Description
Halcon is an aggressively growing oil E&P that trades at ridiculously low multiples (4x EBITDA 2014) even though it is well capitalized. The management team is largely composed of the old Petrohawk management team. The stock ran up after the reverse merger into RAM resources (which was renamed/recapitalized Halcon), trading over $13. Subsequently the stock went back to reality as the company had promise, but not a lot of assets and was largely pricing in the Floyd Wilson magic. The company has done two major acquisitions, lots of land leasing and several equity/debt financings to build 3 core resources plays in the Bakken, Utica and the Woodbine (TX).
We think the opportunity exists because management has done a reverse merger into a small company and has subsequently purged the existing assets, replacing them with resource plays all within a year. Investors are skeptical of all the “mathamagic” happening here. Our view is that with enough capital in hand and appropriate hedging, a huge increase in drilling will enable the accelerated production profile mgmt is targeting. With the ROIICs of oil shale drilling being quite robust, mgmt is correctly approaching the E&P business by trying dump as much capital into the system to get the shale machine rolling/growing. According to mgmt, they are approaching this company with the intention of accumulating a lot of oil acreage and developing it to a point where it is big enough to sell (supposedly within 2 years). In our opinion, discovering new resource plays is becoming less important vs just developing up the resources (as we can see the difference between Cabot vs Chesapeake).
At a high level the economics work as such: $2/mcfe to drill, $10/mcfe revs (60-70% oil), $4/mcfe rough costs (including interest and G&A) and the well produces 30% in the first year. So in year 1, you get 30% of the $6/mcfe you will make, or $1.80/mcfe of the $2/mcfe spent on drilling and you still have 70% of the well production remaining. As production grows, interest, SG&A and even some other operating costs are quite leverageable. This is especially true when taking on concentrated positions like COG and UPL did. HK is focused on 3 shale plays and has a few others that could maturate (last year they spent 75% on land and 25% on drilling, they will flip that this year). Additionally, with hedging, cash flows should be protected for reinvestment as HK anticipates hedging 80% of the next 18 months of production (HK is not trying to play commoidty prices, its all about production growth and reserve growth).
HK's capex this year will be $1.2Bn dedicated towards drilling and completions. With $800MM in expected 2013 EBITDA and $950MM of liquidity, HK will not have to raise equity this year, and subseqently with production/cash flows growing, the leverage ratios will stay under control (ie under 3x). Similar growth companies, like RRC, COG, CXO all trade at or above 6x EBITDA.
So the big risk is that the management team is a serial company developer/seller. But in that process, they sometimes go overboard buying too much land (more than they can chew). With the Petrohawk lesson of trying to buy all the “scarce” land as aggressively as possible, the company almost risked its ability to develop the land. Hopefully this has altered their views of trying to accumulate the most prime acres at any cost, and instead develop the acres they can get at a reasonable price. The company has telegraphed that they have enough acres in all 3 of their core plays, but it is also known that they are working on other resource plays.
The other big risk is the Utica and the Woodbine are not very well understood right now (Bakken has been derisked by the industry). Recently HK revealed an improved production type curve from the Woodbine. Additionally, they have 12 wells already on production with other operators around them reporting good results. This will get derisked this year as the company plans on spending $450MM this year on drilling wells. The Utica is still a little bit more in its infancy, especially where they are located in Northwest PA. RRC is drilling around their acreage and the acreage in OH has shown some real promise. We will see more wells this year, but HK plans to be more aggressive in this area next year as they plan on spending only $200MM this year in the area to understand the basin more.
If HK can successfully execute this program, it is not absurd to think that HK trades close to 6x EBITDA, or $12/share. NAV numbers in the mid teens are quite possible depending on one's commodity prices (we get $16+ at $85 oil and $3.50 gas).
I do not hold a position of employment, directorship, or consultancy with the issuer.
I and/or others I advise hold a material investment in the issuer's securities.
Catalyst
Executing their 2013 guidance
Selling the company
Utica and Woodbine results confirming the resource plays