California Resources Corp. - Divestitures Are Needed As The Clock Keeps Ticking

| About: California Resources (CRC)


CRC continues to be crushed under the massive debt load following the spin-off from Occidental.

The company has quality assets which are breaking-even if we do not consider interest costs.

With debt and equity swap opportunities being limited, a big divestiture is needed to create any potential value for shareholders or unsecured debt holders.

California Resource Corporation (NYSEMKT:CRC) is a company which is and has been in turmoil since the spin-off from Occidental Petroleum (NYSE:OXY). The company has been very leveraged since the spin-off, which in combination with the plunge in oil prices has continued to weigh on the future survival prospects of the business.

While the company made logical moves to cut capital spending and costs, the options to deleverage are limited. The company has issued some stock to buy back debt at a discount, but the market value of equity is very limited currently, making this tactic no longer viable. Given the absence of losses, the only way to salvage some value is to engage in divestitures at reasonable prices, something which so far has not taken place yet.

The Revenue Line

California Resource Corp produced 140,000 barrels of oil-equivalent for the second quarter, down from the 161,000 barrels produced each day in the second quarter of 2015. Production was down by 8,000 barrels compared to the first quarter of this year.

The continued fall in production should not come as a surprise with capital spending totaling just $5 million for the quarter. Two-thirds of production took place in the form of oil, being a key driver behind solid realizations on a per barrel of oil-equivalent basis.

If we back out derivative losses, following the rise in oil prices during the second quarter, quarterly revenues came in at $435 million. Without hedges, realizations for oil came in at $41-42 per barrel, with headline prices averaging at $45-$46 per barrel for the quarter. Given that oil has fallen back to the low forties at the moment of writing, there is not much room for a sequential improvement in realizations.

Almost Breaking-Even

While revenues came in at $435 million for the quarter, total costs came in at $457 million, for a minimal loss. It should be said that $74 million in interest costs have been included in this number as well as a $51 million one-time gain. That means that an unleveraged company would pretty much break-even during the quarter.

This is very important as the company continues to be saddled with debt. Excluding one-time gains, but after taking into account interest payments, losses currently run at a $75 million quarterly run rate. The good thing is that depreciation ran at nearly $140 million for the quarter which in the absence of capital spending actually creates positive cash flows of upto $60 million a quarter.

The issue is that debt remains very high at $5.9 billion in nominal terms, although a portion of this debt trades at just 40-50 cents on the dollar, reducing the market value of this debt towards roughly $5 billion. While the company could use some of these positive cash flows to buyback discounted debt, actual cash flows are very limited. This is certainly the case if CAPEX creeps up again, and oil has fallen in recent weeks.

Debt remains the main overhang with adjusted EBITDAX coming in at just $160 million, or $640 million on an annualized basis. That is still equivalent to 8-9 times leverage, especially as production is falling at a rapid rate due to lack of capital spending.

With capital spending coming in at just $5 million in the second quarter, management has indicated that investments will increase to $10-$20 million in the third quarter, and to higher levels into 2017. That said, investments are likely too low in order to maintain production, with maintenance capital spending seen at nearly half a billion.

Deleveraging Options

CRC proudly claims to have reduced debt by $700 million since the spin-off from Occidental. While this is true it still has nearly $6 billion in nominal debt outstanding, of which roughly $2 billion can be traded and trades around 50% of par value.

Unfortunately organic profits or cash flows are pretty much non-existing given the current oil price, as share issuance will not do the trick either with a market value of merely $400 million.

To generate proceeds, both upstream as well as midstream assets could be sold, but in all honesty management has been saying this for quite a while now. So far, no real divestitures have taken place which is a shame as interest costs continue to weigh on the balance sheet.

The so-called PV-10 method still yields a valuation of $4.0 billion for the business. While this is less than the nominal value of debt, a potential revival in oil prices could perhaps leave some value for claimholders other than the banks. Perhaps the unsecured bondholders could see some value if oil prices recover, as the situation for equity holders remains dire.

The first lien term loan and secured revolving facility have $1.7 billion outstanding which have priority claims on the business. The rest of debt consists out of $2.2 billion in senior 2nd lien notes and $2 billion in senior unsecured notes. The latter trade around 40 to 50% of their nominal value.

Final Thoughts

In essence CRC has 4 separate claimholders. Banks have first term loans and revolving facility of $1.7 billion. This is followed by $2.2 billion in senior 2nd lien notes, and neither these or bank loans are publicly trading. Unsecured bondholders and common stock holders have the lowest priority of course.

That suggests that public investors should only invest in the business if they believe it is worth more than $3.9 billion, the sum of these loans. Note that the PV-10 method yields a $4.0 billion valuation, suggesting that perhaps some value is left in the unsecured loans.

3 separate bonds have roughly $2 billion outstanding and trade around 40-50% of face value, as equity investors still have a $400 million stake in the business. Unfortunately, this $400 million in value will go up in smoke in case the value of the company does not exceed the nominal value of debt, currently standing at $5.8 billion.

The situation is very clear. Significant divestitures are needed before unsecured bondholders or equity holders see any value at all, as things have been very quiet in this area. While I like the capex discipline showed by management, as well as minor debt repurchase transactions, the real big divestments still have to be announced. Until that point of time, the future continues to look very dark, with no real opportunities in sight.

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.