In August I wrote that Whiting Petroleum (NYSE: WLL) was a gamble. The stock has continued to be volatile between then and now. This is exemplified by a high of $22.43 and a low of $14.70 during this time period, a 52% spread. Evidently, the market still isn't sure about how the company will fare in the future. Now that Q3 results are released, I must say that I agree with this sentiment.
Production was at 14.8 MMboe, or an average of 161 Mboe/d. This represented a 38% increase over Q3 2014's level of 15.5 MMboe or 170 Mboe/d. I am usually indifferent to production rates when viewed in isolation, but considering the company's fairly aggressive capital expenditure, this is critical. During the past three quarters, the company has spent $2.14 billion on capex, which is actually a slight increase over 2014's level of $2 billion. In a world when most energy firms are reining in their capital spending, Whiting Petroleum decides to soldier on. But I don't blame them. Given their track record of organic reserve expansion as the result of successful drilling programs, it's easy to think that the return on Whiting Petroleum's capital program will be better than other energy players.
To maintain this aggressive capital program, the cash must come from somewhere. Some of it came from asset sales ($339 million YTD), but most of it will have to come from operating cash flow. After all, it doesn't really make much sense to fund your reserve growth by selling existing reserves (exceptions do exist, but they are out of the norm). This is why high production is so important for the company. Today's oil price of $43/bbl (WTI) is down 46% from a year ago. Theoretically, this means that the company would have to almost double its production in order to achieve the same level of cash flow (ignoring the effect of derivatives). Obviously that is a very difficult goal to reach, but if you buy into management's capital program, then you should be happy with Q3 production numbers.
Coverage Ratio Is Low, But Has Time To Improve
Every dollar generated is being sucked into the company's aggressive capital program, so Q3's debt situation wasn't much of an improvement over Q2. Long-term debt still stood at $5.2 billion and cash was little changed ($60 million to $38 million). However, you may be surprised to learn that EBITDA/interest expense coverage ratio was 6x in Q3, which would be adequate in my book. But don't celebrate just yet, as derivative gains of $208 million made up much of the total EBITDA. Although this is not exactly a one-time gain, it is highly unlikely that the company can continue to make such gains in the future. Overtime, hedges tend to even out. To illustrate, the company suffered $92 million of derivative loss in H1. When we adjust for the derivative gains, the coverage ratio goes down to 3.5x. While this may still be acceptable for more adventurous investors, I still think that the adjusted coverage ratio is not satisfactory given the continued uncertainty of commodity movements in the future. However, the company does have a lot of time to improve, as the first maturity is years away (2018).
The company's high production rate is critical as operating cash flow funds the company's capital program. As I mentioned in the previous article, the company has done well in previous years with its drilling program, so it may be another hit this time around. However, because of this strategy, coverage ratio remains low, and given the uncertainty in the commodity market, I am afraid that the company does not have a lot of room for errors. If everything goes well and the company can continue to expand its reserves, then this aggressive strategy will pay off. If things go south however, I don't think that Whiting Petroleum will have any wiggle room.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.