- Excellent asset base that is misunderstood for a variety of reasons.
- Best balance sheet in the industry.
- Hidden opportunity to be a clean air solution for California.
- Stock is a potential double.
California Resources (NYSE:CRC) is an energy company based in...you guessed it, California. It operates oil and gas wells with 60% oil, 27% natural gas, 13% NGL's (no shale, no fracking) with all of its production in California, which believe it or not, is a major strategic advantage. It also owns storage assets and natural gas fired power generation. Lastly, it is one of the largest landowners in the state with associated mineral rights with vast tracks in the Sacramento Basin, the San Joaquin Basin in the Central Valley, the Ventura Basin and Los Angeles Basin. These landholdings have hidden value I will discuss below.
CRC Production Map
While the company has good assets, it was overleveraged for years. 2020's oil fiasco pushed the company into bankruptcy, from which it emerged in January of 2021 with a clean balance sheet, a new management team, and a new board of directors.
The Investment Thesis:
CRC was spun out of Occidental Petroleum (OXY) in 2012, which saddled the company with too much debt at the spin. It has low risk, low decline conventional oil and gas wells. They know where to drill to find oil and gas, and productivity of their wells declines at 15% annual rates vs. shale peers whose wells decline 35-40% annually. In layman's terms, CRC's wells pump oil and gas for a lot longer than those of most shale companies. Because of this productivity (and the reduction in debt since bankruptcy), CRC's breakeven production price is ~$31/boe, whereas most E&P (exploration and production) companies need at least $45/barrel.
Source Q2 company presentation
The company owns and operates all of its midstream assets (pipelines), has 565MMcf/day of gas processing facilities, and also owns and operates a 550MW power plant of whose power it sells a large portion to the grid.
Carbon Sequestration Assets
You might not have heard much of carbon sequestration yet, but you will. Carbon sequestration is basically the removal of carbon from the air. Trees do it naturally. Carbon sequestration as a business involves capturing carbon at its release point (say a power plant) and pumping underground.
Carbon Sequestration Illustration
Source Environmental Defense Fund
As you can see in the picture above, you need deep underground caverns for this process. These caverns also need to be of "heavy cap rock" meaning dense rock that doesn't let the CO2 escape. CRC's San Joaquin basin assets have heavy cap rock and 1,000 MMT of Co2 storage capacity.
CRC Potential Carbon Sequestration Sites
Source Q2 company presentation
This carbon sequestration could be one of the most environmentally friendly assets and services in California. The company also has identified 5,000 acres as suitable for solar farms.
Source Q2 company presentation
The California Advantage?
While many people might assume California is THE WORST place in the country to operate an oil and gas business given the political pressures and environmental regulation, its geography actually makes it one of the best despite those negatives. California has the fifth-largest crude oil reserves in the US and is the seventh-largest crude oil producer at 4% of total US production. However, while there is a tremendous movement to rid the state of internal combustion cars, California is still the second-largest consumer of petroleum products in the country accounting for 10% of total US consumption and is the largest U.S. consumer of motor gasoline and jet fuel. 4% of the nation's oil production is not enough to feed this thirst.
While there are pipelines supplying natural gas to the state, there are no oil pipelines going into moving oil into California. Therefore, California refiners import 60-70% of oil from shipped sources (including 50% OPEC/Saudi). The rest comes from California producers like CRC. Because of this dynamic, CRC sells its oil at the premium (usually $3-4/barrel) associated with Brent Crude, not WTI (West Texas Intermediate).
CRC also meets and even exceeds California's stringent operating requirements. They do no fracking, no flaring, are clean water positive (actually produce of freshwater from their wells) and operate all of their rigs/machinery with low carbon power (solar/wind/nat gas). The company also has two directors on its new board with an ESG focus, one of whom is considered a climate activist.
Great Balance Sheet
CRC entered bankruptcy with over $5 billion of debt. As I said, OXY saddled the company with too much debt upon spinning it off. CRC emerged from its quick trip in bankruptcy with around $475 million of net debt. This debt number is serviced by over $750 million of base-level EBITDA projected for 2021. Given the company has no great need to spend on exploration and production, we think that company will generate close to the upper end of the $400-$500 million of free cash it guided for 2021, money it can return to shareholders.
Put these factors all together and I think CRC has irreplaceable, defensive assets that hold a tremendous amount of optionality. An attractive valuation, which I outline below, therefore makes this company a very compelling investment.
Even using much lower energy prices than current spot levels, I still get CRC to around $700mm of EBITDA and $450mm of free cash.
Source Q2 company presentation
There's little in the way of interest expense, taxes, or capital expenditures. Therefore I see current valuation as:
|Market Cap @ $42/share||$3.440 billion|
|Minority Interest||$22 million|
|Enterprise Value||$3.940 billion|
|EV/EBITDA '21 (using $750 EBITDA)||5.25x|
|FCF Yield '21 (using $450 million)||13%|
|P/E '21 (using $5 eps)||8.4x|
These valuations compare quite favorable to other exploration and production companies, especially the free cash flow yield in concert with such a low-leveraged balance sheet. EQT Corp (EQT) is another energy company I've written about that has somewhat similar metrics albeit slightly higher leverage (but it didn't go through bankruptcy).
As one can see, the company is relatively low multiple on almost any metric. Moreover, the valuation above assumes ZERO VALUE for the carbon capture and sequestration and solar opportunities. They are essentially free options.
The company will be hosting an ESG day on Oct 6th. The biggest ESG initiatives the company has are the solar and carbon capture and sequestration opportunities. I believe we might get some concrete information on that day that will help the market figure out valuation and timing for realization of these ESG assets.
The company has a $250 million buyback program in place, about 7% of the float. I expect there to be some kind of dividend program given such low leverage and such prodigious cash flows. I believe a dividend can be a catalyst for moving the stock higher.
While there have been some pretty crazy pieces of legislation such as banning all oil and gas production in the state proposed by climate radicals in the legislature. For example, there has been a proposal to ban on new steam flood permits (which involves pressure pumping steam into wells to increase oil production). CRC does very little steam pumping so it's not a major risk to the company, but an investor should be aware of it. Fortunately, most proposals have never made it past the first round of debate in the state legislative house. There are enough realists who understand the only other option is importing Saudi oil at higher cost and brought on ships that are pollutive themselves.
Since CRC is an energy company, obviously it's also exposed to the prices of oil, natural gas and NGL's. I've laid out in a few pieces why I'm bullish energy prices for at least the near term. But anything can happen with energy prices, particularly oil.
Lastly, big blocks of stock are tightly held by some large institutions who converted bonds into stock during bankruptcy. They have been exiting positions, which maybe have been keeping a lid on the stock. I don't think the selling says anything about the company's prospects. It's not unusual for distressed investors to sell after a company emerges from bankruptcy.
CRC Top 5 Shareholders
It's uncommon to find an energy company with such low leverage, low production costs, and plentiful reserves in a relatively captive market. Most companies in the industry face the opposite dynamics. To find one where there are also significant assets to which the market apparently ascribes little value is rarer still. I like CRC as is as a standalone company with 15% return potential just from the company returning free cash to shareholders. On top of that, I believe the company might give some very good information about its plans for carbon sequestration and solar farms at its investor day on October 6th, which could clarify the potential value of those assets, which could equal the value of the oil and gas assets.
This article was written by
Analyst’s Disclosure: I/we have a beneficial long position in the shares of CRC either through stock ownership, options, or other derivatives. 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.
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