Ring Energy: Wishbone Acquisition Has Left It With Higher-Than-Ideal Leverage

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About: Ring Energy, Inc. (REI)
by: Elephant Analytics
Summary

Ring paid for its Wishbone acquisition mostly in cash.

This has left it with a higher-than-ideal amount of leverage, estimated at 2.4x at $55 WTI oil in 2020.

Ring does appear able to grow production modestly and generate a modest amount of positive cash flow in 2020 at current strip prices.

Deleveraging may take a while at mid-$50s oil and there is vulnerability to weaker oil prices.

At 3.2x projected 2020 EBITDAX, Ring's valuation appears fairly low despite the increased risks though.

Ring Energy's (REI) acquisition of Northwest Shelf assets from Wishbone Energy Partners has significantly increased its debt level and left it with higher-than-ideal leverage. Ring had previously funded its growth mostly through equity offerings, but the decision to rely on its credit facility to pay for around 91% of the Wishbone acquisition price has had a negative effect on its share price as oil prices (and valuation multiples) have fallen.

At current strip prices, Ring may be able to generate modestly-positive cash flow while also growing production in the single-digits. It will take a while for it to deleverage at mid-$50s oil though.

The Wishbone Acquisition

Ring Energy's acquisition of Northwest Shelf (also sometimes referred to as North Central Basin) assets from Wishbone helped roughly double its proved reserves, production and projected EBITDAX. However, the final adjusted purchase price of $291 million ended up being funded by around $264 million in cash.

The overall purchase price appeared reasonable at the time, but the large cash component has left Ring vulnerable to decreases in oil prices, leaving it with too much leverage. It had previously expected leverage of 2.0x or less by the end of 2019 and 1.5x or less by the end of 2020. Ring's leverage may end up being close to 2.4x at mid-$50s oil (current 2020 strip prices) though.

With the higher amount of leverage, Ring's share price has also been very negatively affected as its overall valuation multiple has trended close to 3.0x EBITDAX now compared to 5.0+x before (falling valuation multiples have been common with E&P companies).

Updated 2019 Outlook

Ring Energy may average around 11,500 BOEPD in production (90% oil) during the second half of 2019. This would result in it generating around $198 million in revenue at current strip prices, or nearly $50 per BOE.

Barrels/Mcf $ Per Barrel/Mcf (Realized) $ Million
Oil 3,610,268 $54.00 $195
Natural Gas 2,235,346 $1.50 $3
Total Revenue $198

With a $152 million capital expenditure budget, Ring would end up with around $236 million in cash expenditures, leading to a projection of $38 million in cash burn during 2019. This doesn't include working capital changes or the Wishbone acquisition costs.

Ring's Q1 2019 interest expense is lower than subsequent quarter's due to its relatively modest debt during that quarter. Ring's interest expense going forward may be around $16 million per year, while its cash G&A expense may be around $14 million per year going forward (boosted in 2019 due to acquisition-related costs).

$ Million
Production Expenses $44
Production Taxes $10
Cash G&A $17
Capital Expenditures $152
Cash Interest Expense $13
Total Cash Expenditures $236

Leverage And Valuation

At $55 WTI oil in 2020, Ring may be able to generate a modest amount of positive cash flow while also increasing production modestly to 12,000 BOEPD. In this scenario Ring would have around $325 million in debt at the end of 2020, which would be around 2.4x its projected EBITDAX in this scenario. It does have some room with its $425 million credit facility borrowing base, but will need to be careful in a mid-$50s oil environment.

Ring's enterprise value is approximately 3.2x its 2020 EBITDAX at $55 WTI oil with its current share price of around $1.61 per share. This makes it appear relatively cheap, although its leverage and valuation are quite sensitive to oil prices.

At $50 WTI oil in 2020, Ring's leverage may increase to 2.9x, while at $60 oil in 2020, Ring's leverage may decrease to 1.9x.

Conclusion

Ring Energy's Wishbone acquisition has quite significantly increased its debt and also made its share price more volatile with its higher amount of leverage. Ring is attempting to reach neutral cash flow by the end of 2019 and appears likely to plan for 2020 with a roughly neutral cash flow budget.

At mid-$50s oil, Ring should be able to deliver modestly-positive cash flow and a modest increase in production. Ring's leverage would still be somewhat higher than ideal with $55 WTI oil and it probably needs close to $60 oil in order to reduce its leverage below 2.0x by the end of 2020.

At a valuation of 3.2x EBITDAX, Ring may offer some value now, although the risks have also significantly increased due to its higher debt level.

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.