Oasis Petroleum's Latest Results Could Prove It's The Real Thing

| About: Oasis Petroleum (OAS)

Summary

Oasis reported impressive Q2 earnings last Thursday.

It guided to higher production for 2016 and reduced expense guidance.

Strong results reduce the likelihood of dilutive share issuances.

Oasis Petroleum (NYSE:OAS) reported its Q2 earnings last Thursday, and the operational performance was simply excellent given the current low oil price environment. By retreating to its core areas and managing its expenses, the company has been able to realize tremendous operational savings.

Our concern with Oasis Petroleum has been centered around its debt load, and whether it would generate enough cash to maintain an adequate interest coverage ratio for its credit line. As we stated in our last article, the credit line has a convenant that requires that the company maintain an interest coverage ratio of 2.5 to 1 (i.e., essentially EBITDAX to cash interest expenses). Using the conservative figures provided in Oasis' previous guidance, we tested this and found the ratio to be extremely close to, if not slightly below, the required interest coverage ratio. This would mean Oasis would be constrained from a liquidity perspective and may need to issue shares (thereby diluting shareholders) to pay for certain capex investments.

Q2 Earnings

The reported Q2 figures, however, could represent a turning point. For the second quarter, Oasis reported higher revenues and lower expenses than we had originally forecast.

Using the revised production guidance and the mid-point of Oasis' new LOE figures, we believe Oasis will now generate an EBITDAX of approximately $510M (assuming OWS generates $12M per quarter for the remainder of the year). With forecast cash interest expense of approximately $150M, the interest coverage ratio should stay above 3-to-1, leaving Oasis with room to continue using its credit line, and reducing the likelihood of stock issuances and share dilution.

Other items to note in the second quarter were G&A expenses falling over 25% from the first quarter, which means additional efficiencies and some job cuts were likely involved. Well costs were also further reduced from $6.5M to $5.9M. While it remains to be seen how much of these reductions in well costs will survive when oil prices turn higher and oil service companies claw back their margins, for now, any additional decreases help. Lastly, Oasis also firmed up its production guidance by increasing both the bottom and top range of the guidance to 48,500 to 49,500 Boepd.

While the company reported higher revenues and lower expenses than we expected, the company was still cash flow negative when taking into account capex. The company did "live within cash flow" as it stated in the press release, so let's take a look at how and why they claim this.

Cash Flow

When managing through a downturn, a company's focus has to be on preserving cash and managing cash flow. Many investors focus on the income statement, but the cash flow statement (with some help from the balance sheet) is where we can tease out how a company is supporting itself.

Source of Cash

Turning to Oasis' cash flow statement, the company generated approximately $94M from operations (i.e., Oasis' adjusted EBITDA less cash interest expense).

Q2 2016

Adjusted EBITDA

$132,158

Cash Interest

$(37,784)

Cash from Operations

$94,374

Capex

$(131,288)

Capitalized Interest

$4,835

Free Cash Flow

$(32,079)

Change in Assets & Liabilities

$69,120

$37,041

Click to enlarge

The company, however, spent $131M in capex, which meant a cash shortfall of $32M. Oasis CEO Thomas Nusz stated: "Lastly, we further reduced borrowings under our revolver from $65 million at the end of the first quarter of 2016 to $35 million at the end of the second quarter of 2016."

We questioned where the extra $62M came from (i.e., the $32M cash shortfall and $30M to pay down the credit line). In searching through the cash flow statements, it appears as if Oasis brought down working capital by over $69M, and used the extra cash to fund capex and pay down the credit line. We believe most of the reduction in working capital, however, is merely just timing differences, and approximately $45M of the reduction in payables will reverse in the following quarters. Just a quick note: Payables are another way to say "IOUs;" at some point you'll need to pay it down, but until you do, your cash flows are significantly improved.

Jumping to the balance sheet, two items accounted for the bulk of the reduction in payables, accrued interest payable and revenues and royalties taxes payable.

Accounts Payables

Take a look at the historical cadence for accrued interest payable. Oasis has senior notes outstanding and the notes call for interest payments to be made semiannually (i.e., first and third quarter) and in arrears. This means that the second and fourth quarters have higher accruals for interest payable.

Q1 2015

Q2 2015

Q3 2015

Q4 2015

Q1 2016

Q2 2016

Accrued Interest Payable*

$24,677

$49,458

$24,650

$49,413

$24,277

$47,671

Click to enlarge

*From Oasis Form 10-Q (Q2 2016) balance sheet.

Thus, the cash requirements in the second and fourth quarters are "lighter" as the company has accrued for (but not yet paid) $25M of interest due, and can use the cash to either temporarily fund capex or pay down the credit line.

For revenues and royalties taxes payable, higher oil prices begat higher revenues and, in turn, higher roytalties and taxes.

Q1 2016

Q2 2016

Revenues and Production Taxes Payable*

$115,412

$138,451

Click to enlarge

*From Oasis Form 10-Q (Q2 2016) balance sheet.

Here the company has accrued for, but not yet paid out the increased royalty and production taxes (even though it has received the cash from sales). Again, this is a lag effect, and in the following quarters when Oasis is required to remit the royalties and tax payments Oasis will need to find the cash to pay them (generated either from operations or the credit line).

Therefore, while Oasis was free cash flow negative in Q2, changes in working capital (i.e., a reduction in accounts receivable and increase in accounts payable) helped the company achieve cash flow neutrality. We believe most of this is simply timing, and will reverse itself in the next few quarters (although accrued interest payable will continue to maintain its historical cadence). This means that we'd anticipate an increase in borrowings from the credit line (unless cash from operations increases enough to cover these expenses). This is not necessarily a negative, just something to watch out for as we finish the year.

Stabilizing and Looking Ahead

Coming off of low oil prices in the first quarter, Oasis is now much better positioned to use its liquidity (i.e., credit line, increasing stock price, and enhanced cash flows) offensively. If (and when) oil prices stabilizes higher (i.e., upper $40s and potentially into low $50s), Oasis could be primed to take advantage by increasing production, exploring M&A, or paying down debt -- all of which would enhance shareholder value.

In the short term, it does appear as if the risk of share issuances to fund operations and capex are greatly reduced, and with 80% of its 2016 production hedged and an increased production profile, the company should continue to generate sufficient EBITDAX to maintain ample liquidity on its credit line.

So maybe the Oasis isn't a mirage after all ... or maybe higher oil prices simply heal many ailments.

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.