The liquidity at Comstock Resources (NYSE:CRK) was getting a little on the tight side. So, this management did what many successful managements have done in the past. The company sold about 40 million shares of stock to gain additional liquidity before Mr. Market became concerned enough to decimate the stock price. Most likely, the option to sell an additional six million shares will be exercised.
"Following the end of the quarter, the Company completed its scheduled semi-annual borrowing base redetermination under its revolving bank credit facility, resulting in the bank group decreasing the borrowing base from $1.575 billion to $1.4 billion. The commitment level was reduced from $1.5 billion to $1.4 billion. The decrease is related to lowered oil and natural gas prices that the banks used to determine the borrowing base."
Source: Comstock Resources First Quarter 2020, Earnings Press Release
Out of all of the above quote, the very important part is the amount the banks committed to lend. The borrowing base itself means very little to the average investor and really can be ignored. Even the committed lending amount is often limited by covenants. Any requested loan that would cause a covenant violation would not occur regardless of lender commitments.
That decrease in lending commitments may have made management feel that additional liquidity was necessary for the company to operate properly during the coronavirus challenges. Natural gas prices are the beneficiary of decreased oil production. Therefore, there is a very good chance that the next adjustment of the loan commitment will be upwards.
Leverage
Still, the oil and gas industry is very volatile and unpredictable. Conservative managements have long solved problems quickly rather than waiting for the problem to resolve itself or get worse. Too many times, an unresolved challenge becomes more daunting.
Source: Comstock Resources May 2020, Investor Presentation
Production nearly tripled from the year before, thanks to a solid acquisition. But natural gas prices declined substantially, so that the profits reported in the first quarter were comparable to the profits reported in the first quarter of the previous year. Most of the profit gain was due to a swing in hedging from a loss to a gain. Adjusted net income as reported by management only increased roughly $6.4 million.
EBITDAX did double in the first quarter. But that was less than anticipated because the natural gas price decline did decrease revenue, earnings, and cash flow. The hedging program did offset some of the decline, but the effect clearly shows in the slide above.
Management kept the margin in good shape by trimming costs. The acquisition was supposed to result in economies of scale. That appears to have happened. However, the results "hid" that economies of scale progress when natural gas prices further weakened.
Source: Comstock Resources May 2020, Investor Presentation
The result of the first quarter reports was probably a little more leverage than management desired. The first quarter EBITDAX implies an annual rate in the $800 million range. Total debt and preferred stock were heading towards 4 times EBITDAX. Even though the current conditions may mark the bottom of the current natural gas cycle, this management may have desired to "jumpstart" the deleveraging process.
Costs
Since focusing on one basin, Comstock management has made tremendous progress reducing costs.
Source: Comstock Resources May 2020, Investor Presentation
The surprisingly low costs shown above mean that this company still has margins during the current weak pricing environment even before any hedging has been considered.
The slide itself is somewhat misleading because some peers elect to drill for more liquids in the respective basins. Those liquids require extra processing after being separated from the gas. But as long as those liquids can be sold profitably long term, then the extra (incremental) costs are justified.
During periods of lower costs, these operators often have the option of drilling for dry gas and leaving some of the liquids in the gas stream to reduce processing costs. Comstock has very little liquids in its natural gas stream. Therefore, processing costs will remain low. But the company needs to be compared with outside production that has a similar mix. That can be a real challenge with primarily natural gas production because many basins have a wide variety of drilling possibilities.
The Future
Management has demonstrated that they are not afraid to dilute current shareholders in the name of keeping the company solvent. Too many managements borrow money at a time like this because "the stock is too cheap". If the recovery is then delayed or worse, the company has a very difficult time recovering.
Often times when you need to rebalance the equity and debt, "your first loss is your best loss". That attitude often enables a company to solve its problems on a timely basis and move forward for whatever else the future challenges may hold for management.
Furthermore, the low amount of adjustment of the committed lending amount demonstrates some conservative handling of debt. Some managements go for the maximum allowed at all times. Then, there is a considerable adjustment in the current situation. If management does not keep sizable amounts of the credit line open or unused, then management often ends up needing to pay down the credit line balance to the new commitment amount at a time when cash is very dear.
The low operating costs are a sign of operating leverage. That means this company could well appreciate more than many competitors as the high margins translate into above-average earnings gains when natural gas prices rise.
This company has a lack of operating history as presently configured. That would add to the risk of the investment. On the other hand, the management of the company appears deep enough to handle whatever challenges this industry gives management. This slightly speculative investment is suitable for consideration by all but very conservative investors.
Before the involvement of Jerry Jones, Chairman, Comstock Resources had too much debt. Obviously, the market will want some operating history with the new debt attitude. Right now, the long-term bet that these leases will be very profitable appears to be a good bet. But investors do need to be patient with this company.
Investors now can invest in this company for a cost less than Jerry Jones paid. He has now invested more than $1 billion of his money in this company. That is a very strong statement about how he feels about the future of natural gas (particularly, the natural gas from this basin).
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