The last time we left our intrepid MOTR (Middle Of The Road) Club members, they had just reported 4Q numbers that were equivalent to a dead skunk. While that might have seemed like it was bad enough, in 1H of ’19 the E&P sector encountered yet another obstacle, this one the equivalent of a landslide that knocked some companies completely off the road and left others stranded wondering how long they would have to wait before they could continue on their way.
The landslide on PCH in California south of Big Sur was massive, knocking out a major coastal highway for over a year. While the E&P sector has had its own performance issues for a decade now, the recent slide seems to be accelerating to the downside, so far with no sign of reconstruction!
(Note: For those of you who came to this article expecting Fleetwood Mac’s version of "Landslide" instead, it can be accessed here.)
This article is my third in recent days, including:
- E&P Mid-Year 2019 Recap: A Terrible, Horrible, No Good, Very Bad Anniversary
- E&P Bottom of the Barrel Club #19-2: How Low Can You Go?
Following up on those articles with this summary of corporate activities for members of the MOTR Club during 1H of ’19 is intended to provide a basis for reviewing 2Q results in light of what was presented earlier as guidance by those companies. The table below contains such data, which has been compiled largely without change from the recent articles, except to include only data applicable to the MOTR Club.
As with my other articles, top-performing companies are highlighted in green and bottom performers in red; with only 22 companies in the Club, each highlighted group includes 7 companies, so that readers can easily distinguish companies in the top, middle and bottom third of the group. Companies highlighted in yellow are those who have begun trading in the past 10 years. Companies in red text are producers with core Permian acreage.
As explained before too, I am less inclined to do much analysis or comparison until 2Q numbers have been released, since quarter-to-quarter variations can be misleading. M&A activity, in particular, can and will change the data above for 2Q in some cases. By now, companies should be able to provide more certainty to their plans for the remainder of 2019, as well as hopefully begin to discuss strategies for 2020.
The data in the table may inspire different reactions and different conclusions for different readers. That is fine; that is a primary purpose behind publishing this article. One major point I would like to make is that despite whatever level of debt a company may have, banks still are supplying liquidity that, combined with operating cash flows, provides lots of flexibility in the short term... and almost $22 billion in availability. Non-bank debt is the real issue for companies going forward, but the timing of those maturities is spread over several years, unlike the period after 2014, when it was bank debt that caused liquidity issues and a wave of bankruptcies. Not that there won't be more bankruptcies ahead - it's that they will likely be more spread out, even though they could potentially be larger.
Another point from the table is that while companies projected reduced capex in 2019, they were also projecting growth in production (none projected a reduction). What pre-announcements or changes to guidance have occurred have stressed capex reductions due to continued reduction in service costs without changes to production; that may well change with 2Q reports.
Mergers & Acquisitions
Overview. It is apparent when looking at MOTR Club members, compared to their brethren in the Bottom of the Barrel Club, that there has been more activity in the MOTR Club group, which you hope would be the case given their relatively better financial condition. Not that the stock performance reflects dramatically better results, but that M&A activity continued even as companies struggled with deteriorating fundamentals. It was nice to see something other than bankruptcies, restructurings, etc.
Callon Petroleum. Callon (CPE) was pretty busy in 1H ’19, shedding non-core assets in the southern Midland Basin and then expanding with a merger that introduced the Eagle Ford as a new core area. So far, the stock price has not benefited from this asset rationalization program, although the merger has not yet closed and combined financial results are not yet evident.
The asset sale of its Ranger asset was for $260 million plus contingent payments of up to $50 million based on oil prices above $60, a feature that more and more companies may use to minimize feedback that they sold “at the bottom” for too little in proceeds. Ranger consisted of interests in roughly 9,900 net Wolfcamp acres, with 80 existing wells producing 4,000 boepd (52% liquids) and another 70+ undeveloped locations Callon considered economic using an IRR hurdle rate of 25% on strip pricing. Purely as a hypothetical valuation (because an actual value is determined after geologic and engineering reviews by the parties), and using $35,000/bo and $2,500/mmbtu to determine the value of existing production, the purchase price would be $75 million, and based on the remainder of the purchase price of $185 million for 9,900 net acres, a price of $18,700/net acre for the undeveloped potential.
