- Debt was repurchased at a discount.
- The borrowing base increased.
- Shares were repurchased.
- The hedging program helped to maintain adequate cash flow.
- There is plenty of borrowing room to repurchase more debt at a discount.
- This idea was discussed in more depth with members of my private investing community, Oil & Gas Value Research. Get started today »
Antero Resources (NYSE:AR) just blew away any worries Mr. Market had about a crisis. For a while, there were all kinds of worries about rolling over debt when it came due. Never mind that the debt was not due until the end of 2021. That is an eternity in the commodity world. Debt due then was nothing to worry about now. Then, there was cash flow worries, high cost worries, counterparty worries, and in-general viability worries.
Somebody forgot to tell management there was even a problem because this company has been conducting business as usual with a few modifications in the extraordinary situation. The result is that the company has been repurchasing debt at a discount and repurchasing stock at rock bottom prices. There has always been a saying that the market can stay "irrational longer than you can stay solvent". This management is hoping for a long period of irrationality. Then, it can repurchase gobs of stock for pennies on the dollar value and bonds at a discount with plenty of bank line left over.
Source: Antero Resources First Quarter 2020 10-Q
This fiscal year the changes in current assets and liabilities added a whole $7.725 million to cash flow. In the last fiscal year (2019), those same changes added about $109.065 million to cash flow. The 2019 cash flow also received a boost of roughly $40 million from the inclusion of Antero Midstream (AM) during the period. In the last fiscal year, cash provided by operating activities totaled $1 billion.
Clearly, the hedging program has the company in a position to possibly attain that cash flow amount in the current year. That help would happen without the cash received from Antero Midstream in the past or the cash received from the buyout of the midstream by its general partner. This time around, Antero Resources appears poised to live within whatever cash flow is generated by the corporation itself plus the dividends received from Antero Midstream.
Hedging Benefits Yet Again
Much of the cash flow for the quarter came from the hedging program. That kept the latest commodity price dive from doing serious damage.
Source: Antero Resources First Quarter 2020 Earnings Press Release
As shown above, the hedging program clearly supplied the lion's share of cash flow for the quarter. This has happened before in the history of this company. Typically, the hedging program is a major source of profits both in good and bad times. Right now, those profits were needed. But those profits continue a long history of hedging profitability with this company.
For most companies, hedging is a "zero-sum" game. This is one of the very few companies that I follow where hedging has never been a zero-sum game. Instead, the hedges nearly always contribute to profits reported. Very few companies in any commodity industry can make that claim. That does make the hedging program a risk factor when calculating future profits. It also makes predicting future profits and cash flow tricky.
There was considerable misplaced concern about the ability of this company to meet the maturing debt challenges.
Source: Antero Resources First Quarter 2020 Earnings Press Release
If management saw a challenge, they certainly did not mention a challenge. Instead, management reported an increased lending base with the committed amount remaining the same. Very few companies can repurchase debt at any discount without repercussions from the lenders. The increase in the bank line has little practical meaning other than to send a message to the market that this misunderstood company is doing just fine. The bank commitments to loan remained the same even though the bank line increased.
Not only did management manage to report a gain on the debt. But the debt retired in this fashion now accrues interest at the lower rate on the bank line. For those worried about some debt ratios, the interest paid is about to decrease in the current fiscal year. Should the market stay irrational, there is plenty of room on the bank line commitment (to lend) to purchase some debt maturing later at a larger discount to materially help the debt ratios. This is exactly where management hopes Mr. Market stays irrational for a while.
The repurchase of common shares has to go down as "highway robbery". The common was below the bargain basement price. I am not sure any elevator at any department stores I know goes down to the level of that stock price. Clearly, repurchasing stock had to be a huge plus for shareholders. In short, this management has been spending money where that money offers the greatest returns by far and production grew in the first quarter.
Despite cutting the capital budget again, management is maintaining production guidance for the year. Furthermore, management believes that storage facilities are sufficient to store some liquids should prices deteriorate to unacceptable levels. This gives management the option to store the liquids while waiting for a more favorable industry environment combined with the ability to realize the hedging profits. Cash flow at the end of this fiscal year could be very interesting if management is successful in this endeavor.
The costs of drilling and completing wells continue to drop. The weak industry conditions allowed those costs to drop ahead of schedule. This allows management to pursue a counter-cyclical production expansion policy while also generating free cash flow this year. Very few companies in the industry will be able to retire debt at a discount, grow production, and generate free cash flow. This management is, clearly, doing just fine with the current industry situation.
Very few managements can accomplish a small part of what is being done with this company. We are in uncharted territory and there is a way to go before we are past all the coronavirus challenges. But given all the worries caused by the "shelter in place" across the nation. This company has really performed a near miracle that few managements can emulate.
Taking advantage of a market panic the way this management has is something that is learned at business school but very seldom executed in practice. Part of the problem is that usually, companies with discounted debt are in so much financial trouble that the banks will generally limit the debt repurchases. Clearly, that is not the case here (yet).
This was a healthy company rated just below investment grade at the major ratings agencies before the coronavirus demand destruction and the oil price war. This company appears to be exiting the current situation in better shape than when the whole thing began. Any company that can improve its situation during a crisis deserves consideration by investors. Once things return to normal, this management will probably outperform significantly.
The only reason the company reported a loss was the decision by management to write down the goodwill part of the previous gain on investment from the general partner buyout of Antero Midstream. Additionally, Antero Midstream also reported a loss that Antero Resources reported as its share of an equity loss. There was also an impairment of oil and gas properties. None of these amounts involved any cash. Without those non-cash items, this company would have been profitable in the first quarter.
More importantly, Antero Midstream has not reported any financially significant damage that would limit future profitability. Instead, all that happened was the share price declined. That is hardly anything to worry about for long-term shareholders. Instead, the current pessimism of the market is a great opportunity to pick up some shares of a well-managed company on the cheap.
I analyze oil and gas companies like Antero 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.
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