Ring Energy: Piece Of Cake Property Sale Then Growth Ahoy

Jan. 09, 2020 9:53 AM ETRing Energy, Inc. (REI)61 Comments14 Likes

Summary

  • This company features triple digits returned on wells drilled.
  • The central basin and Northwest shelf are more profitable than the Reeves County leases.
  • The Reeves County leases should be an easy sale to raise cash.
  • Cash flow should jump significantly from the doubled production and later lack of acquisition operational-based optimization expenses.
  • This company trades at a very cheap price compared to its low cost reserves per share.
  • This idea was discussed in more depth with members of my private investing community, Oil & Gas Value Research. Get started today »

Ring Energy (NYSE:REI) announced the marketing of its Delaware Basin asset. That monetization could raise enough cash to easily bring the key ratios back to very conservative debt ratios that this management prefers. In fact this management would rather have a debt-free balance sheet.

Source: Ring Energy October 2019, Investor Presentation

The Delaware Basin assets are located near the very lucrative Reeves County Texas oil businesses. This location should be very liquid even during an industry downturn like the present. Anytime leases need to be sold, location and geology are the first considerations. Unlike a lot of companies that need to raise cash, this company has some very important benefits to enable the sale. Management has worked on the supporting water disposal system to make sure it supports expansion.

In addition to a fair amount of exploration and de-risking done, this property has the supporting infrastructure already in place to lower operating costs. Therefore, the advantage supports a decent selling price even if the current hostile industry conditions would indicate a lower price compared to just a year or two ago.

Reason For The Sale

Management had a great opportunity to purchase some Northwest shelf assets and another acquisition. Both of these appear to have materially enhanced the inventory of future prospects considerably. The Northwest shelf appears to have a much higher percentage of oil production than the current properties of the company. That alone would add to profitability.

The debt load, though, climbed a little higher than management would prefer for the current situation as a result of the acquisitions. This management would have preferred little to no debt and therefore will sell something and pay down debt from cash flow until they are comfortable with the debt load.

Source: Ring Energy January 2020, Energy Prospectus Group Presentation

Anytime, the payback approaches less than one year as shown above, then management can drill two wells with the same money in the same fiscal year. This management gets double the benefit of capital expenditures when compared to many competitors. Plus a fast payback of even slightly more than a year often means a higher flow rate when the profits finally begin to be realized. That makes for a higher net present value as well as more profits to show on the statements for shareholders immediately.

Should lower prices render a lower profit margin in the future, there is a very good chance that the profit will still be acceptable to shareholders and management. Fast paybacks put acceptable profit levels at far less risk in this very volatile industry.

Since this is a conventional opportunity, the decline rates are less steep. Therefore, flow rates are a relatively greater percentage of the initial production rates and those greater flow rates last longer. That allows for a fast cash flow build when compared to some unconventional wells.

The cheap well and location costs make up for the lower percentage of oil produced to maintain a decent margin. This is yet another management in a relatively dry area of the country with an excellent water management system to keep costs low and the water supply dependable as needed. Obviously, the conventional opportunities do not have the water requirements of the unconventional opportunities. But a solid water supply in an area with relatively low rainfall is nearly always an asset (even if the water has to be processed first).

Even more amazing is the profit levels in these two areas. Not many companies have profit levels that exceed the Reeves County area. Even fewer companies can claim high profits with a conventional opportunity. This company "set up shop" smack in the middle of the unconventional hub of business by constructing a conventional business. The result is that the conventional business with its cheaper wells and less environmental threats is overshadowed by the unconventional business all around the company operations.

Growth

The acquisitions allowed the company to show tremendous accretive per share growth when compared to the previous year. The market was concerned when the company went from a two-rig program to a one-rig program. However, the acquired properties had a lot of deferred maintenance. Therefore, operating costs could be significantly reduced and production prolonged or even increased by optimizing operations on the acquired properties before resuming growth. A lot of this activity can be done in a quarter or two. Therefore, the market overreaction was clearly overdone.

