Lonestar Resources Has A Second Chance

Summary

• Lonestar stock is bucking the current market trend.
• Production increased nearly 60% year over year.
• Cash flow increases will follow that production increase.
• Debt was successfully refinanced though at a higher interest rate. This also pushed out the secured bank credit line maturity.
• Management has drilled some big wells and has the potential to drill more big wells to dig itself out of its debt and preferred stock bind.

The stock of Lonestar Resources (LONE) has been resisting the market downtrend. That is good news for the long suffering common stock investors.

Source: Seeking Alpha Website April 3, 2018

This stock has actually managed to climb in the latest time period while much of the market is dropping. Some of this is due to the fact that the company had a near-death experience. John Pinkerton, Chairman of the Board, alluded to this during the conference call.

But the last two years have borne some fruit. The debt due dates have been extended. Management has about $100 million or so available on the bank line of credit. The balance sheet is very highly leveraged with about $300 million of debt and roughly 84,000 shares of convertible preferred stock.

But, this year, management acquired some acreage, and the well results represent the quality of the acreage. So, there may be enough financial flexibility for this company to find its way back from almost dead and highly speculative.

Source: Lonestar Resources 2017 Year-End Earnings Slides Presentation

The company increased the interest rate paid on the debt due to extend the maturity of current long-term debt due. The new interest rate is slightly more than 11%. That refinancing also extended the maturity of the senior secured facility. Therefore, no material debt is due for approximately two years.

That gives management time to show some results. The preliminary drilling results are very encouraging. This company needed some large well results to climb out of the debt hole, and it is getting those results.

"Quickly, I'd like to turn - touch base with on Brazos County on Page 9. Wildcat B1H has produced 320,000 Boe in 10 months and its well on its way to producing 350,000 Boe units first year. These wells continue to perform 62% better than the average offset well, and 15% better than the best offset well and I would note that those offsets were drilled by a quality operator."

This may be the best well cited during the conference call. Not every well will have these types of excellent results. But management appears to have several wells that may top 200,000 BOE in the first year. It does not take many of these well results to quickly build cash flow and deleverage the balance sheet in a small company like Lonestar.

Source: Lonestar Resources 2017 Year-End Earnings Slides Presentation

It does not take much out-performance to greatly increase the rates of return and materially shorten the payback period. This company also is getting considerable aid from higher commodity pricing. If every third (or even fourth) well produces at least 200 KBOED, this could be a very different company by year end.

Source: Lonestar Resources Fourth Quarter 2017 Earnings Press Release

Much of the activity has delayed the cash flow increase. The combination of acquisitions and the resulting activity increase require legitimate cash expenditures first before earnings cover those expenses. In this case, much of the annual cash flow increase comes from the changes in operating assets and liabilities. There is (very roughly) about a $12 million swing from unfavorable to favorable.

The fourth quarter cash flow change is far more dramatic. There is about a $37 million increase in cash flow provided by operations. That increase is a forecast of things to come in the new fiscal year.

First quarter production may come close to doubling the production of the first quarter in 2017. The exit rate most certainly will double the exit rate of the year before. Plus, the higher oil prices should guarantee a dramatic first quarter cash flow increase. Management has a goal of $100 million EBITDAX for the year (at least). Continuing favorable oil pricing could obsolete that forecast.

Source: Lonestar Resources Fourth Quarter 2017 Earnings Press Release

Operating costs are very reasonable. The lease operating and gas gathering expense is low for the industry. Management is guiding to a lower cost in the current fiscal year. The key competitive hindrance is interest expense and preferred stock obligations. The rising production will spread those costs over more production. That will lead to continuing decreases.

Continuing well improvements would also help decrease costs significantly. Lonestar was always a relatively low cost producer. But the aggressive strategy of "leveraging the balance sheet because commodity prices were near a bottom" came back to haunt management. In fact, the strategy nearly buried the company.

Now, the stock is probably suitable for investors willing to accept a high degree of risk. This company needs some help from operations. The continuing high prices of oil definitely aid the balance sheet repair cause. There is some dilution ahead from potential preferred stock conversions. But, right now, the future looks good enough to be worth the risk of failure and the current balance sheet leverage.

The company does hedge and has contracted out its costs for a year to reduce risks. But this may be one company that survives a heavily leveraged balance sheet. This stock could easily return $5 for each $1 invested over the next five years IF things go right. One could also bet that this management will stay away from leverage in the future once the company is out of the woods.

Cash flow is not currently sufficient to service the debt and preferred stock. But the ongoing field results would appear to indicate that the cash flow will become sufficient to service the debt and preferred stock within the next two years. Management plans on sufficient cash flow to service the debt this year. If that does indeed happen, then management could potentially refinance the debt at a lower interest rate even if interest rates are rising. This company needs an above average year. But that year does look readily attainable. In fact, the company could have a super year and get where it needs to go a lot faster. This year should be very fascinating.

Editor's Note: This article covers one or more microcap stocks. Please be aware of the risks associated with these stocks.

Analyst’s 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.