Reading a recent Barron's article on the oil equities, "After OPEC Cuts, Analysts Pick Oil Stock Winners and Losers", I have come across a mention that Oasis Petroleum (OAS), the US small-cap E&P company, was downgraded by SunTrust Robinson Humphrey to "Sell." Besides, according to data presented by Seeking Alpha Essential, 14 analysts (in the cohort of 27) rate the stock as "Hold," while the Quant rating is Neutral. In this article, I intend to scrutinize the company's fundamentals to figure out the rationale behind the downgrade and bearish sentiment of the bank and give my assessment if the equity is worth holding or not. Now, let's proceed to details.
Stock performance YTD
Since July 2018, Oasis Petroleum has failed to outperform the S&P 500 (SPY) and oil and gas E&P industry benchmark (XOP); the market cap was pummelled by late 2018 oil volatility and went into a tailspin. The stock has not recovered losses yet.
Nevertheless, it performed much better than the bulk of peers but lagged behind PDC Energy (PDCE) and Parsley Energy (PE). In my view, the critical catalyst for Parsley's 2019 rally, which partly offset 2018 sell-off, was investor appreciation of its growth master plan. For broader context, analysts forecast revenue to nearly double by 2024. PDC Energy, which has not fallen as deep as Oasis, also has relatively high anticipated sales growth. Oasis, unfortunately, has less inspiring revenue prospects.
The top line
Oasis Petroleum is an E&P company focused on the unconventional resources in Montana and North Dakota (the Williston Basin) and Texas (the Delaware Basin). The company has four sources of revenue: oil & gas production, purchased oil & gas sales, midstream, and well services (hydraulic fracturing and equipment rental). It currently trades at EV/Total proved reserves of ~14.6x and EV/Production of ~51x. The Williston Basin is its bulwark; 87.3% of total proved reserves are attributable to that area. Oasis's production soared in 2013-2018 and propelled revenue growth, which was, however, significantly impacted by the oil market meltdown. Average daily output jumped from 33.9 kboepd in 2013 to 82.5 kboepd in 2018 (with a 19.5% CAGR). 1Q19 output headed even higher and hit 91.7 kboepd. Such vertiginous production growth is apparent merit. Nevertheless, in 2013-2018, revenue increased only with a 16% CAGR, while gross and operating margins plummeted from 80% to 54% and from 62% to 17% respectively.
First and foremost, it should not be remained unnoticed that the company is loss-making and FCF-negative. Upon more in-depth inspection, in 2018, OAS turned unprofitable because of a massive non-cash impairment expense. An income tax benefit partly offset it. In 1Q19, higher G&A and exploration expenses, impairment, higher depreciation, and purchased oil & gas expenses again hindered it from showing positive GAAP profit. Also, it has a cash flow deficit due to substantial capex, which consume ~47% of LTM total revenue (before acquisitions). OAS has never been levered FCF-positive (CFFO after NWC changes minus capex) since at least 2009. That is the first red flag. At the same time, the company reported that it turned FCF-positive in 1Q19. OAS defines its FCF as adjusted EBITDA (attributable to Oasis) less cash interest and capex (excluding capitalized interest). In my analysis, I prefer to calculate levered FCF as the difference between operating cash flow (net of working capital changes) and capital expenditures (investments in oil & gas properties). I do not take into account the difference between debt issuances and repayments, yet, it is sometimes used in the equity research. So, I conclude that Oasis was still FCF-negative in 1Q19. Unlevered FCF turned positive in 2016 and 2017 (see Seeking Alpha Essential data), yet, I regard FCF net of interest payments as a more reliable metric in the case of a company with a high debt/equity ratio, as it has to pay sizeable interest which can considerably reduce funds available to shareholders.
