Earthstone Energy: Reviewing The IRM Acquisition And Its 2021 Guidance
Summary
- Earthstone Energy appears to have gotten a good deal with its IRM acquisition, especially given the subsequent improvement in oil prices.
- It appears to have added/acquired a substantial amount of additional hedges for 2021. At strip prices, its hedges may have around $50 million in negative value.
- This will reduce Earthstone's ability to pay down its debt in 2021, although its leverage should still be at a reasonable level.
- Earthstone's production is expected to temporarily decline from pro forma Q4 2020 levels and its stock appears fairly expensive based on 2021 production levels.
- Earthstone appears more fairly priced based on reserve values.
- Looking for more investing ideas like this one? Get them exclusively at Distressed Value Investing. Learn More »
Earthstone Energy's (NYSE:ESTE) may be able to deliver over $60 million in positive cash flow in 2021, although its average production during the year is expected to be below Q4 2020 levels (pro forma for the IRM acquisition). Earthstone's cash flow is negatively affected by its hedges.
At over $8 per share, Earthstone's shares look fairly expensive based on its 2021 production levels, although it appears more reasonably priced based on Earthstone's reserve value.
Midland Basin Acquisition
Earthstone acquired Independence Resources Management for approximately $182 million in cash and stock. This includes $131.2 million in cash (mostly funded by its credit facility) and 12.7 million Class A shares that were worth approximately $50.7 million at the time. This increases Earthstone's share count to approximately 77.9 million (42.9 million Class A shares and 35.0 million Class B shares).
Source: Earthstone Energy
The deal closed in January 2021 and also resulted in Earthstone's credit facility borrowing base increasing from $240 million to $360 million. The acquisition price looks pretty good given that IRM's proved reserves have a PV-10 of $304 million at $50 WTI oil and $2.50 natural gas, and the long-term oil strip is now consistently above that.
Source: Earthstone Energy
The acquisition also adds 70 gross locations (over 4,900 core net acres) with an estimated IRR of 45% at end of November strip prices (roughly $46 WTI oil). Earthstone also acquired 38,500 additional net acres (mostly in Irion, Tom Green and Sterling Counties), but those areas are considered fringe acreage that is not competitive for capital with Earthstone's legacy acreage or the core IRM acreage.
Source: Earthstone Energy
2021 Outlook At Strip Prices
Earthstone now expects to average approximately 20,250 BOEPD during 2021 (guidance range of 19,500 BOEPD to 21,000 BOEPD) with 53% of that production being oil.
This is with a $95 million capital expenditure budget, which doesn't appear to quite be a maintenance capex level budget. Earthstone and IRM's combined Q4 2020 production was 22,550 BOEPD (approximately 52% oil), so it expects to average around 10% lower production in 2021 with that $95 million capex budget.
With 20,250 BOEPD in average production, Earthstone would be able to generate $249 million in revenues including hedges at current strip prices of low-$60s WTI oil. At the end of Q3 2020, Earthstone had 1.46 million barrels of oil swaps in 2021 at $55.16 per barrel.
Source: Earthstone Energy
It seems to have added another 1.87 million barrels in 2021 oil swaps at $43.40 per barrel since then (perhaps from its acquisition), resulting in its hedges having negative $50 million in value at current strip prices now.
| Type | Units | $/Unit | $ Million |
| Oil (Barrels) | 3,917,363 | $62.00 | $243 |
| NGLs (Barrels) | 1,847,812 | $19.00 | $35 |
| Natural Gas [MCF] | 9,756,450 | $2.20 | $21 |
| Hedge Value | -$50 | ||
| Total Revenue | $249 |
With a $95 million capex budget, Earthstone is projected to end up with $186 million in cash expenditures in 2021. This would result in it delivering $63 million in positive cash flow in 2021.
| Expenses | $ Million |
| Lease Operating And Workover | $46 |
| Production Taxes | $20 |
| Cash G&A | $20 |
| Cash Interest | $5 |
| CapEx | $95 |
| Total Expenses | $186 |
Effect On Debt
Pro forma for its acquisition, Earthstone had $245 million in net debt at the end of 2020.
Source: Earthstone Energy
The $63 million in projected positive cash flow would help reduce its net debt to $182 million. This would be a reasonable 1.1x its projected 2021 EBITDAX (including the effect of its hedges). Without hedges and with $50 WTI oil instead, its year-end 2021 net debt would be around 1.2x EBITDAX instead, so its debt situation looks fairly comfortable.
Valuation
Earthstone's valuation appears fairly expensive now based on 2021 production levels. At $8.18 per share, its enterprise value would be around $819 million with $182 million in net debt. I've previously used a 3.5x EBITDAX multiple for it when calculating that it looked undervalued with long-term $45/$50 oil. Earthstone is now trading at 4.2x EBITDAX based on 2021 production levels and $60 WTI long-term oil. One can argue that the improved commodity pricing environment should lead to higher multiples due to the effect it has on increasing the amount of economic inventory. Still, a 4.2x EBITDAX multiple with $60 WTI long-term oil is on the expensive side.
Earthstone's valuation looks better when looking at reserve value rather than near-term production levels. It is valued at 0.8x PV-10 based on its proved reserves at $50 WTI oil or 1.25x PV-10 based on its proved developed reserves at $50 WTI oil.
Source: Earthstone Energy
Conclusion
Earthstone Energy's acquisition of IRM appears to have been well timed, as it looked to be a good deal with $50 WTI oil and near-term oil prices have improved considerably since then.
Earthstone has a much larger 2021 oil hedge position now, and the average swap price has been reduced to around $48, so its hedges may have around negative $50 million in value in 2021. This slows Earthstone's ability to pay down its debt in 2021, although its leverage appears reasonable.
Earthstone's stock (at over $8) looks fairly expensive based on 2021 production levels, but is at a reasonable price for its reserve value. I am neutral on Earthstone at its current share price and would look for a better entry point for its stock.
Free Trial Offer
We are currently offering a free two-week trial to Distressed Value Investing. Join our community to receive exclusive research about various energy companies and other opportunities along with full access to my portfolio of historic research that now includes over 1,000 reports on over 100 companies.
This article was written by
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.
Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.
Recommended For You
Comments (6)
