Parsley Energy Is Expanding Rapidly

| About: Parsley Energy, (PE)

Summary

Lease operating expenses are down sharply from a couple years back into the low $5 BOE range due to less trucking of water.

Production will expand at least 60% this year with a higher rate of production increase for oil.

The stock has already priced the expansion into the current price and more.

Management has been selling a lot of stock to the public because it believes it received excellent value for that stock, but the market has not noticed.

Any kind of expansion, even favorable ones take awhile to assimilate. There is nearly $1 billion in purchases so far with possible unforeseen future issues.

Usually when companies expand, there is a profitable reason to expand operations. But there is a world of difference between a $10 million operation doubling in size and a $500 million operation doubling in size. Even if the $500 million operations grows 20% the logistics of that growth are far more complicated and much harder to sustain. The growth of the larger company involves a lot more planning and checking.

Parsley Energy (NYSE:PE) has been on a buying binge since the start of the year. Prices of leases and royalty interests are viewed as favorable by management and in most cases the acreage is located near company operated leases. Since the company is concentrating on areas that management knows well, the risk involved in these purchases is below average. Still, the company has grown quite a bit over the last year or so, and the size of these acquisitions may temporarily slow the earnings growth in return for a hopefully brighter future. In fact these purchases have not yet had enough time to demonstrate their value. Yet management is still on the lookout for more deals.

To fund this buying spree, the company sold at least 8 million shares of stock to gross more than $200 million in the last few weeks.. The underwriters did exercise the overallotment option for the company to sell about 9.5 million shares and net more than $226 million. In addition, the company sold $200 million of notes for which it expects to net about $195.8 million. The total amount raised is roughly $422 million. Interestingly, the notes can be redeemed under certain change of control situations which will probably reduce the threat of a hostile takeover preemptively.

On April 4, the company sold about 21 million shares of common stock to net about $433 million. In December, 2015, the company sold about 13 million shares and netted about $228 million. Much of the money from these funds is going to past and future acquisitions as well as general corporate expenditures. So far, the market appears to like what it sees, as the stock has not nose-dived. But management would not sell stock unless it thought it was getting good value for the stock sold. For Parsley Energy, management must think the stock is fully valued or overvalued for all the stock they are selling to fund these acquisitions. Clearly, the market is ignoring how long it will take the company to overcome the dilution caused by all this fundraising (not to mention the size of the operations expansion).

In the first quarter, the dilution from the sales of common stock reached roughly 20%, and there is clearly more dilution on the way. Showing good returns on a $20 million purchase can usually be done in a routine fashion. But this company has hundreds of millions in purchases. Such large scale purchases usually take time to show results.

What may help here is that the market appears to like the overall company strategy and the company is losing money. It is a lot harder to determine earnings dilution when a company goes from a loss to profits. Some would say that the stock sales must therefore be accretive. This company is about to become profitable and so it is speculation as to how profitable the company would have been without the acquisitions. What is clear is that the acquisitions and stock sales will materially alter the company and its prospects going forward. Whether or not prospects have improved is the subject of speculation at this point.

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Source: Parsley Energy June, 2016 Corporate Presentation

This latest acquisition is clearly a cost reducing acquisition. The company acquired the 17.5% royalty interest on acreage that it already had leasehold interests. The claim as shown above is the increase in profitability, and the very important lowering of breakeven costs on these leases. The company did have the ability to borrow all the money needed for this transaction, but instead decided to reduce the financial leverage of the transaction and increase the safety by selling some common stock.

The other acquisitions involved acquiring more acreage near company acreage or more interests in acreage already held. While all of this should make the deals safer, its the accompanying increase in operational activity that may be very risky.

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Source: Parsley Energy June, 2016 Corporate Presentation

This slide supposedly takes into account the last six months or so of equity and debt sales as well as the announced acquisitions. The company has announced an astounding 60% or more increase in oil production from the previous year. Management is also banking on the wells on the new (and older) leases being extremely profitably. While management can state that the supporting infrastructure is there, it is entirely another matter to increase the usage of that infrastructure at the proposed pace for the year. Generally the kind of pace proposed by management is not sustainable even at the current size of the company, let alone as the company increases in size. So next year there will be one sizeable drop in activity.

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Source: Parsley Energy June, 2016 Corporate Presentation

The company plans to go to pads whenever possible and has other cost savings in mind. Later in the year they plan to push the limits of fracking and see what happens to costs and production. But most of all, the company management sees enough permanent savings to be encouraged about new drilling at the current prices.

If the results shown above are obtained, than the current burst of activity will transition the company to lower operating costs and lower well costs. Depreciation and other allocated costs would drop significantly as the newer designs and operating improvements predominate. Many companies have a slower transition to the newer costs and therefore the newer costs take a few years to predominate on the financial statements. This company, with the budgeted burst in activity, proposes to vault past those transitions very quickly.

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Source: Parsley Energy First Quarter, 2016, Earnings Presentation Slides

As shown above, the company has already updated the capital budget once to reflect the greater opportunity presented by these acquisitions. In the past the company had good reserve growth, and is presented above, management is expecting some sizeable growth this year. However, anytime the growth rate goes past 20%, problems in future years that would have been handled without disclosure may become material. An operational issue could become embedded in far too many places before management can slow down the activity level and correct the problems. Just as the increase in activity is large, future unforeseen operational issues also tend to be large.

Cash flow from operating activities were about $20 million in the first quarter. Even if that cash flow were to grow to $100 million per quarter, the stock price with its $5 billion market value already anticipates that growth. The market value to annualized cash flow ratio would be more than 10:1 after that accomplishment. But the stock is priced as if that cash flow increase were a done deal. That increase from cash flow is far from certain so there is really no reason to buy the stock right now except for trading purposes. Clearly the stock is going to be very volatile so hedging to avoid sharp losses would be indicated if one does invest either short or long. While the market may favor the stock right now, one hiccup or shortfall could produce a very angry market response. Any signs of a slowdown could cause the market to punish the common stock. Plus a reasonable long term growth rate needs to be established. The most likely long term growth rate will be in the 15% range. Though there could be years where no growth would be indicated. None of these possibilities appear to be priced into the stock currently.

Typically, managements such as this one establish a counter-cyclical strategy that takes advantage of the industry capacity and low costs at the bottom of the market. Then when the recovery is underway, these managements tend to slow down. At the top of the market the company may do the bare minimum. The market needs to pay more attention to the signal that management is sending when they sell company stock. If management thinks they are getting a good deal selling stock, then the market should be looking, investigating, and "checking it twice" before buying. The way this stock is currently acting, it may represent its own bubble in the making. I have written about many other companies such as Raging River Exploration (OTC:RRENF), Granite Oil (OTCQX:GXOCF), Peyto (OTCPK:PEYUF) and others that have superior operations but are not so pricey.

Disclaimer: I am not an investment advisor, and this article is not meant to be a recommendation of the purchase or sale of stock. Investors are advised to review all company documents, and press releases to see if the company fits their own investment qualifications.

Disclosure: I am/we are long GXOCF.

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.