Rex Energy: Positive Cash Flow Expected In 2017, But Longer-Term Future Remains Challenging

| About: Rex Energy (REXX)
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Summary

OPEC agreement is of marginal benefit to Rex given its low percentage of oil production and that higher oil prices will lead to increased associated gas production from oil wells.

Rex may be able to generate $30 million in positive cash flow in 2017 at current strip prices, making the odds of a near-term prepack fairly low.

Its situation in 2018 is considerably more challenging due to higher interest costs. Its estimated breakeven point is $3.50 natural gas, while 2018 strip is at $3.10.

Rex's projected debt to EBITDA is still nearly 8x with $3.50 natural gas in 2018, meaning that it also needs to grow production significantly to deal with 2020 debt maturities.

Rex needs around 25% production growth from 2017 levels plus $3.50 natural gas in order to reduce its debt to EBITDA to around 6x.

Although Rex Energy's (NASDAQ:REXX) negotiations with one of its noteholders ended without an agreement, I don't believe the company is likely to file for a prepack in the near future. Natural gas prices have jumped due to expectations for renewed cold weather in January, and 2017 futures prices point to Rex likely being able to generate a fair amount in positive cash flow in 2017. Rex's situation beyond 2017 remains quite challenging though as its interest costs will rise in 2018, while natural gas futures for 2018 and 2019 remain well below what Rex is estimated to need for breakeven cashflow. The market is expecting that higher natural gas prices in 2017 will increase natural gas production levels and result in larger future storage builds after this winter withdrawal season, which is why natural gas futures for mid-2018 and beyond have been largely unaffected by recent changes in spot prices.

Oil Is Of Secondary Importance

After the sale of its Illinois Basin asset, oil only has a secondary impact on Rex's financials. Oil is expected to account for around 10% of Rex's revenue based on 2017 strip prices, while including NGLs (C3+) increases this to around 30%. NGL pricing is usually at least somewhat positively correlated with oil prices, so a rise in oil prices should translate into improved NGL prices.

A $5 increase in the price of oil (assuming that Rex's realized NGL price also rises $2) has the same impact as a roughly $0.14 increase in the price of natural gas. Thus the OPEC agreement and its subsequent impact on oil prices probably only was minimally beneficial to Rex. Rex's fate is primarily tied to natural gas pricing, and the bounce in oil prices should result in renewed US oil production growth in 2017, which will also translate into growth in associated natural gas production (natural gas production from oil-dominant wells). The impact of that additional natural gas production probably offsets a decent amount of the increased oil price benefit to Rex.

Improved Differentials

Rex mentioned that it expects its natural gas differentials to improve in 2017 with the use of Dominion Lebanon West II pipeline to transport around 50% of its natural gas volumes to the Gulf Coast and Midwest. This will reduce Rex's differentials to around $0.50 per Mcf in 2017 from around $0.95 per Mcf in 2016. This is partially offset by the increased transportation costs, which are expected to increase lease operating expenses to around $1.70 to $1.75 per Mcfe in 2017 versus the $1.45 per Mcfe actual lease operating expense result for Q3 2016. Overall this is approximately a $0.15 to $0.20 per Mcfe net benefit (around $8 million per year).

2017 Outlook

Rex's outlook for 2017 looks pretty good with its 1.00%/8.00% Senior Secured Second Lien Notes Due 2020 still paying low interest rates. It believed it could increase production in the low-single digit range for 2017 while spending within cash flow based on strip prices from early November, and strip prices have improved measurably since then. Thus at current strip prices (with $3.50+ gas in 2017), I think that Rex could generate $30+ million in positive cash flow during 2017, reducing its outstanding credit facility borrowings to around $100 million.

This includes an assumption that net capital expenditures end up around the $30 million range for 2017.

2018 At Strip Prices

The challenge for Rex is that it needs a significant improvement in natural gas prices to avoid burning cash in 2018 once the interest rate on its second lien notes goes up to 8%. At current strip prices I estimate that Rex could deliver around $210 million in revenue at estimated year-end 2017 production levels.

Units

$ Per Unit

$ Million

Oil and Condensate

436,540

$50.00

$22

Natural Gas

44,982,600

$2.60

$117

NGLs (C3+)

2,049,840

$20.00

$41

Ethane

2,505,360

$12.00

$30

Total Revenue

$210

Due to an estimated $53 million in cash interest costs for 2018, Rex would burn around $19 million at strip prices even if the net capital expenditures required to maintain production levels is only $30 million. If maintenance capital expenditures differ substantially from that, its cash burn estimates would change.

Rex needs around $3.50 natural gas to reach breakeven for 2018 now (assuming mid-$50s oil), while the current strip prices for natural gas are around $3.10 for 2018 and falling to around $2.85 for 2019.

Decision Time

With Rex expected to generate a fair amount of positive cash flow at strip prices for 2017, it has some time remaining. However, in 2018 Rex faces a substantial increase in interest costs that would result in it burning a fair bit of cash at current strip prices. The higher interest payment on its second-lien notes is due in April 2018, so for Rex to avoid strong consideration of a prepack filing before then, it probably needs a cold winter next year as well that pushes up natural gas prices for 2018 to near $3.50. Rex does have room under its credit facility to handle some cash burn in 2018, but it likely needs to grow production substantially to be able to deal with its 2020 debt maturities, and that growth seems very difficult to achieve unless gas prices are significantly higher than current 2018 futures prices.

Both Production Growth And Higher Prices Are Needed

At 2018 strip prices, Rex's total debt is approximately 11x its projected EBITDA. At $60 oil and $3.50 natural gas for 2018, Rex's total debt would still be nearly 8x its projected EBITDA. While $3.50 natural gas would probably be sufficient to keep Rex afloat for longer since it would be able to generate breakeven cash flow, it needs to grow production substantially by 2020 to be able to adequately deal with its debt maturities.

However, even a fairly significant increase in production still likely leaves Rex highly leveraged. A 25% production increase (to around 257 Mcfe per day) from estimated 2017 levels combined with $60 oil and $3.50 natural gas gets Rex's debt to EBITDA down to near 6x. At $55 oil and $3 natural gas, Rex would probably need to increase production by over 80% (to over 370 Mcfe per day) to get its debt to EBITDA down to 6x.

Conclusion

While Rex Energy is benefiting from the rise in 2017 gas and oil prices, its long-term situation beyond 2017 remains very challenging. To be able to potentially deal with its 2020 debt maturities, it likely needs natural gas prices to move up $0.50+ from its current 2018/2019 futures averages, while also increasing production by double-digits per year in 2018 and 2019. That would still leave Rex highly leveraged with debt projected at around 6x 2019 EBITDA in that scenario, but perhaps some viable options would open up for it if long-term gas prices (several years forward) moved up to that $3.50+ range. Rex's equity (common + preferred) remains a quite speculative option on a $0.50+ upward shift in the natural gas futures curve for 2018 and beyond.

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