As we patiently watch the erosion of the natural gas storage overhang due to record natural gas demand and slowly ebbing supply we have established three general plays to benefit from the ongoing and future recovery of natural gas prices:
- The "I'm gassy but I'm an industry stalwart and I'm rapidly using my horizontal experience to get oily" play,
- The "I'm a good proxy for natural gas prices and you get paid to wait" play, and
- The "I'm leveraged, gassy, and my stock price has been beat down by fear over my ability to weather low gas prices with all this debt" play.
Today I'm addressing that last play with comments on the leveraged and gassy but adaptable story that is EXCO Resources Inc. (XCO).
The story is fairly basic. EXCO is a mid cap E&P that is unabashedly a natural gas company. Volumes are 96% gas produced largely from the Haynesville and Marcellus shales, with a small amount of liquids coming from the more nascent Permian Basin. The Permian is a sort of late bid to enter the liquid rich rush but on a more measured pace than we have seen with some players who simply abandoned their roots, leaving gas plays like the Haynesville for marginal acreage on edge of the Williston or DJ Basins. Those players often paid a premium for their new found "core" plays while leaving their old cores at a time when completed well costs there were just beginning to fall. EXCO has passed many an over-priced set of liquid focused asset as it hunts the properly priced oil play(s).
Given their lack of liquids exposure, their realizations are still very closely tied to average natural gas spot prices. The slightly better pricing for XCO is due to liquids content (2% oil plus NGLs and they should go to 3 stream reporting soon so we'll have more color at that time).
To survive in this environment as the company awaits higher natural gas prices they have been cutting both capital and operating costs. Drilling and completion costs are falling as other operators flee the gas plays, a benefit of not cutting and running on your bread and butter gas program. In the Haynesville this has allowed them to cut completed well costs from $9.5 mm at YE11 to an expected $8.0 mm later this year, helping to greatly stretch those tight budget dollars.
On the operating side, costs are falling due to a concerted cost cutting program that has pushed cash operating costs (LOE, Production Taxes, and G&A) from $2.59 per Mcfe in 2009 to $1.40 Per Mcfe as of 1Q12. This, along with continued strong, albeit gassy, growth has led to EBITDA per Mcfe that has fallen but not nearly as much as it would have without the operational cost savings and, given the grudging upturn in natural gas prices, should be a near, medium, and long term nadir now.
XCO is leveraged but the debt load is manageable and they do have assets to monetize if needed. The capital program is flexible and should natural gas prices again retreat it can be pared back to accommodate lower levels of spending. While 69% net debt to cap looks high, part of that is attributable to ceiling test impacts (drops the E in the denominator). A better read is debt to trailing twelve month EBITDA and on that measure they are fine. Interest expense is manageable and there is more fear in the stock over their leverage than is necessary as their liquidity is strong (see table below) and they can always further reduce the budget if needed.
In fact, their budget for the year has already been reduced (due to weak natural gas prices and the lower borrowing base) from an early expectation of $710 mm to $470 mm at present and that budget did not rise as they lifted production guidance Monday night, something we have seen go hand in glove this year with many of their peers. It helps to have your production base outperform expectations even as you reduce activity. Year to date, and along with natural gas prices, this reduced budget and therefore reduced growth rate has weighed on share prices.
Liquidity remains more than adequate. In April, like we have seen with other gassy players, their borrowing base was cut from $1.6 B to $1.4 B (a move that was expected and well telegraphed by management) leaving them with $200 mm in available borrowing capacity at the end of April. In fact, they have $145mm in cash and they have been slowly paying down debt and they are within their debt covenants. Expected EBITDA over the last six months of the year should roughly cover 2012's remaining budget, requiring no further reduction in cash balances or increased usage of their revolver. Furthermore, they are likely to sell off chunks of non core producing assets and potentially some of their midstream assets, perhaps with the 3Q12 press release, further enhancing their liquidity.
Nutshell: These guys would obviously benefit from higher natural gas prices. Looking at the table below in the EBITDA section and the production section, one can easily see that in a better gas price environment they would crank out some serious cash flow. Right now, despite the drop in the stock price, the high debt level and low gas prices have prompted them to repeatedly cut their budget back (3 times since November) and this leaves them lacking for growth (at present just 3%) and not exactly cheap, despite the decline, on TEV/EBITDA nor on TEV / proved reserves basis (unlike at PVA).
And they are not rapidly getting oily (also unlike at PVA) but again, that's not why I'm looking here, and the stock price has taken its lumps for their seeming reticence to "go oily" already. I'm looking for the guys that everyone thought were about to die to get up off the floor as natural gas does. When people really start hunting for gas leveraged and financially leveraged names, this one will be high on the list. Moreover, I admire their resolve and think that things could begin to improve for them as the year progress as prices appear to be moving higher at a time when they are wringing costs from their system.