Reviewing Pioneer Natural Resources

About: Pioneer Natural Resources Company (PXD)
by: Callum Turcan

Pioneer Natural Resources just posted its fourth-quarter and full-year results for 2018.

Capital expenditures are set to move lower in 2019 as the dividend climbs higher.

Share buybacks on tap.

Expected negative free cash flow generation will be supplemented by PXD's strong balance sheet, but the firm still needs to be FCF positive sometime in the near future.

The company posted $1 billion in GAAP net income in 2018, highlighting the commercial viability of top-tier unconventional upstream plays in a $60s WTI world.

Permian giant Pioneer Natural Resources (NYSE:PXD) just reported its fourth-quarter and full-year earnings for 2018. The firm's revenue jumped by 73% to $9.4 billion as its net income climbed by over 14% to $1.0 billion. One billion dollars in GAAP net income is no small matter and proves the commercial viability of top tier unconventional upstream plays in America in a $60s WTI world. That being said, Pioneer Natural Resources' stock was down 4% after-hours as of this writing. Let's dig in.

Financial overview

Pioneer spent $179 million buying back its stock in 2018, $128 million of which was spent during the fourth quarter of 2018. The company first authorized $100 million worth of share repurchases in February 2018 before replacing that program with a $2.0 billion share buyback program in December 2018. As of this writing, that is equal to 8% of Pioneer's market capitalization. In Pioneer's Q4 2018 press release, the company notes that it had spent $328 million to date repurchasing 2.4 million shares at an average price of $136, indicating a significant amount of repurchasing activity in Q1 2019.

In an article I wrote back in December that covered management's plan to significantly increase Pioneer's buyback authority, I commented:

"Considering Pioneer has built up a sizable production base in the Permian and has secured firm transportation capacity for almost all of its oil production as things stand today, it is possible management wants to shift gears. That would entail stepping off of the gas pedal and slowing down development activities in the Permian, cutting its 2019 capex budget in the process."

That appears to have been the case, with the company targeting a 2019 capital expenditure budget of $2.8-3.1 billion for its upstream division and $0.3 billion in midstream-related capex (specifically for water handling and gas processing infrastructure). Pioneer spent $3.5 billion on upstream capex and $0.3 billion on midstream capex in 2018, indicating management expects the firm to spend $0.6 billion less in 2019 on a year-over-year basis.

When Pioneer first announced its $2.0 billion share buyback program, that appeared to be management's way of signaling to the market that the firm was no longer going to chase growth for the sake of growth. This thesis is reinforced by the company's recent decision to double its semi-annual dividend to $0.32 per share. While that payout is quite small, dividend increases signal that the firm is confident in its cash flow generating abilities and act as a constraint on Pioneer's growth ambitions, which in the case is good news for shareholders (the idea is that forcing a company to allocate cash flow to dividend payments makes that firm a better allocator of capital and reduces the incentive to invest in projects that may be detrimental to shareholder returns).

Operational overview

Management expects Pioneer will produce 320,000-335,000 barrels of oil equivalent per day net from its Permian division in 2019, up from 283,000 BOE/d net in 2018. The company plans to run 21-23 horizontal rigs in the Permian Basin this year and management forecasts the firm will turn 265-290 wells (I'm assuming gross) in the play online in 2019, up slightly from the 270 Permian wells Pioneer completed last year.

Growing crude oil output will represent a large part of those additional Permian volumes, as Pioneer forecasts its Permian crude production will rise to 203,000-213,000 bpd this year from 181,000 bpd in 2018. At the midpoint, that is equal to 12% total Permian production growth and 17% Permian oil production growth. Note that due to divestments, its 2019 performance won't be directly comparable to its 2018 performance. The company expects to produce a modest amount from its Eagle Ford asset this year (Q1 2019 guidance calls for 13,750 BOE/d), only 24% of which will be represented by oil making that asset only meaningful on the margins.

At current commodity prices and factoring in its hedging program, Pioneer expects to generate $3.2 billion in operating cash flow this year, roughly flat with 2018 levels. That guidance assumes WTI averages $53 and Henry Hub averages $3 this year. I will caution that operating cash flow guidance is just guidance, capricious oil markets have the final say when it comes to upstream financial performance in light of North American natural gas prices remaining subdued.

Modest outspend

It appears Pioneer will run a modest outspend in 2019 as expected capital expenditures of $3.3 billion plus $0.1 billion in expected dividend payments would exceed forecasted operating cash flow. A projected outspend of $0.2 billion isn't horrible but that isn't great either, oil & gas companies need to start generating free cash flow if the space ever wants to attract the interest of Wall Street again. In the event WTI climbs significantly higher, for instance back to $60, Pioneer would likely be in free cash flow territory and management would be wise to keep capex contained.

The firm has a great balance sheet as it exited 2018 with $2.6 billion in current assets (including $1.3 billion in cash and short-term investments) versus $1.8 billion in current liabilities (no short-term debt maturities). With a long-term debt load of $2.3 billion, Pioneer's net debt load of $1.0 billion is quite tame. There is a very good chance Pioneer's remaining Eagle Ford position will be sold off within the next few years based on its past divestment activity, which will front-load cash flow from that asset in the form of cash on hand. As an aside, as Pioneer's Permian division is its most lucrative, shedding non-core assets will bolster its financial performance on a per BOE produced basis.

Final thoughts

Pioneer Natural Resources proved it could be very profitable in a $60s WTI world, but now that the futures curve is back down in the $50s for 2019, management is making the right call by scaling back. Arguably, it would behoove Pioneer Natural Resources to scale back even further in order to achieve cash flow neutrality, but it is likely management wants to maintain operational readiness due to the firm expecting a rebound in oil prices. In other words, Pioneer Natural Resources' 2019 capex budget is likely a bet WTI will climb up closer to $60 by the middle of the year.

Management is trying to communicate to the market that PXD shares are undervalued (seen through recent share repurchases) and that the firm is highly confident in its cash flow generating abilities (seen through recent dividend increases). We will see how Wall Street reacts over the next couple of weeks as Pioneer Natural Resources starts off a new year. Thanks for reading.

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.