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Centennial Resource Development: Improving Capital Efficiency Should Reduce Its Cash Burn

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About: Centennial Resource Development, Inc. (CDEV)
by: Elephant Analytics
Summary

Centennial has made strides in improving capital efficiency, with well costs down 22% and its well production tracking 10% above 2018 levels.

This has allowed Centennial to increase its oil production guidance by 8% without changing its capex budget.

Centennial is probably still going to have cash burn in 2020 due to its high base decline rate from its significant production growth in recent years.

It has sufficient liquidity though, and the capital efficiency improvements point to the potential to generate positive cash flow in 2021.

Centennial Resource Development (CDEV) has made strong progress in improving capital efficiency. This has helped reduce its projected maintenance capex requirements significantly. Centennial is probably still going to burn cash in 2020 due to its still high base decline rate (due to rapid growth), but has plenty of liquidity as well as a path to positive cash flow in 2021 as its base decline rate comes down further.

The cash burn has left its stock trading at pretty low levels, but I believe it should be a good candidate for a longer-term recovery. With its next unsecured debt maturity in 2026 (and yielding around 6.5% to maturity) it has time to prove that it can generate positive cash flow.

Improved Capital Efficiency

Centennial noted that it had reduced total well costs by around 22% by Q3 2019 compared to its initial 2019 expectations. This was helped by a 17% decline in total cycle times (defined as spud to first production) compared to 2018.

Source: Centennial Resource Development

Centennial had previously noted that well performance was tracking around 10% above 2018 levels. Thus if it can sustain the combination of a 10% improvement in well performance and a 22% decline in well costs, Centennial's capital efficiency could be improved by 40+%.

The improved capital efficiency is helping it maintain production levels at around 76,000 BOEPD while reducing D&C capex significantly.

Source: Centennial Resource Development

Centennial has also increased its 2019 oil production guidance from around 39,000 barrels per day to 42,250 barrels per day while keeping its original capex budget.

Source: Centennial Resource Development

Centennial's 2020 Outlook

I am going to look at Centennial's potential 2020 results if it averages 77,000 BOEPD (including 43,500 barrels per day in oil production). This should be fairly similar to its 2019 year-end production levels.

At current strip prices (including $54 to $55 WTI oil), Centennial is projected to generate around $953 million in revenue. Centennial expects to get around 95% of WTI for its oil production in 2020, while it receives Mid-Continent pricing for the majority of its natural gas production. That would help significantly as WAHA prices are still under $1 for 2020.

Type Barrels/Mcf $ Per Barrel/Mcf $ Million
Oil 15,877,500 $51.50 $818
NGLs 4,891,000 $15.00 $73
Gas 44,019,000 $1.40 $62
Total $953

I estimate that Centennial can achieve that production level with around $535 million in D&C capex. As noted above, Centennial's capital efficiency looks significantly improved, while its base decline rate is expected to come down by several percentage points.

Centennial's non-D&C capex is also expected to be lower with infrastructure spend declining as well. This results in a projection of $1.076 billion in cash expenditures and around $123 million in cash burn in 2020. Centennial's net debt is thus expected to reach around 1.9x unhedged 2020 EBITDAX by the end of 2020.

$ Million
Lease Operating $141
Production Taxes $62
Cash G&A $55
Gathering, Transportation and Processing $74
Cash Interest $64
Capex $680
Total $1,076

Centennial should be able to maintain/increase its production in 2021 without cash burn at mid-$50s oil as its base decline rate continues to fall and its facilities capex requirements are reduced.

It also noted that it could monetize its saltwater disposal system to help reduce its net debt, although Centennial looks like it should have a decent amount of liquidity without attempting to monetize that asset. I view the monetization of Centennial's water infrastructure assets to be more of a backup plan due to the extra costs it would add going forward.

Source: Centennial Resource Development

Valuation Notes

At $3.04 per share, Centennial is now trading at only 3.25x its projected 2020 EBITDAX. This includes its projected cash burn until the end of 2020 as well. If Centennial is valued at around 4.0x projected 2020 EBITDAX instead, it would be worth around $4.70 per share instead.

Conclusion

Centennial's share price has been depressed due to its continuing cash burn, although it has a good amount of liquidity and should be able to reduce its cash burn and then deliver positive cash flow as its base decline rate moderates and it doesn't grow its production as fast. It has made significant strides in improving its capital efficiency, which helps with its maintenance capex as well.

Even if Centennial keeps production at around 77,000 BOEPD, it would be more fairly valued at close to $5 per share. This would also value its production at around $32,250 per flowing barrel without giving value to its infrastructure.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in CDEV over 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.