"Pioneer Resources (NYSE:PXD)" is an E&P company with activities in the Permian, Eagle Ford, Raton and Panhandle basin. We wrote already about its strengths and we suggested some prudence following the recent strong stock performance. In this article, we want to take a more fundamental approach, valuing the company at its liquidation value, without considering the growth optionality (and related costs/risks) and considering it stops immediately any development effort.
Pioneer's growth prospects have a disproportionate weight in the current valuation of the stock (a recent Alliance Bernstein analyst estimates it at around 80%) and this exercise allows to really understand what is the implicit de-risked value of the company. We use a sum-of-the-part approach with punctual estimations of the following elements:
+ Value of the oil and gas that will be produced by existing wells;
+ Value of the acreage holdings as if they were to be sold at current market prices;
+ Value of the assets in place (equipment, plants, participations, derivative gains, cash & short term investments);
- Value of the liabilities and contractual obligations;
= Liquidation Value.
This approach allows to focus on the resources on hand, without the burden of estimating true profitability of a yet-to-be-developed field, depreciations, technological progress and business risks. All of those variables are implicitly captured by the current market value, either in the future curve or in the acreage transaction price, assuming that the market is efficient in its pricing action.
Implicit in this analysis is the assumption that current market transactions and prices correctly value all the future optionality intrinsic in Pioneer's huge asset portfolio and technological expertise. In short, we recognize that Pioneer assets are blessed by a deflationary cost environment, multi-stack opportunities and a steep learning curve, but we think it is safe to assume that this is precisely the reason why the Permian acreage is so much more expensive than any other…
It is important to explicit the assumptions regarding the realized oil price, as well as an estimate of the costs involved. We will use the oil and gas prices derived from the current future curve (Sep/19th), while we will assume $9/barrel production costs (as of the latest annual report), $2/barrel taxes and lower corporate costs, since the company would not incur any E&D cost. With current corporate costs at $4/barrel and a 50% haircut, total operating costs equal to $13/barrel, constant for the next 15 years.
Finally, the discount rate used for calculating the present value of future cash-flows is 10% and the tax rate on profits is 25%.
(future curve as of 08/26/16)
1) Wells in place:
Pioneer has exposure to 4 distinctive basins, which should be treated differently. The Raton and West Panhandle (WP) produce natural gas from vertical wells and account for roughly 13% of total production on an oil equivalent basis. Those are long-lived assets which require minimal investments and have a steady decline curve. According to company filings, there are currently 2.200 wells in operation in Raton and 700 in WP for a combined average production of 27.4 MBoed (~9.5 barrels/well/day).
Using reported data on the Raton field which saw no rig activity for the past few years, we can estimate the decline rate at 9% per year (based on 2012-15 data) and the future production profile for the 2 basins. The Raton and West Panhandle fields have thus a steady-state value of $1.5 billion:
Estimating the Permian and Eagle Ford production profile is more difficult, since those basins have both vertical and horizontal wells with significantly different decline rates. For vertical wells, we use the same 9% decline rate as before, while the horizontal wells decline rate is more tricky to calculate. We base our analysis on the work of Linnea Lund (2014, first year decline: 75.2%; second year: 46%; two year combined: 86.6%; 6% per month thereafter) and shaleprofile.com, as well as on our interpretation of the data. To take into account the outstanding well results reported by Pioneer, we improve the decline rate by 5%.
Decline Curve for an Eagle Ford well in 2014.
Pioneer Estimate, August presentation, slides 9-12
The company has started to disclose the types of drilled wells only since 2014, so we base our analysis on the stock of existing wells reported by the management. For the period 2011-12 Pioneer has used most of the rigs for vertical drilling, while in 2013 the activity shifted in favor of horizontal developments (18 rigs out of 29), despite the fact that an horizontal well needs more time to be drilled.
Based on Texas Rail Road Commission data, we have calculated that Pioneer has 327 active wells on the Eagle Ford and 1999 in the Spraberry area (Permian), less than what we had calculated above, probably meaning that in the last 5 years some of those wells (or the legacy ones) have been shut or sold. If we assume that the horizontal wells are still up and running, being relatively young, they would make up 52% of the total number of active wells.
