Shares of Pioneer Natural Resources (NYSE:PXD) have been absolutely slammed by lower oil prices; they are down a whopping 35% in just the past six months. This type of price volatility is either a major warning sign or a tremendous opportunity. In the case of PXD, I believe this sell-off presents a significant long-term opportunity. Now to be clear, I believe this is a long term, not necessarily a short term, opportunity. If oil continues to sell off, it seems like the market will take PXD down with it. As such, your view on oil may color when exactly you decide to buy PXD. While I would not be surprised to see oil sell off further, I have initiated a partial position in PXD in recent days to take advantage of the price drop, in case oil does find its footing. If PXD falls more, I will add to my position. Importantly, PXD has the financial strength and hedges to weather this downdraft while offering significant resource potential when oil prices eventually rise.
Pioneer is one the largest, most entrenched companies in the Eagle Ford and Permian Basin. These are two of the fastest growing regions in the company, and Pioneer has benefited greatly from new drilling technologies. Pioneer's production should jump 18-19% in 2014, and I expect it to grow a similar amount in 2015-2017 (financial and operating data available here). Pioneer is one of the fastest growing large oil companies in the country. Importantly, they also tend to be in lower cost areas than other growth areas like the Bakken, which is important in a falling oil price environment. As an entrenched player, Pioneer also has some of the best acreage in these plays with production costs per barrel of less than $14. Pioneer has also built out is supply chain in these infrastructure constrained areas to ensure a steady flow of water and other necessary materials at a reasonable cost. This should help PXD maintain margins.
Growing production nearly 20% is costly; it requires a massive amount of cap-ex. The decline in oil has weighed on energy bonds, and now is not the best time to have to borrow. Importantly, I expect PXD to self-fund its cap-ex program, which should cost about $3.5 billion next year. It recently sold $1 billion in stock when the stock was $30 higher, so that turned out to be excellent timing. It also is in the process of selling midstream assets in the Eagle Ford, and they should fetch at least $1.2 billion. Even if oil stays at $65, I expect PXD to generate north of $1.6 billion in operating cash flow. Even with its large cap-ex needs, PXD should be retaining $300 million or more in cash.
This cash retention comes on top of an already solid balance sheet as PXD has less than $2 billion in debt, compared to a market capitalization of about $22 billion. Gross leverage is only 1.2x, giving Pioneer one of the more conservative balance sheets in the industry. Pioneer can easily withstand lower oil. Given its strong balance sheet, I also don't expect any more stock offerings in the next 6-12 months, especially if the stock stays at this fairly low level. PXD's funding needs for the next 15 months are being taken care of without the need of any additional debt or equity issuance.
Now, it is also important to note that Pioneer has hedged 85% of expected 2015 production and 45% of 2015 production. This would seem to give the company almost total immunity to oil prices next year, making the drop in stock seem nonsensical. While PXD's hedge profile is one reason I do like the stock, PXD is a bit less hedged than meets the eye, which could be a reason why PXD has sold off so hard. Pioneer hedges via three way collars. Pioneer sells a $99 call option and receives some premium, but now the most PXD can realize from oil sales is $99 per barrel. It uses this premium to buy the $88 strike put, meaning it can still sell its oil for $88 if it falls further. However, this trade tends to cost PXD some cash as the put is more costly than the call, so it also sells the $73 put to come out roughly cash neutral.
This three way collar means the following. When oil is $99 or higher, PXD can only realize $99. From $88-$99, PXD realizes the price oil is trading at. From $73-$88, PXD has no commodity exposure and realizes $88. Below $73, PXD has commodity exposure and for each dollar WTI is below $73, its realization falls the same below $88. In other words if WTI is $68 ($5 below $73), the company would realize $83 ($5 below $88). While Pioneer still has some commodity exposure, the hedges mitigate the magnitude of the decline in oil. Oil falling from $88 to $68 (a 23% drop) will only cut PXD's revenue by about 6%. If oil does continue to fall, PXD's results will suffer, but they will only suffer a fraction as much had they not hedged. PXD's hedges are clearly an asset when oil falls.
Finally, it is important to note that Pioneer's growth won't be short-lived. Pioneer has proved reserves of 845 million barrels of oil, about 13 years of production. Thinking over the long term, Pioneer's potential resources could exceed 11 billion barrels, over 100 years of production (see the most recent shareholder presentation). Now, this estimate assumes oil of $90, which over a very long term time horizon is reasonable. When thinking about reserves, it is important not to focus too much on near term prices as only a fraction of resources are extracted in the near term. PXD is only trading at $2 per barrel of resource potential. Considering PXD generates cash margins north of $10, I believe this valuation is well below the present value of PXD's resources, assuming oil doesn't stay at $65 forever. In fact, I wouldn't be stunned if a larger company like Exxon Mobil (NYSE:XOM) tried to acquire PXD to get its resource potential at such a low price.
With Pioneer's resources, its current valuation is very attractive. Assuming a $5 present value of reserves, which is probably conservative, PXD should be trading closer to $350. Now, I don't expect the stock to get there anytime soon, but when you can buy a company for a fraction of its intrinsic value, that tends to be a good opportunity. With its hedges, internally funded cap-ex, and strong balance sheet, PXD has the strength to withstand a prolonged downturn while its resources give the company a lot of upside once oil moves higher. I would be a buyer of PXD here.
Disclosure: The author is long PXD.
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