On July 15, Callon and Carrizo Oil & Gas (CRZO) announced that they would merge in a transaction valued at $3.2 billion. The “all-stock transaction” (all stock to Carrizo shareholders, but an assumption of Carrizo’s debt as well) is proposed to exchange 2.05 shares of Callon for each Carrizo share, and after the deal closes, the company ownership will be split roughly 50/50 between Callon/Carrizo shareholders.
The combined company will have 200,000 net acres in the Permian (Delaware) Basin and Eagle Ford shale play, with 105 mboepd of production (71% oil) and 2,500 future drilling locations. Callon plans to utilize 9-10 drilling rigs and 4 completion crews through 2020, and hopes to achieve synergies of $65-80 million/yr. through the combination.
Callon stock has sold off from $6.40 when the deal was announced to $4.82 today, a decline of 25%. That values the Carrizo piece at $9.88/share now, vs. the “expectation” of a $13.12 price.
In my opinion, this deal is about two primary things: reducing combined costs to generate more cash flow for capex and/or debt repayment, and using Carrizo’s cash flow to redirect capex into the Permian more so than the Eagle Ford (i.e., “harvesting” Carrizo’s cash flow and using it as the “cash cow” for future growth. Given the reaction that M&A activity has generated, and the stock price declines experienced in the E&P sector overall, it is unclear if shareholders will approve the deal; if they don’t (after being presented with a recommendation "for" the deal), the only break-up costs will be reimbursement of actual costs up to $7.5 million to the party whose shareholders do approve the deal).
Cimarex Energy. Cimarex (XEC) closed on its acquisition of Resolute Energy (a former "Bottom of the Barrel Club" member) on March 1, for a total consideration (including $700 million of debt assumed) of $1.6 billion. Shareholders of Resolute received $35/share, which after proration consisted of $327 million in cash plus 5.7 million shares that would have been valued at $88.76/share (roughly $500 million in stock vs. $48.23 ($275 million) today. Shareholders of Resolute, who received “only” a premium of 15% based on the announcement date, are likely very happy they received cash for at least a portion of their shares; they still own 5% of Cimarex as well.
The 2Q will be the first full quarter of operations for the combined company. Cimarex projected that Resolute would add 28 mboepd (43% oil) and 21,100 net acres, a 34% increase to Cimarex’s existing Reeves County core area. Cimarex has guided to 18% production growth overall and 28% oil production growth from the ’18 midpoint. Given what has happened to product prices since its merger, investors will likely be focusing on revised guidance, possibly with sharp downward revisions in revenue expectations.
PDC Energy. PDC (PDCE) sold its interest in a midstream project and certain water infrastructure in two separate transactions that will result in $310 million in proceeds. Producers like PDC have increasingly been monetizing these projects given greater appetite among both private and public midstream capital providers... something to watch if you own them.
QEP Resources. Timing is everything. QEP (QEP) was spun out in 2010 from its parent, Questar Corp., a natural gas pipeline company. After establishing core areas in the Bakken, Uinta, Haynesville, Permian and other areas, it decided to sell everything outside the Permian beginning in 2018. In November 2018, the company announced a planned sale of its Bakken assets for $1.65 billion to Vantage Energy Acquisition, an SPAC sponsored by PE firm Natural Gas Partners. On February 20, 2019, the deal was terminated and Vantage returned the funds it had raised from investors (which had a 2-year investment period that expired).
In the meantime, despite its ongoing reorganizations, QEP was being pressured by an activist hedge fund investor, Elliott Capital Management, to do more, and it offered to buy QEP for $8.75/share, a premium of 44% above the price of QEP at the time (January 7, 2019), not contingent on the QEP/Vantage deal being completed. However, on July 18, it was reported that Elliott had reduced its bid, which is now very much in doubt.
After the Bakken deal collapsed, QEP was able to sell its Haynesville assets for $735 million to Aethon Energy Management, a private company with backing by RedBird Capital and Ontario (Canada) Teachers’ Pension Plan, which had both backed prior Aethon acquisitions in the Haynesville. PE firms have remained active in the Haynesville, as evidenced also by Covey Park’s (Denham) merger into Comstock Resources (CRK), the public entity now controlled by Cowboys owner Jerry Jones.
