E&P Tier One Producers Club #19-1: Everybody Hurts

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Includes: ALTM, AM, APA, APC, AR, CLR, COG, CXO, DVN, ECA, EQT, OXY, PE, PXD, WPX, XEC
by: Raw Energy
Summary

The markets have not been kind even to companies that are considered to be the "TOP" ones in the E&P sector.

With earnings reports being issued beginning this week, first-half 2019 activities are reviewed for the group, with mergers and acquisitions, capital markets and bond pricing data disclosed and discussed.

While companies in this group have not been immune to stock price weakness, they are in significantly better shape to weather the current storm than many of their counterparts.

We'll see how many people show up here who are either dyslexic or not paying attention; I'm thinking this is about POT producers, not TOP producers! Actually, I think the title for this came to me when I was sleeping, which tells me I must not be getting enough R.E.M. sleep.

For those not yet familiar with my articles or the “Clubs” I set up to make it easier for me to organize my thoughts and research, this is essentially the fourth article that leads up to the release of second-quarter earnings reports, at least in my own mind. The overall macro article as well as articles for the Bottom of the Barrel Club and the Middle of the Road Club can be accessed at the links below, and overall represent something like 50+ companies’ activities in the first quarter of 2019.

The Macro View

Bottom of the Barrel Club

Middle of the Road Club

This group, the Tier One Producers or “TOP Club,” includes many of the large companies that are the institutional and rating-agency favorites, and readers might note a different tone to this article compared with the other clubs. It consists of 15 companies, about to be reduced to 14 with the upcoming merger of Anadarko Petroleum (NYSE:APC) and Occidental Petroleum (NYSE:OXY). Given the dramatic movement in E&P stocks in 2019, it is probably time to reconstitute these Clubs as well, seeing as Enterprise Values - a metric more important to me than simply market cap - have been reduced for companies.

I don’t plan to review stock performance as I often do, but year to date the TOP Club has produced a median loss of 5%; since Sept. 30, 2018, the group median return is a loss of 36%. Hence, "Everybody Hurts" - even Rocky.

I don’t have the specific references to studies I have read that say that something like 80% of a stock’s movement is tied to its sector, and only 20% depends on individual company performance, but that seems to be borne out by what investors in E&P have seen over the past few years. Only one of the 15 companies in the TOP Club has a positive return since that 9/30/18 date, and that company is Anadarko Petroleum, due to its pending merger.

[Note: Best viewed by right clicking on the table, clicking on 'open image in new tab' and then zooming in or out to desired magnification]

As I sat thinking about having published articles on the other two Clubs late today, and thought about taking some time off before publishing this article, it occurred to me that if I wait to publish, some of these companies will already have reported, and the idea here is to provide some background heading into earnings. Of course, it would be easier to forecast things that have already happened, but I decided to publish this as an abbreviated version of what come after earnings.

Obviously, too, this article is intended to give company activity overviews. This isn't with the idea of conducting “deep dives” on them, but rather in order to give readers an overall sense of what may be going on with companies of interest, whether as competitors to existing companies’ readers own, as new ideas for additional research, etc. My apologies if it ends up too brief for readers, but I promise it will be worth more than it costs!

Mergers and Acquisitions

Anadarko Petroleum. Anadarko Petroleum (APC) has agreed to be acquired by Occidental Petroleum (OXY) for $59 in cash and 0.2934 shares of Occidental. At the time of the transaction, that valued Anadarko at roughly $77/share, but at today's price of $52.46/share for Occidental it represents a price to Anadarko shareholders of roughly $74/share - still roughly a 57% premium to where Anadarko closed on Apr. 11, when it announced a merger deal with Chevron (NYSE:CVX). Ultimately the Anadarko Board exercised its fiduciary duty and agreed to confirm the Occidental bid as "superior," thereby incurring a $1 billion termination fee to Chevron.

Critics of the deal immediately assailed the purchase price as too high, the lack of a shareholder vote by Occidental shareholders as unfair, the issuance of $10 billion in preferred stock to Warren Buffett as unfair, etc. Carl Icahn emerged as a disgruntled shareholder and is trying to remove directors after the merger closes, and the merger itself is scheduled to close Aug. 8.

