Rex Energy (NASDAQ:REXX) reported its Q2 2016 earnings and gave an update to its 2016 production guidance. Overall, the results appear somewhat better than my expectations, with cash G&A coming in slightly below where I modeled it before, and 2016's production exit rate guided to slightly higher than my 2017 modeled average.
It also conducted a recent debt-to-equity swap that will reduce its future interest costs and help its leverage, although much more is needed to improve the company's long-term outlook.
Rex has updated its production guidance to indicate that it expects 2016 production to increase 5% over 2015. The 5% increase results in estimated 2016 production of 206 Mcfe per day. This is down from its earlier 5% to 10% range, but includes the effect of its Illinois Basin asset sale (around 5% of its total production and expected to close in Q3 2016) and the delay in the Fleeger II gathering line. Reversing those items would put Rex's production well within its initial guidance range.
Rex also indicates that its December 2016 exit rate will be roughly 205 Mcfe per day. This is slightly higher than the 200 Mcfe per day production average (as a maintenance level) that I've previously assumed for 2017, but the overall effect on Rex's numbers is fairly limited (a few million dollars per year if the production mix is the same).
In terms of costs, Rex's cash G&A appears slightly lower than I modeled, and may come out to around $15 million to $16 million per year. The Illinois Basin asset sale appears to have resulted in a slight reduction to cash G&A (of around $0.7 million in Q1 2016). This is based on cash G&A from continuing operations of $5.4 million in Q1 2016 versus the originally reported $6.1 million. Lease operating costs from continuing operations appear to be roughly in line with my expectations.
Continued Debt Exchanges And The Effect On Rex's Valuation
The recent debt exchange indicates the high level of concern about Rex's long-term survival. The exchange involved $43.5 million in second-lien notes being exchanged for 16.8 million shares, which had a value of $10.9 million based on the closing price of Rex's shares on the day the new shares were issued. The noteholder, therefore, received around 25 cents on the dollar for its notes. This noteholder wanted more liquid securities, and also appears to be skeptical of Rex's long-term survival (as indicated by the low price relative to par value).
With the sale of the Illinois Basin asset, oil has become of relatively limited importance to Rex Energy, except for the relationship of NGL prices to oil prices. The common equity still needs natural gas to get to around $4+ to have more than minimal intrinsic value.
Taken to its extreme conclusion, the swap of debt to equity (at the recent exchange rate) could result in Rex Energy ending up with over 320 million shares outstanding, but no debt outside of its first-lien credit facility. This would result in its common equity having around its current share price in value at $50 oil and $2.75 natural gas (and probably only needing $2.25 gas for its equity to have minimal intrinsic value). Its common shares would also be worth around $1.35 at $60 oil and $3.25 natural gas. While those oil and gas prices are above current strip prices, they represent the long-term prices that it appears that many producers are currently being valued at.
It is true that large debt-to-equity swaps would reduce Rex's upside. However, I calculate that it would take a valuation (using a 6x EV/EBITDA multiple) that is based on $70+ oil and $4.50+ natural gas for the estimated share price in the massive debt-to-equity swap situation to fall below the estimated share price using Rex's current debt and share count situation. Basically, if you think that oil and gas will go to $70+ and $4.50+ respectively (or at least that companies will be valued based on those prices), then it would make sense to be against massive debt-to-equity swaps. At prices/valuations below that level though, the debt-to-equity swaps enhance the value of the current common equity.
This is just a theoretical exercise since it is very unlikely that 100% of noteholders would be interested in doing debt-to-equity swaps, and Rex is currently only authorized to issue 200 million common shares as well. However, this exercise does show that debt-to-equity swaps would theoretically increase the value of the common equity in scenarios that don't involve a very sizable increase in gas and oil prices.
Rex Energy is displaying solid performance operationally, with Q2 results and guidance indicating slightly better performance for both cost control and production levels than what I had modeled. Rex is also improving its 2018 situation (as the interest rate on its second-lien debt rises to 8% in 2018) by doing debt-to-equity swaps.
However, Rex does still have a very large amount of debt after its latest debt-to-equity swaps and probably still needs to get rid of an additional $250+ million in debt before its leverage situation becomes potentially manageable. Generally speaking, debt-to-equity swaps should be beneficial for the common equity in situations with expectations for sub-$70 oil and sub-$4.50 natural gas. The common equity will remain just an option on significantly improved gas and oil prices for now, but that could change if Rex is able to reduce its debt by $250+ million via various methods.
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