Debt Exchange Improves Rex Energy's Near-Term Position, But Common Equity Still Of Limited Value

| About: Rex Energy (REXX)

Summary

Debt exchange will reduce interest expense by over $40 million in 2017.

This should help Rex achieve positive cash flow in 2016 and 2017. Without the exchange, there was a significant chance of a liquidity crunch.

Rex does still need much improved gas and oil prices by 2018 to avoid burning cash in 2018 and risk using up its credit facility.

Debt load remains quite challenging and indicates limited value for the common equity.

Even at $60 oil and $3.60 natural gas, debt is expected to be over 7x EBITDA. Debt + preferred shares is around 8.5x EBITDA at those prices.

Rex Energy (NASDAQ:REXX) has bought itself some time with its recent debt exchange. Without the exchange it would have likely burned cash in 2016 and 2017 even with reduced capital expenditures and potentially could have run out of availability with its credit facility. The exchange allows it to minimize interest expenses for a couple of years, although by 2018 Rex likely needs $60 oil and $3.60 natural gas to reach breakeven again.

2016 Financial Projections

Rex projects 2016 production to be 5% to 10% higher than in 2015. This means that production will be approximately 210 MMcfe/day at the midpoint of the guidance. Based on trends and Rex's focus on the Appalachian Basin, its 2016 production will include less oil. Rex's recent deal with INEOS Europe AG for the sale of natural gas liquids to Europe and the additional processing capacity from the Bluestone III facility should support better pricing and volumes of NGLs (including Ethane).

At $40 oil and $2.50 natural gas in 2016, Rex should be able to reach $205 million in revenue, including $37 million in hedge value.

 

Units

$ Per Unit

$ Million

Oil and Condensate [Bbls]

896,700

$35.00

$31

Natural Gas [Mcf]

46,116,600

$1.80

$83

NGLs (C3+)

2,177,700

$18.00

$39

Ethane

2,049,600

$7.00

$14

Hedge Value

   

$37

Total Revenue

   

$205

Click to enlarge

With the deal to exchange most of its unsecured notes for second-lien notes, Rex's cash interest expense should fall to $31 million in 2016. Rex is paying the accrued and unpaid interest on the exchanged unsecured notes, but then only 1% interest on the second-lien notes for the October 2016 and April and October 2017 interest payments. After that, interest rises to 8%.

With the $31 million in cash interest for 2016, Rex's cash expenses are estimated at $201 million, resulting in slightly positive cash flow of $4 million.

 

$ Million

Production and Lease Operating Expense

$120

Cash G&A

$22

Cash Interest Expense

$31

Capital Expenditures

$28

Total Expenses

$201

Click to enlarge

2017 Financial Projections

For simplicity's sake I have left 2017 production at the same level and splits as 2016, although it is likely that Rex's production will continue to include less oil. Increased gas and NGLs production and decreased oil production (with flat total production) may result in revenues decreasing by a few million.

In this scenario with $50 oil and $3 natural gas (along with a similar improvement in natural gas liquids and ethane pricing), Rex Energy would have approximately $213 million in oil, gas and NGLs revenue. The hedges have minimal value in this scenario, only adding an additional $1 million.

 

Units

$ Per Unit

$ Million

Oil and Condensate

896,700

$45.00

$40

Natural Gas

46,116,600

$2.30

$106

NGLs (C3+)

2,177,700

$22.00

$48

Ethane

2,049,600

$9.00

$18

Hedge Value

   

$1

Total Revenue

   

$214

Click to enlarge

Rex Energy should save a substantial amount of interest costs in 2017 as the new second-lien notes only pay 1% interest in 2016 and 2017. This brings Rex's cash interest expense down to around $12 million in 2017. I am not entirely certain about what level of capital expenditures is required to maintain production levels in 2017, but have put down $50 million as an estimate. Rex Energy's cash expenses would be around $204 million, resulting in positive $10 million cash flow.

 

$ Million

Production and Lease Operating Expense

$120

Cash G&A

$22

Cash Interest Expense

$12

Capital Expenditures

$50

Total Expenses

$204

Click to enlarge

After 2017, Rex's cash interest expenses go back up to around $56 million per year. This will result in Rex's breakeven point being approximately $60 oil and $3.60 natural gas (along with a realized price of $26 for NGLs and $11 for Ethane) before any preferred dividends.

Notes On The Debt Exchange

The exchange of unsecured notes for second-lien notes saves Rex Energy over $60 million over the next two years and allows Rex to be slightly cash flow positive (around $14 million) in the scenario I outline above. Without the exchange, Rex would likely have maxed out its credit facility. As it stands, Rex will probably be okay until 2018, although further borrowing base reductions or lower prices than modeled (especially for natural gas and NGLs) will force Rex to cut capital expenditures or otherwise face a liquidity crunch.

Rex's exchange offer was quite popular, with around 94% of the unsecured notes being tendered. The reasons for this is probably include that there was no reduction of the principal, that the exchange meaningfully improves Rex's survival chances during the next two years, and that not participating in the exchange would seriously affect the recovery rate.

Rex's first-lien borrowings are only 1.6x EBITDA in the $50 oil and $3 natural gas scenario, making it quite worthwhile to move up into a second-lien position from the unsecureds since it probably removes the potential for other second-lien debt to be added to Rex's capital structure. The new second-lien note position is huge (around 9x EBITDA at $50 oil and $3 natural gas), so any remaining unsecureds are likely to be out of the money if Rex is forced to restructure in the future.

Conclusion

With the debt exchange, Rex's position appears reasonably secure for the next couple years. There is still some vulnerability if the oil and gas markets fall well short of the prices that the current strip indicates. As well, Rex does need significantly higher than strip oil and gas prices in 2018 to avoid running into potential liquidity issues again.

While Rex is making progress in improving its position with its recent moves (including the joint agreement with Benefit Street Partners), its common equity is still very speculative though. Even if oil prices reach $60 and natural gas reaches $3.60, Rex's debt to EBITDA is around 7x, indicating minimal value for the common equity in such a case. As Rex's common equity is also behind its preferred stock, it probably would take $70 oil and near $4 natural gas for the common equity to have more than minimal intrinsic value.

Rex does have the ability to sell assets such as its Illinois Basin properties, but the effect on its debt reduction is probably going to be minimal. Wells Fargo estimated in June 2015 that the Illinois Basin asset was worth $35 million and the market for oil assets has since weakened.

Note From The Author: If you found this article informative, please scroll to the top of the article and click on follow to see my newest articles as they are published.

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.

Editor's Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.