California Resources: Still Cashless EBITDAX
Summary
- Cash flow at the parent company level dropped.
- The consolidated statements overstate the cash resources available to the parent company to service debt.
- Mezzanine Equity balance is still growing which implies larger future cash obligations for this preferred stock.
- A thorough capital structure overhaul is probably necessary due to the lack of parent company cash flow from operating activities.
- At best, common shareholders can expect a lot more shareholder dilution ahead.
- This idea was discussed in more depth with members of my private investing community, Oil & Gas Value Research. Get started today »
California Resources (CRC) management ballyhooed some accomplishments with key ratios. Everything that management was stated was true. It is always what is left unstated which is at least as important. Usually, that is in the details of the 10-K for investors to find on their own. This article will attempt to dig out some of those details for investors to make up their own minds about this investment. It was particularly interesting that cash flow at the parent company level declined as consolidated EBITDAX climbed.
Joint Ventures
The joint ventures have commitments to the partners that do not show as company expenses. Yet, these commitments result in less cash available for California Resources to use for debt reduction.
Source: California Resources Corporation 10-K For Fiscal Year 2019
It should be especially noted that the mezzanine equity, which common shareholders should count as debt for their purposes, is still growing. There are a cash payment and an in-kind payment combination. It has a rather expensive after tax cost to shareholders that probably sops up any (or at least most and a significant amount) consolidated cash flow attributable to that joint venture at the current time.
Source: California Resources Corporation 10-K For Fiscal Year 2019
To further complete the overall picture, the joint ventures are shown above as the "Non-Guarantor Subsidiaries" and show relatively few assets. There is every possibility that this company has joint ventured the best prospects the company has. That may "shut" any possibility of the parent companies receiving cash flow from the more profitable parts of the company for the foreseeable future. Therefore, profits and cash flows will take a "hit" until such as time as management can recapture a greater interest in the partnership cash flows.
Given the growing Mezzanine Equity shown above, that recapture could be a tall order for a big chunk of joint venture cash flows. To make matters worse, the distributions on this joint venture preferred issue are after tax. That is a far more expensive way to accomplish financing than debt.
Source: California Resources Corporation 10-K For Fiscal Year 2019
On the main financial statements, this detail is not there. All there is, in fact, just one item on the consolidated income statement for non-controlling interests. But as shown above, cash flow at the parent company level (Parent and Combined Guarantor Subsidiaries) clearly fell in the latest fiscal year.
Consolidated EBITDAX is not representative of the cash flow situation. At the parent company level, cash flow appears to be deteriorating. There is a gamble that more cash flow will be available when needed. But currently, that gamble appears to be a longshot.
Source: California Resources Corporation 10-K For Fiscal Year 2019
All of that leads to the following major issue. The distributions to joint venture partners are shown under financing in the cash flow statement. That $151 million is about as mandatory a cash payment as one can have without it being classified as obligatory as interest on the debt. The claim on the cash flow of the joint venture partners is generally superior or larger (depending upon the agreement and financing of each one) to any claim that California Resources would have at the current time. Therefore, those non-controlling distributions, therefore, should be subtracted from cash flow from operating activities to get the "true" cash flow available to the parent company. Even then, there could still be some non-controlling interest claims remaining in some of the available assets and cash.
If that is done, then consolidated cash flow would drop to about $525 million for the current fiscal year. Of that, the parent company level cash flow (Parent company plus Combined Guaranteed Subsidiaries) was $409 million for the latest fiscal year. In reality, the parent company has access to the $409 million-plus whatever part of the additional $116 million that the joint venture partners would agree to distribute. Since many of the joint ventures are relatively recent, there is a very good chance that an insignificant amount of the joint venture cash flow is available to the parent company.
Source: California Resources Fourth Quarter 2020 Earnings Conference Call Slides
Management rightfully claims that long-term debt has decreased. However, the mezzanine equity should be counted as debt by common shareholders. Furthermore, the only EBITDAX that should be used by common shareholders is the EBITDAX attributable to the parent company. I will use the more conservative parent company cash flow mentioned previously of $409 million. Using that figures mean that cash flow is less than 10% of long-term debt and mezzanine equity.
Management has probably admitted to the current financial situation by initiating an exchange offer.
That is an extremely precarious position for any parent company to find itself in. Anytime an exchange offer like the one shown below makes an appearance, the common shareholders should be concerned. This would account for the doubts in the bond market as demonstrated by the low prices of the company bonds.
Source: California Resources February 2020, Press Release
This kind of offer is often considered a "distressed" or "coercive" offer. It is indicative of significant financial challenges. Ratings companies often do not treat this type of offer very well. The reason is that bondholders are asked to give up a superior position in the financial structure often for values considered less than the face value of their current holdings.
