Centennial Resource Development IPO: Is The Oil Industry Back On Track?

| About: Centennial Resource (CDEV)
This article is now exclusive for PRO subscribers.

Summary

Oil and gas company Centennial Resource Development is preparing an IPO that will launch later this year.

Oil companies have been going bankrupt as prices plunge, and Centennial took serious losses in 2015.

Centennial operates many horizontal wells in the Delaware Basin, which has seen growing oil production over the past few years yet has unexplored areas.

The problem of continued low oil prices may be too much of a problem, though investors will have plenty of time to wait before reaching a decision.

Centennial Resource Development, an energy company which has focused on the Delaware Basin in West Texas, has filed for an IPO which could signify a rising oil and gas industry. The company has filed a placeholder value of $100 million and will be on the NASDAQ under the symbol CDEV.

The oil industry has been bit hard over the past year by low prices, with oil bankruptcies piling up even though the crude price has recovered from lows reached earlier this year. But as oil prices slump again in the aftermath of the Brexit, investors have to be careful to avoid oil companies with high debt.

Investors have a lot to think about when it comes to Centennial, as low oil prices will be a problem but the company has rich drilling prospects. For now, they should probably sit and wait.

The indebtedness problem

The oil industry has a serious indebtedness problem. A consulting and audit firm estimated in February that a third of all publicly traded oil companies could go bankrupt in 2016, and numerous oil companies such as Sandridge Energy and Linn Energy have gone out of business since then. Far too many companies in 2014 made investments assuming that the high oil prices of that year would remain, dooming them when prices fell.

Consequently, anyone looking at an oil company needs to see that the company is not struggling with debt.

In that regard, Centennial's numbers are mixed. The company states in its SEC report that it intends to use the raised proceedings to pay back a $65 million term loan as well as debt incurred from its revolving credit facility. While that may be concerning, Centennial also stated that it intends to fund capital expenditures through 2018 and use some of the money "for general corporate purposes."

The problem is that Centennial was hit hard by lower oil prices. The company had a total revenue of $90 million in 2015 compared to over $131 million in 2014, and had a total revenue of just $15 million in the first three months of 2016. After recording profits of $18 million in 2014, Centennial had a total loss of $38 million in 2015 and $14 million in the first three months of 2016.

The problem is that those 2015 losses came when the price of West Texas crude was at $48.67 according to the Energy Information Administration (EIA). The EIA forecasts that price to rise to over $51 in 2017, but that will not be enough for Centennial to turn things around if they stay still. The company must slash costs and find new avenues of exploration.

The rise of the Delaware Basin

Fortunately, Centennial is doing that. It operates 61 horizontal wells - what laymen would know as "fracking" - in the Delaware Basin. The Delaware Basin is a sub-basin of the Permian Basin, from which 2 million barrels of oil are produced every day.

Much of that production has been in the Midland Basin, another sub-basin, instead of the Delaware. While the Delaware was once a major oil producer, producers had chosen to look elsewhere.

But those producers left before the development of horizontal drilling. Now the Delaware Basin is one of the fastest growing segments within the Permian Basin, as production rose to 72.6 million barrels in the fourth quarter of 2015 from 22.5 million just three years. Producers are trying to acquire land in the Basin, with an acre fetching $10,000 to $25,000

Wait and See

If Centennial can become successful, that would be a good sign for the oil industry. There has not been an oil company IPO since pipeline operator Penntex Midstream Partners (NASDAQ:PTXP), which priced at its midpoint at $20 per share. Centennial has a successful operation in the developing Delaware Basin and is not just scrambling to go public in order to raise cash.

But the company has been hit with heavy losses due to the low price of oil, and oil prices are not come close to their old peak until 2018 at the earliest. And while continued expansion into the Delaware Basin should be profitable, investors should wonder how much it will help.

Centennial has stated that it intends to go public at some point this year, which will give investors plenty of time to reach a decision and see if the price might rise again. But for now, it may be better to hold off and look elsewhere.

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. I have no business relationship with any company whose stock is mentioned in this article.