the fourth quarter 2015 presentation), an investor can get a sense of the improvement not only of IP's but also of total recovery from the newer wells. The initial flow rates are up at least fifty percent in about a year and in some case double what they were a year ago. Now geology plays a part in this and maybe not all areas will show the same improvement, but the trend is impressive nonetheless. The company stated in the conference call that several areas in both projects had potential locations with an approximate thirteen to fifteen percent return when oil was at the price of WTI $30 per barrel. With improvements shown here, the economics could improve significantly within one year for this project even if oil prices remain low. This project should be a money maker unless prices go lower and stay lower for a long time. Since very few projects make any money at all, let alone be marginally profitable at WTI $30 per barrel, oil should not stay this low or lower for a long period of time.

Both projects already have considerable infrastructure in terms of both pipelines and processing plants. So that additional cash investment in not necessary and adds to the attractiveness of the joint venture. Plus the company found the price attractive without having to consider any down spacing. Since down spacing will happen anyway to increase profits, down spacing will be another added bonus to this purchase. The company mentioned that the properties currently have more than 6K BOE of production. So the project already has some cash flow.

Click to enlarge

Source: Murphy Oil 2015 Fourth Quarter Presentation

From the presentation (click on the fourth quarter 2015 presentation), management had previously stated that they needed to learn to live with WTI mid-thirty dollar oil. This is one part of that equation. Now the company has preliminarily guided to a cost of $8.50 next year for LOE. That cost does not include a heavy oil project that has high costs and that the company will work on, however that high cost project is well under one-fifth of the company production before the latest acquisition. Since the WTI price actually went below $30, the company will probably push to exceed its guidance in this area. Costs are getting hard to improve upon when LOE gets this low, but the survival of the company may depend upon just that, so let's see what happens next year.

The company has some hedging but not nearly enough to protect against prices this low, so the only alternative is to efficiently cut costs.

The latest announced deal supposedly has break-even costs below the corporate average, so when the deal closes, that will automatically help the company lower its average costs.

Click to enlarge

Source: Murphy Oil 2015 Fourth Quarter Presentation

From the presentation (click on the fourth quarter 2015 presentation), the finding and development costs (everything is per barrel) of $18.70 when combined with the LOE guidance of $8.50 (not including the heavy oil)mean that the majority of the costs total to $27.20. There was also some severance and ad valorum taxes of $.61 and then G&A plus some other expenses of about $3 (in the latest quarter). The total per barrel cost for the company is $30.81. With the corporate commitment to achieve further cost reductions, the company will be profitable not only at the corporate goal of WTI mid-thirties, but could well be profitable at WTI $30 per barrel where oil prices are currently.

A further confirmation of this would be the cash flow statement. In the fourth quarter, the cash flow was $87 million, and that is a pitiful amount compared to previous quarters, but it roughly (very roughly) confirms that the above per barrel costs calculated in the last paragraph are in the ballpark. Annualizing that $87 million as a conservative guess for this year's cash flow (and hope for better) gives a yearly cash flow of $348 million. That would make for a long term debt to cash flow ratio of ten-to-one. That is one miserable ratio, especially when it is cash flow from operations.

However, helping out the cash flow was a sell down of some Malaysia production earlier in the year, and the current announcement of the sale that generated C$538 million (which will help the 2016 cash flow). This company has the assets to sell for cash if it wants to, and it is doing just that. The cash left over after expenses for the joint venture deal lowers the long term debt to cash flow ratio to about six to one, even though it would have to be converted to US dollars and that cash did not come from operations. Still the deal goes a long way towards demonstrating how the company will survive the current downturn.

Some of these will be sales of lower profit assets to make way for investments of higher yielding assets, and other sales will just raise cash. Since the company has done more than one sale in the last twelve months, it can be presumed that more of these sales will be done to bolster cash flow if needed in the future.

The company ended the quarter with more than $400 million in cash and short term investments. Now it just added another C$285 million to its cash balance while keeping the long term debt more than manageable. Then there is the unused credit line of approximately $1.4 billion. The company even managed to pay back some debt in the fourth quarter. The company has a total debt to total capital ratio constraint of sixty percent from its lender, and it is nowhere near that constraint, even with all the impairment charges. This would imply that should the company need a higher debt limit, it would probably be available, but management has in the past not liked to borrow much during industry down-turns, so it would be no surprise if management does what it can to bolster cash as needed and not increase long-term debt at all.

Click to enlarge

Source: Murphy Oil 2015 Fourth Quarter Presentation

From the presentation (click on the fourth quarter 2015 presentation), (click on the fourth quarter 2015 presentation), management has reduced the guidance for both capital expenditures and production for the year considerably as commodity prices have declined. Those reductions should really not surprise anyone. But with the focus on well design improvement and cost reductions, management could easily exceed its guidance on production, while potentially cutting its capital budget more if needed. Plus this company has the ability to make acquisitions in a market with a lot of distressed properties available. The company has already made one acquisition, so investors should probably count on more to be made when the price is right. However, management has been very averse to doing deals that dilute the common shareholders, so as of right now do not expect the company to do a deal involving the issuance of common stock.

The latest deals also bolster the dividend as they provide the company with more cash not only for the capital budget but also for the dividend. Interestingly, with the latest sale announcement (adding C$285 million before conversion to US dollars) and the annualized fourth quarter cash flow of $348 million, plus the cash (and short term investments) of more than $400 million, the company basically has the capital budget already funded with a little left over for the dividends. Cash dividends cost about $240 million a year, so the company really does not need much more for a cushion of safety against more borrowing. The dividend is still looking safe for another year whether or not oil and gas prices rally this year. The latest purchase should add at least $15 million per quarter to cash flow so the finding the cushion process has started.

When it comes to valuing the stock, there is not much cash flow to create much of a current value for the company. Any valuation or anticipated increase in the stock price will be based on a belief that the company can reduce its costs further enough to make money in the current environment and/or that commodity prices will rally. The current $1.40 per year dividend provides a decent yield at the current stock price of $19 per share and it appears safe under many scenarios. However, should there be another decrease in commodity pricing that lasts more than a few months, the dividend could be in danger of being cut or eliminated.

With the release of the fourth quarter costs and the guidance so far for next year, it appears that the company will be decently profitable if oil prices rally to $40 for the WTI. Nearly $10 BOE profit may not look like much but it is a huge improvement over the last few years. Cash flow would approach about one fifth to one sixth the current market value, so the stock would probably appreciate from current pricing levels about thirty percent or so.

The company now will work closely with a new joint venture partner, should Murphy Oil see something of what it likes in this new partner, it could make an offer to purchase the joint venture partner as the company is definitely small enough when compared with Murphy Oil that it would make an easy transaction to do should Murphy like the company. Murphy gained a foothold in a low cost area. A possible merger or purchase would increase the exposure to that low cost area. In any event, with the latest press releases, Murphy Oil is now on the hunt for low cost properties and low cost companies.

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.