To help pay for the deal, Occidental agreed to sell TOTAL, S.A. (NYSE:TOT) foreign concessions that Anadarko owns for $8 billion when the merger closes. In addition, Occidental is reportedly shopping a share of Anadarko's interest in Western Gas Partners, which has a total market cap net to Anadarko of approximately $8 billion. Excluding the debt at the Western Gas Partners level, which is effectively non-recourse to Anadarko/Occidental, leaves the total deal size at significantly less than the $40 billion to $50 billion estimates I have seen in other media reports.

The Permian properties that Anadarko owns are the primary reason for the deal, according to Occidental. Occidental has been very active in the Permian lately, in drilling new development wells and in conducting waterflood and steamflood operations there. Occidental expects to improve greatly upon Anadarko's fairly miserable track record in the Permian, but time will tell. Outside of the Permian, Anadarko also owns significant assets in the Gulf of Mexico and in the DJ Basin. Plenty of Seeking Alpha articles about the deal are available for readers, so I do not intend to discuss it any further here, except to say that it is a gutsy move and an interesting strategy whose success or failure will likely be determined over years, not before the deal closes.

Antero Resources. Antero (AR) completed a “Simplification Transaction” in which it received $297 million in cash and 158.4 million shares in Antero Midstream (AM). After the transaction, Antero will own 31% of Antero Midstream and will no longer fully consolidate Antero Midstream in its financial statements, treating it solely as an “investment.” The transaction was only completed in March, so the second quarter will be the first one in which the new reporting will take effect.

Apache Corp. It is worth noting that Apache (APA) created a midstream company in mid-2018, contributing its Alpine High gathering, processing and transportation assets to Altus Midstream (ALTM), in which it owns a 71% interest. Kayne, Anderson, a PE firm, contributed $952 million in cash for a 29% stake. Altus was active in its midstream business in ’19, as the note below will show.

Apache also recently announced that it had closed on two separate divestitures in the Mid-Continent area of Oklahoma, for $612 million. Production from the properties sold averaged 33,000 boepd, with 90% being natural gas. No acreage figures were released; the price would calculate out to roughly $18,500/flowing boe, but I expect there was probably additional undeveloped potential as well.

Presidio Petroleum, a portfolio company of PE firm Morgan Stanley Energy Partners, purchased some of the Apache’s western Anadarko Basin assets. Red Wolf Natural Resources, a newly formed company backed by PE firm Pearl Investments, purchased Apache’s interest in the SCOOP/STACK/Merge plays.

Concho Resources. Concho (CXO) and its partners in the Oryx I oil gathering and transportation system in the Permian agreed to sell their interests to Stonepeak Infrastructure Partners for $3.6 billion. Concho’s share of the proceeds was approximately $300 million and brought its total return from a $45 million investment to over $450 million, a 10X multiple. Oryx is the largest midstream operator in the Permian Basin. WPX Resources (WPX) and PE firms Quantum Energy Partners and Post Oak Capital were the other sellers.

Devon Energy. Devon (DVN) continued its aggressive divestiture program, selling its Canadian assets for $2.8 billion to Canadian Natural Resources. The properties contained proved reserves of 409 million boe, producing 113,000 boepd and an estimated $236 million in annualized cash flow.

Encana Corp. Encana (ECA) merged with Newfield Exploration in a deal where they exchanged 2.6719 shares for each Newfield share, and assumed Newfield's $2.2 billion in debt. Originally valued at $7.7 billion with Encana's stock at $10.24 when the deal was announced on Nov. 1, 2018, the value was roughly 20% less by the time it closed, and Encana's shares are now $4.38/share, 57% less.

Newfield's assets were located primarily in the deep STACK/SCOOP areas of Oklahoma, where it was an early entrant, a top acreage holder and a leading operator. Encana's expressed intent was to utilize its "Cube Development" expertise to develop Newfield's properties, and the second-quarter report will be the first full quarter of operations for the combined company. Again, rather to go into more detail here, I would suggest looking for Seeking Alpha articles, and I may revisit the deal after earnings.

