Ring Energy: Debt Continues To Make Its Stock High Risk
Summary
- Ring had conservatively managed its finances before, primarily funding its growth via equity offerings.
- The Wishbone acquisition was a high-risk, potentially high-reward acquisition that pushed its leverage up from 0.6x at the end of 2018 to 3.0x at the end of 2019.
- Ring should be able to pay down its credit facility debt below $300 million in 2020.
- Leverage based on forward EBITDA would still be 3.4x at $45 WTI oil in 2021 and 2.9x at $50 WTI oil in 2021.
- A significant borrowing base reduction is still expected.
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Ring Energy (NYSE:REI) may have been conservatively managing its finances before its Wishbone acquisition, primarily funding its growth via equity offerings. This changed with the Wishbone acquisition though. Ring's Wishbone acquisition significantly increased its production, reserves and EBITDA, but also greatly increased its risk due to the company funding the acquisition primarily (approximately 90% of the price) with cash.
Ring is now a company that likely requires at least mid-$50s WTI oil and probably more like $60+ WTI oil in order to get its leverage down to a reasonable level. In any oil price scenario below mid-$50s WTI oil, Ring's elevated leverage makes its stock high risk. I considered the risk/reward for Ring's stock to be more balanced when it was at 60 or 70 cents. At over $1, this equation is less favorable though.
Before And After Wishbone Acquisition
Ring's 2019 production (including 11 months of Wishbone production) ended up 78% compared to its 2018 production.
Ring's adjusted EBITDA went up +81% over the same period, from $66.5 million in 2018 to $120.4 million in 2019. This was due to the increased production along with a slightly higher realized price per BOE in 2019 (after derivatives).
Source: Ring Energy
However, primarily due to the acquisition, Ring's leverage also increased considerably. At the end of 2018, its credit facility debt was only $39.5 million, or 0.6x its 2018 adjusted EBITDA. At the end of 2019, its credit facility debt reached $366.5 million, or 3.0x its 2019 adjusted EBITDA.
Source: Ring Energy
The 2019 adjusted EBITDA numbers come with WTI oil averaging $57 during the year. This suggests that Ring will need higher than mid-$50s WTI oil in the long run in order to bring its leverage down to an acceptable level.
Estimated Forward Leverage
Ring's production is expected to decline noticeably during 2020 due to its limited capex budget, as well as the sale of its Delaware Basin assets. Those items (along with its hedges) are also expected to contribute to its credit facility debt falling below $300 million.
Ring's forward leverage (based on end of 2020 production levels) is estimated at approximately 3.4x at $45 WTI oil, decreasing to 2.4x at $60 WTI oil.
| WTI | $45 | $50 | $55 | $60 |
| Forward Leverage | 3.4x | 2.9x | 2.6x | 2.4x |
This does include the effect of Ring's 2021 hedges, which have no impact at $45 or $50 WTI oil, a very slight negative effect at $55 WTI oil and more of a negative effect (due to the average ceiling being around $54.57) at $60 WTI oil.
We can see here that Ring realistically needs mid-$50s or better oil (and more likely closer to $60 WTI oil) for its leverage to come down to more acceptable levels.
The projected leverage numbers also are another indication that Ring's borrowing base is likely to see a noticeable reduction. At $425 million, Ring's borrowing base would be over 5.0x its projected 2021 EBITDA at $45 WTI oil. With bank price decks typically using oil prices close to strip, and 2021 strip (despite improvements) still at under $40, a 20+% reduction (including the effect of its Delaware Basin sale) still seems reasonable to expect.
Conclusion
The idea that Ring Energy is conservatively managed went out the window with its Wishbone acquisition. This was a high-risk, high-reward type of acquisition that ended up increasing Ring's leverage from 0.6x at the end of 2018 to 3.0x at the end of 2019 (based on similar realized oil prices after derivatives in both years).
If oil prices had remained in the mid-$50s or higher, the decision to take on more debt may have worked out fine for Ring Energy. However, as I mentioned in September 2019, "Deleveraging may take a while at mid-$50s oil and there is vulnerability to weaker oil prices."
Ring Energy is doing what it can to improve its situation with the dramatically weaker oil prices now. However, it is important to also acknowledge that Ring and other significantly leveraged companies are facing massive challenges during this period of weak oil prices. Ring's hedges protect it reasonably well during 2020, but it is still vulnerable to the effects of its borrowing base re-determination, and as I've noted above, it needs at least mid-$50s oil for its leverage to get down to a semi-reasonable 2.5x level.
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