Bill Barrett: High-Return Oil Plays, But Capital Needs Could Pinch

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Summary

Bill Barrett has lagged some of its peers on worries about declining IP rates for Wattenberg wells, but even the new wells are ahead of the type curves.

Chalk Bluffs and East Bluebell could offer significant upside to current estimates and valuations, but it's going to take a lot of capital to exploit its drilling inventory.

A NAV-based fair value above $31 offers worthwhile upside today, particularly if Chalk Bluffs and East Bluebell are better than expected.

Oil and gas companies are definitely not all the same, and those differences (be they adjusted production growth, well-level ROEs, capital structures, or what have you) eventually show up in valuations. Bill Barrett (BBG), PDC Energy (NASDAQ:PDCE), and Bonanza Creek (NYSE:BCEI) are all interesting E&P companies in the $2B to $3B enterprise value range, but their performance since my October 4, 2013 piece on Bill Barrett has diverged pretty significantly - with PDCE down almost 7%, Bonanza Creek up almost 18%, and Bill Barrett up about 2%.

Looking ahead, I'm encouraged by the company's production and return potential in the DJ Basin and Uinta (or Uintah) Basin and eager to see whether initial tests in the Chalk Bluffs area will match up to the results reported by EOG (NYSE:EOG) and further expand its resource potential. On the other hand, the company's capital needs are considerable and I'm concerned about the debt/balance sheet-adjusted production growth prospects.

Sharpening The Focus

Bill Barrett has put its Powder River Basin acreage up for sale and this property should generate some much-needed cash. My baseline assumption is that the company will get $200 million or more for this property.

After that sale, the company will be more focused on its DJ Basin acreage (the Niobrara and Codell formations) and its Uinta Basin acreage, particularly the high-return East Bluebell acreage where the company's production curves and well costs project IRRs of 60% per well. For 2014, management is devoting 75% of its budget to a 3-rig program in the DJ Basin where it looks to drill 85 gross wells and participate in 45 non-operated wells. The Uinta will claim about 15% to 20% of that budget, with a 2-rig program targeting 22 wells.

To me, this focus on the DJ Basin makes sense as a strategy to increase production (production from the Niobrara was up 137% yoy and 25% qoq in the first quarter) and generate cash flow. Management believes that it has de-risked about 70% of its Northeast Wattenberg acreage (about half of its DJ Basin holdings). These wells are expected to generate recoveries of almost 340K boe (56% oil) at a cost of about $4 million, with wells with longer laterals producing recoveries about 160% larger at a 90% higher cost. Bill Barrett's recent 30-day IP rates have been trending below those of Bonanza Creek (whose acreage cuts across Bill Barrett's), but the overall curves are still broadly similar to those of Bonanza Creek, Noble Energy (NYSE:NBL), and PDC.

Bill Barrett's "Core Wattenberg" acreage is also pretty interesting, with more than 130 locations that management believes can generate IRRs above 50%. For the time being, though, I'm more interested in what the test wells in the Chalk Bluffs reveal. This is an area on the Colorado/Wyoming border (near Laramie, WY) that seems promising for the Codell formation and EOG has reported test well IPs of more than 1,300 boepd on average for long laterals and 700 boepd for shorter laterals. These results have led EOG to move into development and while they are no guarantee that BBG's acreage will be similarly productive (the company's acreage is east of EOG's), the company's own test well results in a month or two could be a meaningful value-changer.

Uinta No Afterthought

While the DJ Basin is getting the lion's share of the company's attention, that shouldn't be interpreted as a slight against the Uinta Basin acreage. These wells may not be hugely productive (EURs in the 200's), but they don't cost a lot ($2.5 million estimated cost) and they generate strong 60% IRRs and the output is almost entirely oil. As an aside, Ultra Petroleum's (NASDAQ:UPL) acreage in this basin is nearby and has generated a fair bit of enthusiasm from investors and analysts - and Bill Barrett seems to be using much more conservative assumptions. Maybe BBG's acreage is different … or maybe management is taking a conservative view of this asset. All told, Bill Barrett's Uinta acreage makes up about one-third of my value estimate for the company.

Drill, Baby, Drill Takes Money, Money, Money

This company has gone a long way from transitioning toward a cost-competitive oil company and leaving behind its legacy as a higher-cost gas-focused E&P. Bill Barrett offers over 1,600 drilling locations just in the DJ Basin and Uinta with impressive IRR potential. The problem is that it takes money to drill and those funding requirements could limit production growth.

I expect that the company's capex budget could approach or exceed $600 million in 2015 and $700 million in 2016, but operating cash flow may not hit $500 million until 2016 or 2017. Improved well designs and completion techniques could improve recoveries and lower well costs and there looks to be some room for better production costs with added scale. Even so, I think the company is looking at a challenging balance sheet-adjusted production growth profile and that is my biggest company-specific concern (oil prices, differentials, and state laws on fracking apply fairly equally to all the DJ Basin operators).

Estimating The Value

Drilling success in the Chalk Bluffs could certainly change the company's estimated fair value for the better, while lower IPs from new wells in the Northeast Wattenberg and/or higher costs could cut the other way. Likewise, oil prices/differentials have a significant impact on the long-term value.

I estimate a gross fair value of $27.50/share from the company's proved acreage (about one-third of the company's 2P reserves are considered proved). Among the risked assets, I calculate a value of $14/share for the Northeast and Core Wattenberg and $2.50 for the Chalk Bluffs. I add $10/share for the Uinta, $1.50 for the Piceance, and $4 for the Powder River. Subtracting debt, taxes, costs, and so on, I calculate a fair value of $31.50 per share today.

For Wattenberg operators, 7x is a popular forward EV/EBITDA multiple and one that isn't out of line with other growth E&P companies outside this region, but choosing the "right" multiple is very arbitrary. At 7x forward EBITDA, Bill Barrett's fair value approaches $29.

The Bottom Line

I'm not as bullish on Bill Barrett as fellow SA writer Richard Zeits, and I'd encourage readers to read his pieces as well (here and here, for starters). Even so, I do see upside to its efforts and acreage in Chalk Bluffs and East Bluebell and "not as bullish" does not mean bearish. A 15% to 20% discount to estimated NAV is nothing to sneeze at and Bill Barrett could be a stock to explore further as a catch-up play in the DJ Basin.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.