Parsley Energy: Management Came Up Short

Summary

• The management team at Parsley has made a number of wise decisions aimed at shoring up the company's financial position.
• These are great moves that will help to preserve value, but a lot of details are missing.
• Investors should find the lack of guidance provided by the business discouraging.
• This certainly adds to the company's admittedly low-risk profile.
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2020 has been a rough year so far. This is true for every industry just about, but it's especially the case for companies in the oil and gas industry. Soaring inventory levels, accompanied by record-low pricing caused by fears over the economic impact of COVID-19, have resulted in a lot of pain for the companies operating here. Some firms are handling this well, changing guidance to reflect a lower-priced environment. But others, like Parsley Energy (NYSE:PE), are dropping the ball. Though fundamentally solid for now, and likely to remain that way, management's recent stance on how they are adapting to market conditions is the exact opposite of awe-inspiring. Investors look toward management teams for security during times of crisis, and if they cannot get it there, pessimism will only be that much worse.

What management is doing right

Before we discuss where management is botching its job during these tough times, we should first commend them on where they are doing well. The most obvious thing management has done is to significantly reduce its capex budget for the year. Initially, the company intended to spend between $1.6 billion and $1.8 billion on capex for 2020. This has been slashed now to 'less than' $700 million. Precisely what 'less than' means is open for interpretation, but we do know that the company allocated $379 million toward its capital budget during the first quarter of 2020. This leaves, at most, $320 million for the remainder of the year.

Naturally, according to management, this will require a cessation of all drilling and completion activities moving forward. This has resulted in the company being forced to incur a $15 million charge associated with the early termination of rig contracts that will be realized in its second quarter earnings release later this year. This is painful, but it's the lesser of two evils when you consider the alternative would be to continue spending as management previously planned.

To cut costs further, management has instituted some pay cuts for employees of the rank of Executive VP and above. The decrease in cash compensation for these top figures will amount to at least 50% of what they received in 2019. This, combined with other cost-cutting measures, will help to reduce cash-based general and administrative costs this year down to $130 million from the $165 million previously anticipated using mid-point guidance figures.

Part of management's plan to reduce costs also involves voluntarily shutting in higher production. By the end of April, management had already cut output by between 5 thousand and 7 thousand boe (barrels of oil equivalent), on a net basis, per day. That translates to between 1.83 million and 2.56 million boe per annum. That appears to be just the start for the company though. They announced plans to shut in a further 23 thousand boe per day of output in May, which works out to 8.40 million boe per annum. It's uncertain if further production decreases will occur or how long these ones will last, but this is bound to have an impact on output for the year. If it saves the company money, though, then so be it.

The last big thing management did that made a lot of sense was to refinance some of its debt during the first quarter. The firm refinanced some of its Senior Notes due in 2024 in exchange for Senior Notes now due in 2028. Not only was the term of debt repayment extended, but the interest rate also decreased from 6.25% per annum to 4.125%. Because the 2024 Senior Notes were redeemed at a price of 104.688% of par, this maneuver alone increased the company's debt by $18.75 million. However, the reduction in annual interest from this change will total $8.5 million, saving the company significant cash over time.

Where management has dropped the ball

During the first quarter, Parsley was hit hard. The company recognized an impairment charge of $4.4 billion, plus it saw another leasehold and impairment write-down worth $557 million. Given the sudden drop in energy pricing, this could not be anticipated. And it certainly isn't management's fault. Where the company did drop the ball, though, is on guidance for this year. As you can see in the image below, the company, currently, is offering very little in the way of guidance.

Source: Parsley Energy

Some investors might argue that it's unreasonable to provide significant clarity given how volatile the energy environment has become. This argument could be accepted if it weren't for the fact that management is forecasting free cash flow for 2020 to hit $300 million or higher. This assumes WTI pricing of between $20 and $30 per barrel for the remainder of the year compared to prior expectations of $30 to $35 per barrel. In order to make that kind of call, management must have internal models showing where output is likely to hit.

Showing investors what these figures are is incredibly important. Not only will the end result for this year be important for valuing the business as it currently stands, but it will also have an impact on the prospects of the enterprise in the years to come. Capex has long-term consequences and if the output is allowed to fall this year, the free cash flow the company is slated to enjoy now could go out the window if spending needs to ramp up to stop production declines for future years. It's one thing to optimize cash flow this year, but it's another thing entirely to do so at the cost of cash flow in future time periods. I'm not saying that management should be responsible for a single accurate call on where the output will be. But they should be able to come up with a range of scenarios to share with investors.

Another issue that investors need to keep a close eye on is debt. As of the end of the latest quarter, net debt for Parsley stood at $2.95 billion. This was up from the $2.18 billion seen at the end of last year. This increase seems to have been due to its acquisition of Jagged Peak Energy that was completed in January of this year. During the first quarter, the company's EBITDAX totaled $457.2 million. If we annualize this, we end up with EBITDAX for 2020 of $1.83 billion. That works out to a net leverage ratio of 1.61. This is quite low and it in no way places Parsley into the risky category of E&P firms, but with continued low pricing and the likelihood of a multi-year impact on production, investors should watch where this ratio trends moving forward.

Takeaway

At this time, Parsley is in a pretty good position. It's certainly in a better spot than many of its peers. What's more, the business is making some wise moves by cutting capex, curtailing some output, and reducing operating costs. These are all great signs, but during these tough times, shareholders need more. Having what is practically a blank slate looks bad and does not instill confidence. This is especially true when management is clearly in a position to offer guidance of some sort since it would be impossible to project a specific free cash flow floor without it.

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.

Comments

[Dan Opp]

The earnings presentation had details on production guidance.

s21.q4cdn.com/...

See page 6

[Daniel Jones]

Check page 13 of that presentation. Sadly, their page 6 only covers net oil production, not total production. 63% of their boe production comes from oil.

[brookpe]

Let me see that impairment charge. Proven Reserve Value 12/31/2019 $4.96B, Net Book Value $9.45 Billion, negative -$4.49 B. APPRAISED AT $53.97 Oil Price. That negative value look familiar? BUT THE FACT THAT HALF THE MONEY THEY INVESTED EVAPORATED AT $54 OIL IS NOT MANAGEMENT"S FAULT. OMG you're kidding me!!! Search impairment in the CC transcript. Good Luck

[Avatar910]

Nice analysis, but the confluence of COVID-19 demand destruction and the continuing spat between Vladimir & the Saudis likely makes it difficult to offer any guidance that has a high degree of confidence. Ranges are valuable when the underlying data is sound.