For our next bond review, we go to the Midwest, where an oil and gas producer is focusing its efforts in one of the country's most prolific plays. Alta Mesa Holdings, a private exploration and production company, has been steadily increasing its production in the STACK play in Oklahoma. 2016 is shaping up to what could be a banner year for this independent producer.
- In January, Alta Mesa began a joint venture agreement, which will effectively increase production without incurring additional capital expenditures.
- The company is bringing back previously curtailed/shut-in production, which represents 15-20% of its total Oklahoma production.
- Lease operating expenses and general and administrative expenses have decreased year over year by as much as 42%.
With the increased production from the joint venture and the previously shut-in production, Alta Mesa's production should increase significantly over the course of 2016 and into the next few years. Coupled with the recent increase in oil prices, this should significantly and positively impact Alta Mesa's bottom line. The company's October 2018 bonds, couponed at 9.625% and priced indicatively at about 88, offer great cash flow and over 16% yield to maturity, and meet the criteria for addition to both our FX1 and FX2 global high-yield income portfolios.
Joint Venture with Bayou City Energy
Alta Mesa has locked in a way to add production to its bottom line without the usual high capital expense that goes along with drilling new wells. In January of this year, Bayou City Energy (BCE) announced a joint development agreement with Alta Mesa Holdings to finance the drilling of joint wells on Alta Mesa's acreage in the STACK play in Oklahoma. Under this agreement, Bayou City will initially finance the development of 40 horizontal wells in 2016/2017. The terms of this agreement include Bayou City funding 100% of each well's drilling and completion costs, up to a maximum of $3.2 million for each well. In exchange for Bayou City's payment of drilling and completion costs, BCE will initially receive 80% of Alta Mesa's working share until it achieves a 15% internal rate of return, at which time its share will reduce to 20%. Once BCE achieves an internal rate of return of 25%, BCE's share again reduces to 7.5%. In Q1, 11 wells were drilled/completed under this agreement.
This agreement effectively adds an additional 20% of production from these newly drilled wells with no associated cash outlay by Alta Mesa. With West Texas Intermediate (WTI) prices up nearly 75% from its lows earlier this year, the additional production will give Alta Mesa what amounts to a "free" boost to its bottom line.
Bringing Back Shut-In Production
Alta Mesa is also in the process of bringing production back online that was previously curtailed or shut-in due to the lack of access to midstream services. According to the company's latest conference call, between 15% and 20% of its Oklahoma production was curtailed/shut-in. Alta Mesa is in the process of expanding its midstream services. Once completed, the company has about 20 wells that will be able to produce at full capacity. With the increased production from the joint venture and the shut-in production coming online, Alta Mesa's production should increase significantly over the course of 2016 and in the next few years. With the oil prices increasing, this should significantly increase Alta Mesa's bottom line.
About the Issuer
Headquartered in Houston, Texas, Alta Mesa is a privately-held company engaged in onshore oil and natural gas acquisition, exploitation, exploration and production whose focus is to maximize the profitability of its assets in a safe and environmentally sound manner. The company seeks to maintain a portfolio of lower-risk properties in plays where it identifies a large inventory of drilling, development, and enhanced recovery and exploitation opportunities in known resources. Alta Mesa believes its balanced portfolio of assets in the Sooner Trend (Oklahoma) as well as South Louisiana has decades of future development potential. The company's areas of focus are typically characterized by multiple hydrocarbon pay zones, and because it is re-developing fields and areas left behind by major oil and natural gas companies and other previous operators, these assets are typically served by existing infrastructure.
The STACK Play
Alta Mesa operates primarily in two different regions, the Weeks Island area in Louisiana and the STACK play in Oklahoma, with the majority of its efforts currently focused in its Oklahoma properties. The economics for drilling in Oklahoma's STACK play is compelling. A recent report by IHS Energy Research indicates the play's productivity is nearly on par with the more well-known Eagle Ford play in South Texas. What's more, the economics of the STACK play are also extremely desirable. Although oil prices have begun to recover, at the current levels of $47-50 per barrel, prices are still significantly lower than their highs above $100 per barrel in mid-2014. But the STACK play has been showing economic promise at oil prices below $45 per barrel. Given these statistics, it's easy to see why Alta Mesa continues to focus on this area. In 2015, the company spent nearly half of its capital expenditure (capex) budget in its Sooner Trend acreage within the STACK play and will spend approximately 83% of its 2016 capex budget in this same area.
