One of the worst-performing stocks I've seen recently has been Whiting Petroleum (NYSE:WLL). Since I last wrote about the business's cash flow (so I'm excluding my earnings preview I wrote not long ago) on May 27th of this year, shares of the entity have fallen by about 31.9% and are trading, as of the time I conducted my research on it, at $8.18 apiece. Given a change in the price of oil and natural gas, and given a major addition to management's debt reduction plan, I've decided to revisit the business and present my thoughts on how the fundamental picture has changed.
In my last relevant piece on the topic, I stated that I believed Whiting has potential based on its cash flow, but that investors should be cautious since a move by management to reduce debt by pushing convertible notes could cause shareholder dilution. This warning came, of course, after the company used this strategy to equitize $476.74 million worth of long-term debt, essentially charging shareholders in order to lower leverage. As a result of this, the firm's share count rose by 41.8 million shares, diluting investors by around 17%.
Now, management is at it again, but its approach has been slightly different. In a nutshell, management has issued convertible notes that either it or its holders can force to convert, covering debt worth more than $1.09 billion. Unlike in the prior case, where the number of shares issued would be fixed, the conversion price in this scenario is based on the daily volume-weighted average price (or VWAP), with 4% of notes converting every day for 25 days. Based on management's most recent release on the topic, it's looking like the number of shares issued will dilute shareholders by between 29.7% and 31.2%. This excludes the dilution shareholders prior to the last debt deal had to contend with.
How has cash flow changed?
Given that a quarterly release regarding Whiting will be made later this month, it's hard to tell what to expect of the business in terms of cash flow for the quarter, but I do think we can have a fair understanding of expectations as a whole this year and moving forward based on assumptions derived from management and based on changes in oil and natural gas prices. In my work below, I've made the assumption that oil prices average, from this year through 2019, $44.95 per barrel, a decrease of 9% compared to the $49.40 per barrel I used in my last article, and I also assumed that natural gas prices average $2.736 per Mcf, an increase of 42.4% compared to the $1.921 per Mcf that I used previously.
Based on this data, combined with the fact that management's new debt reduction strategy will lower annual interest expense by about $32.58 million per year, I was able to create the table below. In it, you can see that this year should be pretty impressive for the firm, which can be expected to generate cash flow of $331.70 million if nothing changes. Next year, however, as hedges roll off, the picture will worsen considerably (but still be pretty good), with cash flow of $97.20 million. It's only in 2018 and 2019, when hedges roll off entirely, that cash flow should drop to about $33.79 million, which is quite a blow if prices do not recover but may be enough to allow the entity to survive if it can manage to refinance debt due in the future (which may be a stretch).
Overall, the financial picture here isn't terrible, but it's materially worse than where I saw the picture in May, which can be seen in the table below. Then, thanks to higher oil prices, cash flow was slated to be about $350.89 million this year, followed by $166.78 million next year. In both 2018 and 2019, we were looking at $124.74 million, about 3.7 times what the picture looks like today. Certainly, it is true that debt reduction has helped, as has an increase in the price of natural gas, but this has been more than offset by lower oil prices. If management took the opportunity earlier this year to increase hedging activities, it's very possible cash flow numbers could end up being higher, but absent this and/or absent meaningful cost reductions, the fundamental picture has certainly worsened.
There is no denying that Whiting presents investors with very attractive prospects due to its fairly low cost structure, but investors need to be cognizant that risks are present. As I've stated multiple times now, dilution has been and will remain a risk for shareholders as management tries to lower leverage, but this is better than the alternative of declaring bankruptcy. The other risk that I've pointed out in the past comes from Whiting's poor hedge portfolio.
Although this is a tremendous strength if oil and natural gas prices continue to rise (which I believe is more probable moving forward than them dropping materially), there's no denying the fact that every $10 move in the price of oil, keeping all else the same, will move cash flow by around $343.44 million in a world without hedging. Because of these risks, I am not touching Whiting at the moment, and I probably won't until I think the dilution is entirely behind us, but the firm does warrant some attention from long-term oil bulls.
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.