Parsley Energy (NYSE:PE) is a relative new player in the quest for the black gold in the shale revolution. The company made its public debut through an IPO in March of 2014 at a price of $18.50 per share.
Shares quickly rose to highs of $25 during the summer amid peaking oil prices as they fell to lows of $11 amid the oil sell-off. In recent weeks shares have seen a much bigger rebound compared to some of its competitors, currently trading at $16 per share.
The Business And Its Plans
Parsley focuses on the production of oil in the Midland Basin in Texas. Average production in the third quarter came in at little more than 15,300 barrels of oil-equivalent per day. Of this production little over half took place in the form of oil, while the rest was produced in the form of NGL and natural gas.
At the time the company guided for production of 17,000 to 17,500 barrels of oil-equivalent per day in the second half of 2014, suggesting that production could come in around 19,000 barrels of oil-equivalent per day in the final quarter of the year.
It is clear that the business is still growing rapidly following huge capital expenditures being made, including a $454 million investment made during the third quarter which contained a $290 million deal component. The $164 million organic investment rate is however anticipated to slow down to $96 million to $136 million in the final quarter of 2014. This still implies an investment capital spending pace of close to half a billion per year.
In the third quarter, Parsley sold its gas, oil and NGL at around $58 per barrel based on WTI prices of around $95 for the quarter. Assuming similar percentages in terms of price declines, realized prices could have fallen to just $34 for the blend at the moment. Projecting these kind of sales prices on Q3 production would have yielded revenues of $48 million instead of the near $84 million reported.
Total costs for the quarter approached $50 million, including $2.5 million in acquisition-related costs, which shows that the company is currently breaking-even before considering interest expenses which totaled $10 million over the past quarter.
It must be said that depreciation charges for the quarter totaled some $20 million resulting in modest positive operating cash flows at the moment despite break-even results on an operating basis.
The Great Hedging Plan
The rapid growth shown by Parsley has an unexpected benefit. The company has hedged production for 2015 and 2016 at an aggressive pace. Actually the company hedged production for the upcoming two years at a production base of 150% of the production rate in the third quarter of 2014. This suggests that the business has hedges for daily production of roughly 23,000 barrels of oil-equivalent for the upcoming two years in place.
Combined with a flexible rig schedule, the company has an option to be very short energy prices, thereby being able to reap a big one-time gain if it decides to slow down production growth. This option is actually a possibility given that the company has a flexible rig schedule, not being tied up into fixed contracts.
In terms of specific hedges, Parsley has about 23,000 barrels of oil-equivalent per day hedged at a price of around $80 for the current period until the second quarter of 2017. Assuming that the average curve of WTI for these time period comes in around $60 at the moment, Parsley could realize a huge $300-$350 million one-time gain on these hedges.
Premium Valuation, Relatively Contained Leverage
Parsley Energy ended the third quarter with $133 million in cash and equivalents, while it had another $575 million available under its credit line. Debt totaled $550 million in the form of senior notes which were only due in 2022, resulting in a net debt position of nearly $420 million. If the company were to realize all the gains from the hedges at once, Parsley could end up with a roughly flat net cash position.
Parsley currently has 125 million shares outstanding which at $16 per share implies a valuation for the equity in the business at around $2.0 billion, valuing the entire business at $2.4 billion. If the business would eliminate all hedges, the valuation would come in around $2.0 billion as all the net debt position will have disappeared.
The problem for now is that depreciation charges total just $80 million per year, while Parsley is investing at a rate of roughly $500 million per year, in what essentially is a break-even investment based on GAAP accounting. This cash flow shortfall does result in a net debt position built up of roughly $400 million per year.
The problem is that it is still uncertain how quick production will increase in 2015 as the company has not yet delivered on a 2015 capital budget plan or production growth plan. Other players often end up investing a billion or so to increase production by some ten thousand barrels per day, so production rates to their mid-twenties thousand of barrels of oil-equivalent per day seems very much among the possibilities.
This follows production of around 19,000 barrels of oil-equivalent per day in the final quarter of 2014, and the current investment rate which still exceeds a $100 million per quarter.
Comparisons to competitors are not directly applicable and comparable. For starters, many shale oil and gas players have very different realizations as a result of a different composition in oil and gas production. Other key differences include hedging strategies, break-even points, capital expenditure budgets and the pace of production growth, among others.
As such traditional valuation metrics like price-earnings multiples are not so much applicable in this case, with many producers including Parsley posting operating losses at the moment. For many emerging shale players the focus is on surviving the current turmoil.
Parsley is a new player and despite a rapid pace of dealmaking the company has great flexibility amid solid cash holdings and a fairly limited and long term maturity of its debt.
In May of this year, I checked out the prospects for the shares following the IPO with shares trading in the low twenties at the time. I applauded the balance sheet strength, growth and earnings. At the same time, I warned for relatively high capital expenditures and limited operating history which urged me to remain cautious as I decided to watch the action from the sidelines.
The real benefit comes from the fact that the company has already hedged its anticipated production growth for the upcoming two years, which creates a massive short position if the company does not deliver on this production growth in the coming time periods ahead. This essentially creates a huge short position in oil prices which gives the company a huge option if it wishes to slow down production growth by cutting capital expenditures into 2015. Note that Parsley has not yet announced its budget for the upcoming years, but many other emerging players have cut their budget by percentages of up to 50%.
As such the company is very well-positioned in terms of its leverage position, being able to survive the current storm perfectly, especially if it capitalizes on parts of its hedges, by cutting the growth in production in 2015. This is probably the reason why the market has discriminated between Parsley's shares and the remainder of the market. Shares have already jumped back roughly 50% from their lows on the back of this great financial position in recent weeks, as other players have seen a much more modest recovery in their shares.
That said, shares are not an immediate buy as well in my eyes. Based on the third quarter realized prices, Parsley could post operating earnings of $180 to $200 million for 2015 based on production of 23,000 barrels of oil-equivalent. Subtracting $40 million interest payments and applying statutory tax rates, and earnings would come in just shy of a hundred million. To break even Parsley would require WTI prices of $70-$80 next year, something which is not very likely with WTI still at $55.
The fairly small production base in relation to the valuation and the fairly high break-even point do not make shares necessarily attractive at current levels despite the fact that the business is very well positioned to survive this storm. For these reasons I continue to avoid the business, but applaud management for a great, but probably unintended hedging strategy, which turns out to be a great advantage currently.
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.