Alta Mesa's production numbers over the past few quarters highlight the lucrative nature of the STACK play. In Q4 2015, average daily production for this area was up 60% from Q4 2014. And in Q1 2016, oil production from this area grew by 43% year over year. The company currently has three drilling rigs operating in the STACK play, with plans to deploy one or two additional rigs this year. And with the company's efficiency in drilling time (the company has brought down well drilling time from 30 days to 15 days over the past few years), it won't take much time to add additional production.
Alta Mesa actively uses hedging to reduce its exposure to commodity price fluctuations and provide more even cash flow. In Q1 2016, the company's realized prices for oil were $53.21 per barrel, and realized prices for its natural gas were $2.44 per MCF. The company has an active hedging program, and as of March 31, 2016, had approximately 72% of its forecasted production hedged through 2019 at average prices ranging from $2.88 to $4.50 per MMBtu for natural gas and $61.05 to $67.05 per barrel for oil.
Due to the lower prices in oil and natural gas, Alta Mesa has responded by continuing to look for ways to reduce its ongoing expenses. In Q4 2015, the company's lease operating expenses (LOE) decreased from $25.7 million in Q4 2014 to $23.1 million, a 10% reduction. In Q1 2016, LOE continued to decrease, dropping from $26.0 million in Q1 2015 to $22.3 million, a 14% reduction.
The company has also decreased its general and administrative (G&A) expenses. For 2015, the company reduced its G&A expenses by 35% over 2014 levels. And in Q1 2016, Alta Mesa continued to reduce these expenses, registering a 42% year-over-year decrease ($17.7 million in Q1 2015 to $10.2 million in Q1 2016).
Although Alta Mesa registered a loss from operations in Q1 of $7.9 M, when removing depreciation, impairment and accretion, the company showed a profit of $15.8 M. This amount fell just shy of the company's interest expense of $16.4 M. One also needs to consider the additional expenses in Q1 for expanding the company's midstream services to the shut-in wells that were not yet producing. With the added production from the shut-in wells as well as the added production from the BCE joint venture coming online, as well as increasing oil prices, cash flow and coverage should continue to improve.
The default risk is Alta Mesa's ability to perform. The company's focus in the STACK play in Oklahoma appears to be paying off as evidenced by its increasing year-over-year production for the past few quarters. When combining this with the joint venture with Bayou City, the previously shut-in production coming back online, and the increase in oil prices since the beginning of the year, Alta Mesa appears to be perfectly positioned to profit from the turnaround in oil.
Commodity risk is also present as Alta Mesa's revenues are directly tied to the prices of oil and natural gas on the open markets. We have seen the increase in oil prices this year, from a low near $26 per barrel to its current levels around $47-50 per barrel. Also natural gas prices have also rebounded this year from a low close to $2.00 to around $2.98 a few days ago. Also, Alta Mesa's hedging program should help to even out cash flows as prices continue to recover.
Alta Mesa had cash on hand as of 3/31/2016 of $3.7 million. While this level may seem on the low side, one should also note that the company also has access to $142 million in restricted cash that can be used for general corporate purposes.
These high-yielding 27-month bonds are similar in risk and duration to other bond issues reviewed on bond-yields.com, such as the 17% Pengrowth Energy (NYSE:PGH) and 30% Natural Resource Partners (NYSE:NRP) bonds.
Summary and Conclusion
Alta Mesa has a seemingly winning combination for increasing its revenues and profitability. It is currently focused on one of the most productive oil and natural gas plays in the country. In addition to this, its joint venture with Bayou Energy will add production to its bottom line at no additional cost to the company. The previously curtailed/shut-in wells coming back online will also increase production. When all of this is combined with increasing oil prices and decreasing expenses, Alta Mesa looks to profit handsomely. The outstanding 16.33% yield on these bonds is a great way to increase portfolio return and profit from the recovering oil industry. Consequently, we are targeting these relatively short-term bonds from Alta Mesa Holdings for addition to our fixed-income1.com and fixed-income2.com global high-yield income portfolios.
Issuer: Alta Mesa Holdings
Yield to Maturity: ~16.329%
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Disclosure: Durig Capital and certain clients may have positions in Alta Mesa Holdings' 2018 bonds.
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