Source: Ring Energy Third Quarter 2019, Earnings Press Release

This company is clearly posting major earnings advances over the previous year. Investors should not expect free cash flow when the company has those kinds of profit margins. It would be crazy to expect management to give up the margins shown above in the name of letting cash set on the balance sheet for some blanket market-based goals that will probably fade over time. Plus there is an excellent acquisition to optimize.

The profit margins shown above approach 20% after tax. That is nearly unheard of in many industries. The latest acquisition of the Northwest shelf allowed management to instantly nearly double production without the issuance of all that many shares. Cash flow to debt ratios will be out of wack until there is about a year of clean production history without all the purchase items in the income and cash flow statement. But the lenders realize this. Now Mr. Market needs to catch up with the lenders.

Source: Ring Energy Third Quarter 2019, Earnings Press Release

Even with the one-time acquisition and operations optimization charges, the company is beginning to show increasing cash flow. The adjusted long-term debt-to-cash flow from operating activities ratio is currently around 3. Management wants to "move the needle" into safer territory with more flexibility "just in case." There is absolutely nothing wrong with that attitude.

The well profitability should also lead to a very fast cash flow buildup. Management intends to quickly reach cash flow neutrality that the market so blindly demands. That sad part is that the exceptional profitability would lend itself to decent leverage without a lot of financial danger that is evident in many leveraged competitors. Yet the market does not take into account profitability when demanding free cash flow and living within cash flow.

In any event, the goal is to knock about $100 million or so off the debt balance as quickly as possible and then aim for a debt-to-cash flow ratio of probably about 1.5 or less. Hopefully then, the market would not worry much about the prospects of this company during a downturn.

Break-Even

This very profitable company has one of the lowest break-evens in the industry.

Source: Ring Energy January 2020, Energy Prospectus Group Presentation

The break-even here is comfortably below those break-even points cited by such giants as Occidental Petroleum (OXY) and ConocoPhillips (COP). In fact, this company will be growing production when the two giants are maintaining production or even experiencing slight production declines due to lower commodity prices.

The Future

The market clearly lumped this company in with companies that have a broken business model. The situation here is very different and the market will get around to realizing that sooner or later.

Source: Ring Energy January 2020, Energy Prospectus Group Presentation

The low production costs and low break-even points cited early verify the reliability of the reserves per share shown above. This company is one of the least likely in the industry to suffer reserve reductions due to lower oil and gas pricing. That is one of the large advantages of low costs and low break-even points for new wells.

Source: Ring Energy January 2020, Energy Prospectus Group Presentation

As shown above, quarter-to-quarter growth has been stymied by the recent acquisition digestion process. That can be poisonous to this momentum-based market. However, reasonable growth should resume next year even as many others in the industry pull pack or decrease activity due to weak commodity prices and a perceived recession on the horizon.

Source: Ring Energy January 2020, Energy Prospectus Group Presentation

The biggest risk here would be lower commodity prices. That appears to be very unlikely. With the assimilation of the acquisition nearly complete, any assimilation risks are now pretty much in the past.

This company trades at a very low enterprise value to cash flow ratio of probably less than 4 once the assimilation charges are in the past. A company with this low cost, growth prospects, huge profit margins, and great location should probably trade closer to 10 times cash flow. That does not consider the undervaluation of the very low cost reserves behind each share that would allow for even more appreciation.

This is one of the more undervalued Permian operators. Notice that this is one of the few operators that includes the land cost as part of the rate of return calculation for investors to review. Many competitors do not because their land costs are astronomical and therefore would materially lower the total rates of return that are presented to investors.

The future of this company is very bright. The current low price of the stock presents very little long-term risk. Normally, a company of this quality does not get anywhere near this cheap. A great variety of investors and speculators may want to consider investing in this stock for the sizable asymmetrically high recovery potential of these shares.

I analyze oil and gas companies like Ring Energy and related companies in my service, Oil & Gas Value Research, where I look for undervalued names in the oil and gas space. I break down everything you need to know about these companies - the balance sheet, competitive position and development prospects. This article is an example of what I do. But for Oil & Gas Value Research members, they get it first and they get analysis on some companies that is not published on the free site. Interested? Sign up here for a free two-week trial.

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Disclosure: I am/we are long REI. 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.

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