Range Resources Corp. In October 2018, Range Resources (RRC) sold a 1% overriding royalty interest in 300,000 net acres it owns in Washington County, Ohio. Wells producing 1.7 bcfgpd and roughly $25 million of cash flow/year ($10 million/year net of interest) were included.
In July, 2019, Range Resources announced another set of sales, this time announcing sales of 2% overriding royalty interests on 350,000 net acres, with wells producing 1.9 bcfgpd and roughly $48 million of annualized cash flow ($18 million after interest). Altogether, Range disclosed that such sales had generated proceeds of almost 75% of its market cap.
To which most investors should reply, “So what?!” The real stats are what impact the sales have on NAV and on debt, not market cap. With $5 billion in debt plus working capital deficit, the 2019 sales will represent around 13% of debt, and the true impact on NAV is unknown. Range was careful to point out what the current cash flow impact would be but did not disclose whether it had any future plans for development on that acreage, in which case future net revenues to the ORRI owner could increase substantially, all with no future capex outlay to them.
Ring Energy. Ring (REI) closed on its acquisition of properties in the Central Basin Platform from Wishbone Energy, a portfolio company of PE firm Carlyle Group (CG), for $291 million, composed of $264 million in cash and 4.58 million shares of stock originally valued based on the stock price of roughly $6.50/share. The transaction doubled many of Ring’s metrics.
The assets consisted of 38,000 net acres, with a base of 127 existing wells producing 5,400 boepd, and included 360 potential San Andres horizontal wells (much shallower and with lower reserves than other areas within the Permian Basin) as well as related infrastructure. Ring had operated with little debt up to that point, so investors will likely be looking specifically at that and at guidance for the combined asset base in 2Q reports.
WPX Energy. Like QEP, WPX (WPX) was originally part of a natural gas pipeline company, Williams (WMB), and was spun off in 2012. Originally focused on the Williston Basin and Rockies areas where Williams was active, WPX shifted focus to the Permian Basin in 2015 with the $1.5 billion purchase of RKI Exploration.
In 2019, WPX has closed on the sale of two of its midstream units in the Permian, generating $550 million in proceeds. Its original cost basis for the two was $125 million, and WPX retained shipping rights in both systems, since it still owns production there.
Overview. There were very few deals done on the equity or debt side in 1H ’19 outside of M&A activity. However, as the previous table showed, companies in the MOTR Club retain significant liquidity, with available bank lines of $21.6 billion to supplement operating cash flows if necessary or desirable. While investors often complain about continued capex spending in light of debt, most of that debt is unsecured and does not come due for some period of time, so companies should not be pushed into restructuring in the short term, even if long-term prospects do not turn up soon.
Readers will note several recent buyback programs that have been initiated by companies in response to the current weak price environment. I am not at all a fan of buybacks when cash flow should be retained for debt repayment and/or capex, and the E&P sector is sufficiently cyclical to warrant retaining either cash or availability to survive through the next cycle/s, not simply enough to pay the bills for a shorter period of time.
Callon Petroleum. Callon redeemed its preferred stock for roughly $75 million in cash.
Centennial Resource Development. Centennial (CDEV) issued $500 million in 6.875% senior unsecured notes due ’27.
Cimarex Energy. Cimarex issued $500 million in 4.375% senior unsecured notes due 2029.
Extraction Oil & Gas. Extraction (XOG) announced an extension and increase to its stock repurchase program, moving the date to December 31, 2019 and the amount to $163 million.
Gulfport Energy. Gulfport (GPOR) completed a $200 million stock repurchase program and initiated a new $400 million repurchase program to be completed within 24 months.
Laredo Petroleum. Laredo (LPI) did not repurchase any shares in 1Q under its $200 million repurchase program that expires in February 2020. In 2018, the company repurchased 11.0 million shares for $97 million ($8.78/share). The stock currently sells for $2.70/share.
PDC Energy. PDC authorized a stock repurchase program of up to $200 million that expires on December 31, 2020.