Traders may see a gain here and, therefore, might consider this. But there is the old problem that remaining holders could wait for maturity to be paid in full. That could prevent a successful conclusion to the offer. However, even if this offer succeeds, there is a good chance that a lot more comprehensive solution to the capital structure of this company is needed.
The cash flow at the parent company level is capable of supporting a fraction of the current long-term debt and mezzanine equity. That is particularly true when it is known that the mezzanine equity is part of a joint venture for the electric plant. That electrical generation plant was an expense reduction (but still netted to an expense) until the joint venture converted it to a profit center.
The market appears to desire cash flow equal to about half the debt load. The minimum lending requirement is typically cash flow equal to one-third of debt. The current parent company level cash flow is nothing close to any of these measurements.
The Future
There are still a lot more issues with this complicated company. The production has not grown and the continuing commitment to joint ventures tends to eliminate immediate growth in return for future growth at hopefully decent oil prices. But the fact is that despite a relatively robust capital budget, this company has not managed to return production to levels seen a few years back. This operator actually has a worse capital record than many unconventional companies I follow.
Therefore, the cash flow is unlikely to improve much in the near future. That means that debt reductions will have to be handled by some sort of debt for equity swaps. If those swaps fail, then some sort of reorganization would be the last resort. Management is already beginning down this strategy road with the latest swap offer.
These volatile shares are best left to experienced traders who can take advantage of the volatility. This company is not a real good investment for long-term shareholders.
Source: Seeking Alpha Website February 29, 2020
This chart is unlikely to turn favorable until the above-mentioned cash flow and debt challenges are resolved. The debt issues have hamstrung management since the day this company came into existence. Unfortunately, the analysis above shows no material improvement despite some very commendable management efforts.
This is definitely a "buyer beware" stock.
I analyze oil and gas companies like California Resources 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 are not published on the free site. Interested? Sign up here for a free two-week trial.
This article was written by
Long Player believes oil and gas is a boom-bust, cyclical industry. It takes patience, and it certainly helps to have experience. He has been focusing on this industry for years. He is a retired CPA, and holds an MBA and MA.
He leads the investing group Oil & Gas Value Research. He looks for under-followed oil companies and out-of-favor midstream companies that offer compelling opportunities. The group includes an active chat room in which Oil & Gas investors discuss recent information and share ideas. Learn more.Analyst’s 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.
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Comments (205)
So patience will pay off. At the same time, I am running out of bullets to buy.
Yes the accrual from the 13.75% preferred dividend causes the mezzanine equity to grow. The $750m deferred preferred is a senior claim on that asset which must be paid back. Crc 50% holding in common A only worth is above the mezzanine equity level, which likely is zero at $800m due. This is my understanding too.
Dudes like Seth Lowery claiming this can be monetized just ain’t getting it.
CRC sold lots of puts in the $52-$53 area. They eat each $1 loss below that.
The hedge book is done hedging and not designed for this type fall. Sell fat premium puts is great until they are not.
Commingled books and complete lack of Visibility separating them a true sign they are hiding the cash flow collapse internally.
The tender being a reasonable success is actually a poor sign for the firm. 2nd lien holders are willing to take 35% permanent haircuts to get into paper probably worth half that again when traded . Just to uptier .25 from 2nd to 1.75 lien. Wow.
The $750m preferred owned by Ares has a 3 year deferred feature. The rate in 13,75%. The common equity CRC owns and calls mezzanine equity looks like accounting gimmicks. Clearly the senior preferred claims owns the power plant at $750m.....unless someone (Lowery) assumes that power plant is worth well over $1b. Chances are it’s not worth the $750m other than Ares paid up for exclusive business.
@grahamdavid063 SP downgrades CRC to CC. "We will raise our rating on CRC if we no longer expect default to be a virtual certainty".LOL....have a good day Dave.
24 Feb 2020, 03:24 PM
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countryinvestor Comments334 | + Follow
Quote it all:"The negative outlook reflects the possibility of holders of existing notes
exchanging into new securities at what we consider to be lower value than
originally promised. Should this occur, we will lower the issuer credit rating
to 'SD'.We would lower the issuer credit rating upon completion of the debt exchange
or conventional default.We could raise our ratings on CRC if we no longer expect default to be a virtual certainty. This could occur if the company comprehensively addresses its over-levered capital structure and upcoming debt maturities without utilizing an exchange we view as distressed."How is this a surprise? There is swap on the table. Call it distressed/coercive or whatever you want, but it is axiomatic that this would result in these comments from a credit rating agency.
24 Feb 2020, 04:03 PM
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