As operating cash flow was not sufficient enough to finance sustaining and growth capital investments, the firm used proceeds from Revolving Credit Facilities. To be fair, debt was its key source of funds. In 2017 and 2016, it also issued equity. So, OAS used primarily non-operating sources of cash, and that is another essential flaw I noticed. Indeed, no dividend payments could be considered, as the company has to generate a cash surplus at first place and only then ponder an option to return cash to shareholders; using borrowed funds to cover DPS is value-destructive.
The bad news is that even its adjusted EPS, which was positive in 2018 and equaled $0.26, will likely fall in 2019; analysts expect it to decline by ~31%. Without the improvement of net CFFO margin or sizeable cutting of capex, it will likely remain without cash surplus. At the same time, analysts anticipate quick earnings recovery in the 2020s and forecast EPS to double from 2021 to 2023. That makes the stock worth considering for the GARP-focused investors with a long term horizon.
However, the silver lining is that Oasis's capital structure has been ameliorated since 2014 when it had cyclopean debt and Debt/Equity ratio of 1.42. Net worth ultimately overlapped total debt in 2016 and now is higher than total borrowings. At the moment, the total debt/LTM EBITDA is ~1.9x. Nevertheless, the company has only $15.4 million in cash & cash equivalents. So, I reckon that it would likely not engage in any M&A activity buying smaller companies, as it merely has no funds to follow this path. Also, using borrowed money to finance an acquisition will jeopardize the balance sheet robustness.
As far as Oasis is loss-making (on a GAAP basis), earnings yield is irrelevant and useless. FCF yield is also unavailable due to gargantuan capital investment needs of the company. According to Seeking Alpha Essential data, debt-adjusted earnings yield (EBIT/EV) of OAS is above the sector median; sector EV/EBIT is 12.78x, while OAS trades at 11.96x. Yet, its Forward EV/EBIT based on analysts' projections is well above the sector median and equals 16.3x. So, the stock does not look like genuinely undervalued.
I have also picked the following Oasis's closest peers (regarding market cap and revenue) to compare their P/S and P/B ratios:
- Gulfport Energy (GPOR)
- Laredo Petroleum (LPI)
- PDC Energy (PDCE)
- Range Resources (RRC)
- Whiting Petroleum (WLL)
- Parsley Energy (PE)
In the cohort of comparables, Oasis looks reasonably valued.
P/B of 0.5x certainly undervalues the company, but that is due to the apparent market's cautiousness provoked by negative FCF. Also, in the peer group, minuscule P/Net Worth ratios are a regular practice. For instance, Gulfport Energy (which has a positive GAAP profit but negative levered FCF) deals at virtually bargain level. So, in my view, OAS is imperfectly priced compared to the broad market (median P/B of 1.8x) but reasonably valued compared to its US-focused E&P peers.
In sum, Oasis Petroleum has been aggressively growing, but it was barely FCF-positive. As market capitalization plummeted ~10x in 2014-2019, the market seems to be extremely skeptical about that strategy. Now, its revenue growth prospects are not spectacular, and the firm has to adjust capital allocation plan to show a cash surplus. The stock is not dividend-paying and will likely remain such in the medium term. At least, if the company will not figure out how to cut capex without serious harm for the revenue growth or prop up operating cash flow margin.
The essential catalyst for the share price is WTI dynamics; onerous oil market swings could leave OAS with even less inspiring cash flow. However, in 1H19, the stock has not precisely reflected the gyrations of the benchmark and lagged behind it. So, the oil market sentiment is important, but the improvement of the cash flow statement is also vital to restore investor confidence.
Extended OPEC+ production curbs provide a robust catalyst for WTI and Brent rally. At the same time, global economic growth remains uncertain, given the unsettled trade tensions between the US and China. German chemicals giant BASF (OTCQX:BASFY) has recently issued a profit warning slashing 2019 EBITDA forecast. The company blamed a trade dispute. As far as chemicals giant face headwinds, global demand for feedstock used in petrochemicals production might be hurt. Summarizing all of the above, I rate the stock as "Hold."
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.