By Kathleen Martin
Some energy companies have recently started to move away from the exploration and production of natural gas - Newfield Exploration (NFX) and SandRidge (SD) come to mind. These companies have made the brave decision to buck the trend toward cheap and plentiful natural gas and move into high margin oil exploration, development and production for growth and stability. Newfield wants to be known as an oil company and have gas removed from its business description entirely. Is this a good thing for the future of the company and its shareholders?
Despite the decrease in demand from Europe and Asia, the Saudi increase in production in advance of the Iranian oil embargo, and the Energy Information Administration reporting that increases in North American oil production have supplies at their highest levels in 22 years, Newfield is concentrating all of its efforts on oil exploration and development.
The company's internal analysis did not indicate any near term rebound in the natural gas prices at the end of the first quarter 2012. The company undertook the sale of non-strategic assets in 2011, hedging programs, and shifting human capital and resources to profitable oil properties.
The company started shifting its focus from natural gas to oil in early 2009. Since then, we have seen significant increases in Newfield's oil and liquids volume. Oil and liquids represented 47% of its volumes in the first quarter of 2012. NGLs accounted for 5% of its total production. It is expected that the second half of the year will see over half of Newfield's production coming from oil and liquids.
In 2011, the company sold $300 million of gas assets along the Gulf coast to reduce its natural gas portfolio. Its production of gas in the Rockies has been in decline since 2008. Newfield has not drilled any new wells in that region. The bulk of Newfield's natural gas production is coming out of the mid-continent region.
The company is particularly proud of its management and operational team which absorbed project setbacks in 2011 to execute and deliver a strong 2012. The company now has a broader inventory of assets over multiple geographic areas. The inventory is a competitive advantage and it is being well managed. It is focused on the timely assessment of high margin properties and executing in development, which will build momentum and oil growth going into 2014.
The company is making efforts to reduce costs and expenses where it is able, and is using the savings to drill the high margin oil and liquids plays and to make sure the wells are drilled, completed, and converted into sales in a timely manner. Cost effectiveness is a result of efficiency gains and reduced service costs. Increased production is a result of better than expected well completions and strong performance of that business unit.
Despite not running any gas rigs, the company's natural gas production was higher in the first quarter than originally expected, which caused the company's guidance for the year to be slightly higher. The company expects full year production will range from 292 to 302 billion cubic feet equivalent. Capital spending is expected to reach $1.5 to $1.7 billion. Oil production in the first quarter of 2012 was 400,000 barrels ahead of production estimates. The company has delivered a compound annual growth rate of 20% since 2009. The company's inventory is geared toward sustainable future oil growth.
The company is seeing record gross oil production in Malaysia as a result of the successful development drilling program and better than expected performance from the wells. Off the shores of Malaysia, the company is finding new ways to increase oil production and to ensure there are new opportunities in the future. Malaysia's offshore region has been profitable, with projects generating 30% to more than 100% IRR. Exxon (XOM), Royal Dutch Shell (RDS.A), Chevron (CVX) and BP (BP) all operate in Malaysia. Newfield is now the fourth largest producer in Malaysia.
Domestic oil has seen increased drilling activity in the Uteland Butte, Wasatch and Lower Black Shale and the Central Basin. The company expects to double its Central Basin production by 2014. It has seven and 10 year refining commitments so that refining capacity will keep pace with production growth.
The Bakken play has seen the completion of new wells with the average initial production in excess of 2,600 boe per day with two to four operated rigs running throughout 2012. The company expects reduction in its well costs of 8% to 17% in the Bakken as Newfield moves to pad drilling, which provides cost savings of $400,000 to $700,000 per location. Completion costs will continue to improve into 2013. Newfield joins its peers, Chesapeake Oil (CHK), EOG Resources (EOG) and Marathon Oil & Gas (MRO) in the Bakken.
Fitch Ratings downgraded Newfield's outlook to "stable" from "positive." The stable outlook reflects the timing and challenges in transitioning from a natural gas producer to an oil focused company. Debt balances have increased as a result in a decrease in proved developed natural gas reserves. The growth in natural gas reserves were offset by the reclassification of 15mmboe of natural gas from proved to probable reserves, as they probably won't be developed in the next couple of years.
The company has a relatively conservative financial profile. Management is willing to borrow to finance acquisitions. Fitch would prefer acquisitions to be relatively small and financed with divestitures of non-core assets. Fitch expects its negative free cash flow from operations to continue throughout 2012. Asset sales may be a way to fund its deficit without increasing debt levels. The company's liquidity remains strong from cash balances and full availability of its $1.25 billion credit facility. It redeemed $325 million of senior subordinated notes through the use of the company's credit facility in April of this year. Newfield employs commodity hedges to reduce its exposure to short term commodity volatility which continues to support operating cash flow levels.
Newfield announced its issuance of new Senior Notes, due in 2024, and the redemption of Senior Subordinated Notes, due in 2016.
Newfield appears to have done everything right in changing its profile from natural gas to oil. It certainly appears that it has reigned in its medium term debt, extended it to long term, and reduced the interest expenses in the interim. It has developed oil rich plays domestically, and continues to get high yields and high margins from its overseas operations.
Newfield's common shares trade around $29.30. The stock has a 52 week range of $25.01 and $73.30. The price earnings ratio is 5.91. The earnings per share are $4.96. It does not pay a dividend. The company has total cash of $27 million and total debt of $2.92 billion.
The current ratio is 0.93. It is slightly on the side of not being able to meet its current obligations as they come due, and this bears watching. Commodity price volatility will affect the current ratio.
Its book value per share is $30.59. The float is 94.6% held by institutions and .069% held by insiders. The float is 4.1% short as of July 15, 2012. With 4.1% of the stock sold short and only 5% of the stock in the hands of retail investors, who do you think the institutions are selling/shorting the stock to?
Institutions are shorting the stock because they do not see measurable increases in the share prices in the near term. This could be because the stock is being held down for equity financing, either through a prospectus offering, a PIPE, or some hybrid debt/equity scenario. Either way, the market is not reflecting the book value of the stock, and the institutions are not so much trading the stock as playing poker to see what the next guy's hand will hold. It is too bad that this is the ownership concentration because it is a good company but it is no place for a retail investor at this time.