Why I Won't Consider Buying Pioneer Natural Resources

| About: Pioneer Natural (PXD)

Summary

Pioneer continues to try to increase its production results and will reach an output of 225,000 barrels per day in Q2.

The full-year operating cash flow will be $1.4B, but an asset sale is needed to cover the capex shortfall.

Is it wise to invest in production expansion right now?

The NPV of the reserves (10% discount rate, pre-tax) after deducting the net debt is just a fraction of the current share price.

This indicates Mr. Market is valuing Pioneer's land position and the possibility for higher oil prices at in excess of $20B!

Introduction

Pioneer Natural Resources (NYSE:PXD) is one of the largest oil and gas producers in the world, but my main question would be about how the company is currently weathering the oil and gas climate, and if it will be able to cover its capital expenditures. As Pioneer has just released its production results and financial results for the first quarter of the year, this is a good moment to have a closer look at PXD.

PXD Chart

PXD data by YCharts

Q1 2016 started off nicely with a 3% production increase

Pioneer's first quarter was actually much better than the market expected, and the company was even able to beat its own production guidance. Pioneer produced approximately 222,000 boe/day which was 3% more compared to the fourth quarter of the financial year 2015. That's pretty good, and even great if you know the company was guiding for a total production rate of 211,000-216,000 barrels of oil-equivalent per day. That's also the reason why the market rewarded Pioneer with a nice bump of its share price.

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Source: company presentation

The total revenue in the first quarter was approximately $685M, a substantial double-digit percentage lower than the first quarter of the previous financial year and as the oil and gas price is much lower than a year ago, this definitely shouldn't surprise anyone. In fact, the revenue is even a bit higher than what one would have expected as the company sold more oil and gas, it had to purchase.

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Source: financial statements

The total production cost also increased from $980M to $1.1B, but the majority of this increase (actually the entire increase) was caused by the fact Pioneer had to purchase more oil and gas as well. This led to a pre-tax loss of $408M and a net loss of $267M or $1.65 per share. Okay, interesting, but not surprising considering the company also reported a $353M depreciation rate which is very likely higher than the total capital expenditures that are needed to keep the oil and gas production at the same level.

That's why the cash flow statements play an important role in valuing an oil and gas company. And indeed, Pioneer reported a positive operating cash flow of $111M, but if you'd correct this result to take the changes in Pioneer's working capital position into account, the adjusted operating cash flow actually increases to $243M which is already much better.

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Source: SEC filings

Okay, this won't be sufficient to cover the expected capex program totaling $2B, but it does cover a lot of the expenses. And you also shouldn't forget the $2B capex bill is based on the company's desire to increase the production rate by an additional 12% in 2016. And approximately 10% of the total capex is related to production facilities rather than drilling, and is most definitely growth capex rather than sustaining capex. The company expects to cover 70% of the total capex bill with its operating cash flow, and that's pretty decent considering the amount that has to be spent on production growth rather than sustaining capex. The shortfall will be covered by the cash inflow from an asset sale (as well as the recent capital raise).

How does the company's reserve report look? Is there any value left in the stock?

I have to say I was very impressed by the company's share price performance, and as it will generate a substantial amount of operating cash flow over the next few years, even at $40 oil, I was really wondering what the fair value of those reserves is.

In the oil and gas sector, the best way to base an investment decision is to have a look at the reserves report, which is usually published right after the end of a financial year. Pioneer already published its report in February so I had to dig through some numbers there.

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Source: company presentation

After a first glance I was already negatively surprised by the reserve report, as the company 'lost' approximately 135 million barrels of proved reserves in 2015, compared to the situation as of at the end of last year. The year-end oil-equivalent reserves contained less than 665 million barrels of oil and even though that does sound very impressive, I was definitely disappointed. Why? Well, as Pioneer will be producing in excess of 220,000 boe/day in the current financial year, its total oil-equivalent production rate in 2016 will be approximately 80 million barrels, so a total reserve estimate of 665 million barrels results in a reserve life of just 8 years (but fortunately for Pioneer, the majority of the useful life consists of developed reserves).

But what was really an eye-opener was the PV-10 value of the reserves. According to the estimate of the company's consultant, Pioneer's PV-10 (which is the present value of the revenue from oil, on a pre-tax basis, discounted at 10%) is just $3.2B. I first thought I must have misread it, but Richard Zeits confirmed my thoughts. The total value of the oil reserves using the price deck of Pioneer's consultant is REALLY just $3.2B.

Not only is this terribly low (and calculated at a higher oil and gas price than the current spot prices), once you deduct the net debt from this result (which was in excess of $2B as of at the end of Q1. This does exclude the proceeds from the asset sale which is expected to occur this year, as the proceeds will immediately be used to fund the growth capex), the NPV-10 (on a pre-tax basis) is just $1.2-$1.8B (depending on whether or not you're including the proceeds from the asset sale).

Investment thesis

So, Pioneer Natural Resources currently has a market capitalization of almost $27B which is substantially higher than the net value of its current reserves. Sure, in a better oil market the value of these reserves will be (much) higher, but why would I want to pay a substantial premium on the PV-10 value if I can buy Pioneer's competitors at a much lower valuation?

I'm really baffled to see Pioneer's share price increasing by 50% in just 2 months' time. Yes, I do understand the company can (and very likely will as it still has a lot of land to drill) increase its reserves and thus its PV-10 value in the future, but as Richard Zeits correctly states, this 'valuation gap' is enormous, and I would prefer to invest in oil through a 'safer' company.

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.