Description

I am recommending a long position in Energy Partners (EPL), a post bankruptcy reorg trading at slightly more than 1x normalized cash flow.   I believe that the current valuation will not last for long as investors begin to discover this special situation.   Additionally, it seems as if there was some forced selling by debt holders that were converted to common during the reorg over the past several weeks that has begun to dissipate. 

 Bankruptcy background:

EPL entered bankruptcy on May 1, 2009 as a result of three occurrences:

• Hurricanes in August and September 20008 caused a shut-in of a large amount of the company's production thru early 2009
• The rapid decline of energy prices
• The credit crisis reduced the flexibility of the company's creditors

 As a result of these three circumstances the company's credit facility was reduced from $150M to $45M and the company was not able to pay money owed on its revolver nor interest payments on 9.75% 2014 fixed or 2013 floating notes and EPL was forced in Chapter 11. 

 Reorg background:

The reorganization was fairly quick and smooth.  On July 23^rd the company received confirmation on its plan of reorganization and on September 21^st the company emerged from Chapter 11.  The details of the recap were as follows:

• $473M of outstanding debt and accrued interest exchanged for 95% of the new equity
• Old equity received 5% of new equity
• 40M new shares were issued
• Exit capital was provided by GE and current noteholders

 Farralon owns 10%+ of the current equity, most likely they were debt holders during bankruptcy.

 Company Description:

EPL is an oil and gas drilling company whose assets are located in the Gulf of Mexico.  The company's assets are split approximately 60% oil and 40% natural gas.  The company has 24 producing fields that are located in what the company refers to as:

• Eastern offshore - East Bay field
• Central offshore - four producing fields near the Bay Marchand salt dome
• Deepwater Gulf - 22 offshore blocks
• Western offshore - 15 producing fields from offshore central and western Lousiana to Texas
• Gulf Coast onshore and other - mostly south Louisiana and Texas

The eastern (21% of production and 37% of proved reserves in 2008) and central (46% of production and 43% of proved reserves in 2008) areas represent the core of the company's assets and focus.   The company has proved reserves of 37MMBoe, which is down from a peak of 59MMBoe in 2005.   83% of the reserves are developed but approximately 70% are PNP and PUD.

 Valuation:

For the past 10 years the company has only had one year in which operating cash flow was negative.  During the past four years the company has averaged more than $250M in operating cash flow.  However, historically most of the company's cash flow has been spent on exploration capex.  This has been a bad strategy for the company.  Post reorg, the management team is significantly cutting back on capex.  In fact, EPL will spend only $10M in capex during 2009 vs. $200M in 2008, $324M in 2007 and $342M in 2006.  Although the $10M level is not sustainable going forward, the new strategy is to only spend additional dollars on developing current PNP or PUD wells and not on any additional exploration (approximately 50% of the wells are PNP and 20% are PUD).  As with a lot of E&P companies, earnings for the most part have been negative due to depreciation, depletion and amortization.   The company was able to ramp production back to pre-hurricane 2008 levels earlier this year and will average approximately 14k - 15k Boe per day during 2009 (5Mmboe total in 2009) vs. 13.1k during 2008 

$355M mkt cap (40M shares x $8.87)

$100M debt

$50M cash

= $405M EV

The PV-10 using $70 oil and $6.40 natural gas is approximately $1B.   The PV-10 using $45 oil and $6.05 natural gas is $425M.  The company is trading for less than 1.5x  price / normalized cash flow.  I would not argue that the company has the greatest asset base but as you can see the margin of safety is rather big here.  If the company can continue to generate $250M+ in cash flow with its current assets, the return to equity holders would be substantial.   Personally, I think the stock has the opportunity to double or triple from here and you get a free call option if commodity prices move higher once we get through the economic malaise. 

Risks:

The general risks here are similar to many other e&p companies:

• Variability in commodity prices
• Hurricanes in the gulf

More company specific risks include:

• Inability to get more out of their current assets
• Company has $180M in undiscounted asset retirement obligation (PV of $95M)

Catalysts:

• Valuation
• Special situation that is currently undiscovered, not followed by sell side
• Easing of selling by debt holders that were converted to equity during the reorg

Catalyst