Description

I am recommending a long position in Civitas Resources.  The company currently trades for ~3.5x EV/2022e EBITDA; each additional 1x turn of EBITDA adds ~$20 per share.  Current base dividend implies 3.2% dividend yield with upside of additional shareholder returns; targeting 50% of free cash flow after paying base dividend.  Clean balance sheet with platform to acquire attractive adjacent assets, realize synergies, rinse/repeat.

The company is underfollowed with limited financial information given its recent formation and management delaying the release of their 2021 10-K.  As the financials become clearer and coverage increases I expect the stock will respond and could appreciate 50%+ by year end with an attractive dividend while you wait.

This idea depends on one’s view of energy, oil, natural gas, etc.  My personal view of where oil prices are headed isn’t worth anything.  My 30,000 foot view is US E&P companies caught a dose of religion and are showing more interest in running their companies for shareholders.  The move to renewables will likely take longer than many hope while our energy needs continue unabated.  I am not expecting a significant increase in trading multiples, but as Civitas executes on its stated plan investors could be more willing to pay for future performance.   

Background
Civitas is the rebranded entity resulting from the combination of four companies with operations and land holdings in the Denver-Julesburg (DJ) Basin.  It is now the largest operator in the area:

The architect behind the creation of Civitas is Kimmeridge, a private equity firm founded in 2012.  Ben Dell, managing partner of Kimmeridge, is the current Chairman and interim CEO (as of February 1) of Civitas.  The company announced the CEO transition at the same time they announced the acquisition of Bison Oil & Gas for 1.7x 2022e EBITDA.  Prior to Kimmeridge, Dell was a Senior Research Analyst for Oil & Gas Exploration at Sanford C. Bernstein.  Prior to Bernstein he was in the M&A and finance group at British Petroleum (BP) and also held positions as an exploration geologist and geophysicist across various BP business units.

Dell became Chairman of Extraction Oil & Gas (XOG) in January 2021 when Kimmeridge became its largest shareholder (38%) after its emergence from bankruptcy.  The subsequent mergers and acquisitions are highlighted in the above slide from Civitas’ most recent investor presentation.  The Dell and Kimmeridge view is that unconventional energy companies have been run as growth companies by their management teams; overpay executives and reward growth.  Dell pushes for cutting executive pay, manage businesses for investors on a total return basis and for the environment.  I believe this is the first time Kimmeridge has been the architect of a public company roll-up.

Key statistics:

YTD Production (thru 9/30/21) ~169 MBoe/d

Annualized EBITDAX ~$1,600 mm

Net Debt $587 mm

Net DJ Basin acres ~525,000

Gross locations ~1,300

*The above is adjusted for the recent Bison Oil & Gas acquisition.

Production thru 9/30/21:

Oil 40%
Gas 35%
NGL 25%

For those unfamiliar with energy terminology, Boe is Barrel of Oil Equivalent; it is a statistic calculated to standardize energy content between oil, natural gas and natural gas liquids.  Barrels of oil + (Gas (MMcf) divided by 6) + Barrels of natural gas liquids.  

Acreage

The DJ Basin is located in eastern Colorado (under the Denver-Aurora Metropolitan area), extending into southeast Wyoming, western Nebraska and western Kansas.  Civitas’ acreage is roughly evenly split between the Northern, Eastern, Southern and Western development areas.

Plan and Rough Financials

Civitas plans to keep 2022 production flat with 2021 production by investing ~50% of EBITDAX.  After incorporating the Bison Oil & Gas acquisition this equates to ~169,000 Boe.  In their December presentation the company estimated ~$26 per Boe of EBITDAX assuming $65 WTI and $3.50 Henry Hub gas prices; this equates to ~$1,600 mm in EBITDAX.  Using EBITDAX to approximate Free Cash Flow, that leaves $800 mm to pay the base dividend of $160 mm.  Management has stated their plan to return 50% of the remaining cash flow to shareholders.  Assuming it is paid out in a dividend implies $3.65 in a special dividend; equating to a full year dividend yield of 9.5%.  This would leave ~$320 mm of excess cash.  Pay down debt?  Re-invest in adjacent resources?  Increased shareholder return?  Who knows but it is good to know my interests as a shareholder are directly aligned with the person/entity currently pulling the strings.  As you can see, I am using $65 WTI.  Maybe conservative, maybe aggressive.

The company is scheduled to report earnings this week and we should have more information/detail on the combined financial performance and expectations for 2022.  Could be risky to post prior to the quarter but I’ll take the risk.  I realize the financials discussion is a little lacking.  I plan to update when more information becomes available.

Production growth at all costs with free flowing capital markets was good for energy consumers and, ultimately, bad for shareholders.  The tide has turned and investors are benefiting at the expense of consumers.  The asset valuation model of E&P companies where you model well economics and multiply by the number of prospective well locations to arrive at a value appears to be dead or at least dying.   Will management teams stick to their plans and not increase production beyond cash flow is an outstanding question.  It will understandably take time for investors to fully embrace.  No doubt there will be volatility along the way.

Ownership & Management

Canada Pension is Civitas’ largest shareholder owning ~25%; the Plan was the largest shareholder of Crestone Peak which as you can see in the above slide was one of the four combined entities.  Kimmeridge is the second largest shareholder with a 13% ownership.  Moving beyond the top 2 shareholders there isn’t much to note.  There is risk that the Canada Pension Plan is a seller.  Time will tell.

Beyond Ben Dell, the executive team is former Extraction Oil & Gas and Bonanza Creek leadership.  Eric Graeger, the recently replaced CEO, was previously the CEO of Bonanza Creek.  Civitas is currently searching for a permanent CEO.

Valuation

The million dollar question.  Assuming no multiple expansion and flat production a shareholder should receive close to a 10% total annual return.  Not too bad in today’s environment.  What will shareholders pay for Civitas’ strategy?  Maybe 4x?  Again, anyone’s guess.  At these levels I am willing to take the risk.  What is the major risk?  Most obviously oil and natural gas prices.  Maybe the fact that I am writing this up means we are at a top.  Could be, but again a risk I am willing to take.  Civitas also owns midstream assets with a book value of $300 mm.  Not terribly relevant to the investment case but thought I would mention.

Conclusion
I believe in oil, natural gas and natural gas liquids.  Civitas is trading at an attractive valuation with a Chairman/significant shareholder aligned with my interests.  The company has the balance sheet and cash generation to continue to scale and further lower operating costs.  I am paid an attractive dividend while I wait.  Kimmeridge is a private equity investor so there is also potential for an attractive exit.

Catalyst

Execution