We assume that a vertical well can produce around $10 Boed (no decay) and according to company presentations, an average horizontal well yields 200 Mboe after 360 days on production. We take these data for granted and apply the decaying factor starting from the second year onwards. Other estimates point to a wide range between 120 and 450 Boed in the Eagle Ford, both more conservative than what we used:
Click to enlarge The Eagle Ford and Permian wells in operation (already developed) are worth $4B, which gives a total value of current operating activities of around $5.5B (Permian + Eagle Ford + Raton + WP).
2) Value of the acreage assets:
Pioneer has been able to accumulate a significant amount of developed and undeveloped reserves that might be sufficient to assure production for the next 20-50 years. The company has a total (developed + undeveloped) leasehold acreage of around 1.8M net acres. They disclose the breakdown by basin but we could not find any specific number on the Eagle Ford net assets (only the gross number is mentioned). We assume that the net acreage in the EF equals 85% of the disclosed gross acreage.
Moreover, little credit will be given to the undeveloped reserves, since 93% of this acreage is located in Colorado, where no oil has been found. According to Gabriele Sorbara of Topeka Capital Markets, the undeveloped assets in Colorado might be sold for $100-$200 / acre, for a total consideration of $60-$120M (he thinks Eagle Ford's 230k acres might fetch $3.5-4.0B as well).
To finally compute the value of the Permian, Eagle Ford and Panhandle acreage, we have compiled a list of recent transactions in those areas. The list is not exhaustive and not all deals are comparable, since some of them came with already-producing wells and in several different counties. Highlighted in yellow the transactions that we consider more representative and are used in the following analysis.
Adding around $500M for the remaining Undeveloped areas, the acreage assets are worth around $25B (for reference, the carrying value in the balance sheet is $16.8B).
3) Value of the assets in place:
Pioneer owns a sizeable infrastructure which has allowed them to reduce costs and control the technical development of its basins. The latest annual report lists 7 gas processing plants, 8 treating facilities, sand mining operations that cover 50% of the sand needed for their frack jobs, 8 fracture-stimulation fleet. In total, the net carrying value of equipment and (non-oil producing) properties is $1.5B.
Another "asset" that the company owns is the unrealized gain on derivative contracts. As of the latest annual report, if Pioneer were to unwind those hedging positions, it could earn more than $230M (as of the latest quarterly report). In fact, oil production for 2016 is 85% hedged at or above $65/barrel, while 50% of 2017 production is hedged at or above $49/barrel.
Finally, cash ($1.8B), short term investments ($1.4B), accounts receivables ($434M) and inventories ($165M) sum up to around $3.8B.
Asset in place are thus worth a combined $5.5B.
4) Value of the liabilities and contractual obligations:
The company has slightly less than $700M in accounts payable and fairly limited debt ($3.6B). Moreover, it carries future commitments (drilling contracts as well as future minimum purchase, gathering, processing and lease commitments) that total around $400M. Clearly, for the purpose of the analysis, we could consider that the company might drill some wells in order not to record a loss on those contractual obligations, but we'll skip this exercise given the limited size of these impairments.
Moreover, Pioneer carries in its book $1.5B in deferred income taxes and $112M in value of stock-based compensations, for a combined $6.3B in future liabilities.
We estimate that the fair value of Pioneer equity is $29.7B, just 5% below the latest market cap of $31.5B.
Our model tries to limit the number of assumptions on future optionality and capital expenditure decisions, which are very difficult to predict. Instead, it relies on market data (future prices, transaction history and balance sheet appraisals) that are supposed to condensate the collective wisdom of operators and investors, not only on the current state of the business, but also on the future developments of the industry.
The analysis clearly showed that Pioneer Resources is backed by solid fundamentals and that the current valuation is not just about hype and inflated forecasts based on unrealistic growth opportunities. Despite of that, the stock price is slightly above the intrinsic value and thus we recommend to wait for a better entry point before investing in this high quality operator.
Major risks to our estimates relate to a sudden drop in prices in the Midland region (which contributes almost 85% of the company value) or lower realized oil and gas prices (especially because hedging at favorable prices is getting more and more difficult).
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.