There is understandable anger directed at E&P companies by outside investors, given an extended period of extremely poor financial results, and shareholder “activism” has increased. I have mixed feelings about these efforts so far, because often the “plans” proposed by these activists are short-term props rather than long-term solutions to company problems. Standard proposals like repurchases, increased dividends and similar concepts are much more difficult to apply to a cyclical, commodity-based depleting asset industry like E&P, and repurchase programs in the past have proved largely ineffectual, in my opinion.
Companies in E&P should be retaining enough cash flow to replace or grow their asset base profitably over time, and they should also be retaining enough cash flow to support their existing debt load over multiple refinancings, rather than simply expecting that refis will be there when needed regardless of NAV coverages. Lacking that, concepts like FCF will turn out to be little more than corporate versions of "Distributable Cash" that helped decimate the upstream MLP industry.
Alta Mesa Resources. Alta Mesa (AMR) remains the most distressed company in the MOTR Club. Huge impairments, uncertainty about economic viability, the failure to date to resolve debt issues with its banks, liability from potential class action lawsuits, an SEC investigation and a potential delisting by the NYSE are significant open issues that must be addressed shortly.
Carrizo Oil & Gas. Lion Point Capital acquired a 5% stake in Carrizo and pushed for a merger or sale. Carrizo subsequently agreed to merge with Callon Petroleum, as discussed above.
Gulfport Energy. Firefly Value Partners acquired an 8% share of Gulfport and pushed for several changes. Gulfport subsequently adopted a new $200 million repurchase program, as described above.
Laredo Petroleum. Sailingstone Partners acquired a 16% stake in Laredo, seeking measures it believed would increase value by more than 200%.
PDC Energy. Kimmeridge Energy Mgt. acquired a 5% stake in PDC, seeking to replace PDC’s Board and effect several changes. PDC’s shareholders rebuffed Kimmeridge’s move, although PDC did authorize the stock repurchase program above.
Range Resources. Range added a director as part of an agreement reached in 2018 with Sailingstone Partners, owner of 16% of Range’s shares.
(Note: In addition to Laredo and Range, Sailingstone owns significant holdings in Antero Resources and SRC Energy.)
Some Observations Ahead Of 2Q Reports
1.) As always, it is the market's reaction to reports that matters more so than the reports themselves. Individual investors do not move the markets with their actions, but institutional buys and sells do.
2.) My articles,
contain many things that readers may want to consider as companies report, just for their own research and analysis. Your choice... at no cost to you.
3.) Be careful about assumptions regarding M&A activity. Although it can be an ongoing part of any E&P's strategy, it is often difficult to discern which companies will be acquirers and which will be acquired... and at what potential premium and price. The Callon/Carrizo deal is a good example, where many thought Callon was setting itself up to be acquired. That may still hold true after their merger, but the deal itself appears to have been structured to ramp up cash flow and drilling by squeezing out costs in the short term.
4.) Do not simply try to fit the data that comes out into pre-conceived notions about any particular company, and watch world/regional trends for their impacts.
5.) Do not let trades turn into investments, and do not let investments turn into huge losers. It is much easier to overcome a lost opportunity than losses to capital. Being right should take a backseat to making money, and do not let emotions rule your investment/trading strategy.
6.) Remember, "it is always darkest before... it goes pitch black" (sorry, a bit of gallows humor there, courtesy of comedian George Carlin).
7.) There are now several companies in this Club that may now qualify for my "Bottom of the Barrel Club" going forward.
With almost daily reminders of how poor investment returns have been in the E&P sector over the past 10 years, waiting for signs that the current bout of selling has abated is not a bad strategy, and 2Q reports and presentations offer investors revised outlooks from managements as well as big investors (by how the stocks react). There are always uncertainties and risks in E&P, so continuous research and research, whether on Seeking Alpha or not, is critical, and it is also important to keep major turning points in mind, i.e., the upcoming end to 3Q, when many institutions will prune their portfolios, often to add to positions that have done well this year (are there any??) and sell those that have underperformed. Trading strategies, this year in particular, may also focus on tax-motivated trades, where institutions sell stocks in which they have losses to offset gains elsewhere (pretty much everywhere else). As a final suggestion/conclusion, flip through new company presentations when they are updated with 2Q information... with an eye towards analysis rather than merely confirmation.
Disclosure: I am/we are long AMR. 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.