Approach Resources: Extreme Cost-Cutting

| About: Approach Resources (AREX)

Summary

After the market closed on August 3rd, the management team at Approach Resources released financial results for the business's second fiscal quarter this year.

Based on the data, management achieved the lowest oil and gas operational expenses they've ever recorded and also the lowest drilling costs ever.

Management intends to complete 3 new wells in the third quarter on top of the 2 they did during the second quarter.

The only area that is slightly concerning in my mind relates to debt.

Though the business appears fine, the company should be focusing on reducing debt, not increasing it.

After the market closed on August 3rd, the management team at Approach Resources (NASDAQ:AREX) released financial results for the second quarter of the business's 2016 fiscal year. In this article, I decided that it would be a wise idea to revisit the financial situation associated with Approach and give my own thoughts on what the business has done over the past quarter and how it compares to my own expectations previously reported.

Management emphasized cost cutting

According to management, Approach was able to reduce its cost structure during the quarter. During the second quarter, lease operating expenses averaged $4.56 per boe (barrel of oil equivalent). Management stated that this was actually the lowest on record for the firm and represented a decline of 8.2% compared to the $4.97 the company reported in the second quarter of its 2015 fiscal year.

Another key area of cost reduction for Approach was the firm's cash general and administrative costs, which came out to $3.88 per boe, a slight improvement over the second quarter last year when the metric came out to $3.91 per boe (so a decline of 0.8% year-over-year). Exploration costs, however, did increase due to activity by the company this year, coming in at $1.41 per boe compared to just $0.84 per boe in last year's quarter. However, this is the good kind of cost in my view, since it should result in higher production in the long run and is completely optional for the business to incur.

A look at completions

One thing I indicated in my last article, besides that management would focus on reducing costs, was that management may consider accelerating its completion activities. Previously, the firm stated that it would complete two of its nine drilled but uncompleted wells in the second quarter but did not provided guidance on the other wells. Unfortunately, management stuck with the two well goal but did stated that, in the third quarter this year, they will complete three more in an attempt to mitigate the declines of its other wells. Though completions will come first, management did tout the fact that they've gotten their well drilling costs down to $3.7 million each, the lowest they've ever enjoyed. This could open the door to additional wells being drilled in the months to come.

Debt was a disappointment

So, first off, I should mention that management did not disclose operating cash flow or free cash flow (and the 10-Q isn't available as of the time of this writing) but it did provide an estimate for EBITDAX, which is probably the best substitute despite my own philosophical biases against anything of the sort. During the quarter management touted EBITDAX of $13.71 million, which is actually pretty impressive even though it was lower than the same period a year earlier.

Despite this measure, Approach was not able to reduce debt. With a low long-term debt-to-capital of 46.2%, a slight worsening compared to the 45% seen at the end of last year, the company's debt picture doesn't look terrible but I had wanted it to engage in some form of debt reduction. Instead, total debt came out to $499.68 million, an increase over the $496.59 million seen the same period in December of last year. This was also higher than the $495.96 million management reported in the first quarter of this year and was driven entirely by increased borrowings under its credit facility. Approach does, thankfully, still have nearly $50.6 million available to borrow under its credit facility but I very much would have preferred the company engaging less in completing wells and focusing more on lowering its borrowings under the facility.

Takeaway

Based on the data provided, I'm fairly happy with Approach and its financial results for the quarter. The company did well in lowering its costs and it has announced plans to complete additional wells in the third quarter in order to keep production as high as possible. I am a bit depressed about management's decision to tap into the credit facility more but when you consider that the firm still has a strong balance sheet otherwise, it's not the end of the world right now and is unlikely to pose a meaningful threat to the enterprise moving forward (unless things get really bad with energy prices). Moving forward, I intend to continue holding my stake in Approach but I will be watching its debt picture more closely next quarter.

Disclosure: I am/we are long AREX.

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.

Editor's Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.