Encana also sold its Arkoma Basin assets for $165 million after completing the Newfield merger. The properties consisted of 140,000 net acres with wells producing 77 million cfgpd, with 98% of production natural gas.

Pioneer Natural Resources. Pioneer (PXD) sold its remaining interests in the EagleFord shale to Ensign Natural Resources, a portfolio company of PE firm Warburg Pincus, for an expressed total consideration of $475 million. The properties consisted of 59,000 net acres and wells producing 14,400 boepd. The highly unusual sale price consisted of $25 million in cash at closing and up to $450 million in future contingent payments based on product prices, prompting many analysts to complain that Pioneer had basically given away the assets. After the sale, Pioneer had been transformed into a pure-play Permian operator.

WPX Energy. WPX (WPX) was a partner with Concho in its Oryx system sale, receiving $350 million from that sale. In addition, WPX sold its interest in another system for $150 million, bringing total sales to $500 million vs. a cost basis of $125 million.

Capital Markets

Apache. Apache repurchased $1 billion in unsecured notes due 2021-2023 at par.

Cabot Oil & Gas. Cabot (COG) increased its remaining stock repurchase program by 25 million shares to 31 million in total, pledging to use up to 50% of its FCF to repurchase shares.

Continental Resources. Continental (CLR) announced a $1 billion stock repurchase program and the institution of a token dividend.

Diamondback. Diamondback completed an IPO of its midstream unit, Rattler Midstream Partners, raising $665 million for a 24% stake. Another Diamondback affiliate, Viper Energy, raised an upsized $300 million through the sale of 9.5 million units.

Encana. Encana is currently in the process of conducting a modified Dutch Auction tender for up to $213 million of its shares in a price range from $4.70 to $5.40. Shareholders effectively offer to sell shares at prices in that range, and ECA will then select which shares, if any, to buy. Encana shares are currently $4.38/share, and the auction expires Aug. 14.

Bond Prices

The bond pricing table below shows the next two maturities of TOP Club members' debt. Readers who have viewed similar tables in the other Clubs will probably react in shock at the low YTMs, more or less contradicting many of the dire predictions for overall sector debt. Clearly, the market is not concerned about these companies' finances, and the table above shows more than adequate bank liquidity available as well.

Activism

I would be remiss if I did not at least mention EQT's (EQT) proxy fight with an investor group headed by Toby Rice. The Rice group recently prevailed in ousting EQT directors and will be seeking to alter the company's strategy going forward. That will be interesting, as Rice Energy incurred negative net cash flows during its own existence prior to its sale to Equitable.

Observations/Conclusions

It is fairly easy to see that, despite claims to the contrary, banks remain open to lending to E&P companies, especially members of the TOP Club, and that debt maturities are scheduled out sufficiently to avoid any financial distress for an extended period. Private equity firms remain active, as can be seen throughout the articles for all clubs, although overall dollar figures may be diminished. The real questions for companies coming out of earnings will revolve primarily around capex and production expectations for 2019-2022, with most company pre-announcements stressing capex reductions due to savings rather than reduced activity - but we will see if that changes given recent weakness.

Finally, as a send-off for reading earnings releases, I suggest that readers play "buzzword bingo," writing down and then tracking whether the following words or phrases are used by management in their discussions: (1) FCF or Free Cash Flow; (2) return to shareholders; (3) capital discipline; (4) "line of sight" to future FCF or some other attribute; (5) cube, corridor, factory or other method of development; (6) "breakeven," whether half-cycle or full-cycle; (7) locations; (8) years of inventory of locations; (9) parent/child wells and (10) drainage and/or "frac hits." Feel free to add to the list, get a bowl of popcorn and be entertained!

Hopefully, like Rocky in the movies, investors will be able to pick themselves up off the canvas and recover! If not, well, at least Rocky had several tries at it and made Sylvester Stallone a famous actor.

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.