Description

Executive Summary:

LPI’s balance sheet is heavily levered, historically lacks FCF, its debt yields >9%, and the Company pivoted its asset base starting in 2019.

Marginal assets in a supply constrained environment can be attractive investment assuming the constraints in the industry persist for longer than the market expects (and demand holds). After retracing its run up from late May and June, LPI provides portfolio managers high beta exposure to higher for longer oil prices.

While LPI is significantly hedged for 2022 (~81% hedged on oil), 2023 is relatively unhedged (~27% hedged on oil) providing upside exposure to oil prices. At the beginning of June LPI provided guidance (at 5/31/2022 commodity prices) for free cash flow over the next two years of ~$900 million. The Company intends to use this cash flow to pay down $700 million in debt (with an average cost of ~9.5%) and $200 million in share repurchases. LPI’s current enterprise value is $2.5 billion (~40% two year FCF yield).

LPI will de-lever its balance sheet over the next two years, begin returning capital to shareholders via repurchases, and maintain its current production. If these events playout LPI should see its valuation move in line with peers.

What We Expect:

• Oil prices remain above >$80 for the next two years
  • Geopolitical risk premium is likely to persist
  • If oil prices collapse LPI is in trouble
• Debt paydown to derisk the balance sheet
  • Optionality in the future to refinance the debt at a lower cost
  • ~$940 million of LPI’s bonds are callable in January 2022
• Capital return to shareholders to start in 2023 via share repurchases

Notes

E&P companies love fancy investor presentations. LPI is no different. Here is a link to the latest deck from June.

The issues the deck attempts to address:

• LPI new asset base
  
  • Major transactions
    • 10/18/2021 – Pioneer Acquisition closed. Total consideration $206.3 million comprised of $131.6 million in cash and $70.9 million in equity (959,691 shares). The difference of $3.8 million is attributable to transaction costs and post closing adjustments.
    • 7/1/2021 – Sabalo/Shad Acquisition closed. Total consideration $863.1 million comprised of $606.1 million in cash and $240 million in equity (2,506,964 shares). The difference of 17 million is attributable to transaction costs and post closing adjustments.
    • 7/1/2021 – Sold a 37.5% Working Interest to Sixth Street Partners for $405 million upfront with a possible $93.7 million in contingent consideration based on cash flow targets (largely driven by commodity prices). The proceeds were used to fund the Sabalo/Shad acquisitions.
  • The old asset base was in bad shape as it was no longer economic. A common risk for E&P and highlights the importance of inventory runway. As a result the company began acquiring and testing acreage in Howard starting in 2019-2020 before making a big acquisition in 2021 to complete the pivot. These transitions are not uncommon in E&P land but they can be risky. LPI, like many of its brethren, greatly benefited from higher commodity prices in its transformation.
• Lack of inventory
  • Management does play a shell game with shareholders through its definition of free cash flow. LPI’s free cash flow guidance does not include “non-budgeted acquisitions costs”. See the section above about LPI’s transactions. As a result, there is a risk that management will dilute shareholders with equity funded acquisitions by acquiring goat pasture or overpaying for reserves in place.
    • This is why the recent share repurchase announcement is a massive positive signal to the market that the Company is taking steps to return capital to shareholders rather than empire build. It’s an important departure from the shale era capital allocation of the 2010’s. We can all hold our breathe until the first shares are repurchased but it’s a positive indication.
  • If the bid/ask spread in the A&D (acquisitions and divestitures) market tightens we would expect LPI to pursue additional acreage acquisitions to grow its inventory runway.
• Oil price sensitivity
  • Oil mix ~49% of 2022 MBOE/d
  • 81% of Q2-Q4 2022 oil production is hedged @ weighted average floor ~$62. There is some upside here as LPI uses collars for some of their hedges.
  • ~27% of 2023 oil is hedged with collars between $66 and $81
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  • Henry Hub prices are extremely volatile and have materially moved since this deck was put together at the end of May.
• Balance Sheet
• January 2025 Notes are likely to be called in January with excess cash on hand and a draw from the company’s revolver (current cost is 3%). In one year, LPI’s leverage ratio will be closer to 0.75x EBITDA than the current 1.9x. However, these projections are all determined by commodity prices. Just another reminder that the underlying bet here is higher oil prices for longer.
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Valuation

LPI currently trades for 2.0x 2023 EBITDA.

Lets look at MGY as a comp

• It’s a former SPAC
• Assets aren’t great
• Balance sheet is near net debt zero (cash offsetting the outstanding debt)
• Returning capital via a base dividend and share repurchase
• MGY does not hedge

This is where I believe LPI is heading (LPI may hedge more than MGY in the future but with less debt it will be less important).  MGY trades for 3.5x 2023 EBITDA. If LPI de-levers and follows through on its capital return promises it should trade for a similar multiple. A 3.5x EBITDA LPI shares would trade at ~$180 share price (not including the benefit of paying down debt).

Risks:

• Recession
• European demand blows up
  • To quote Stephen from Braveheart, “The Almighty tells me he can get me out of this mess, but he's pretty sure you're f***ed”
• Offsetting Europe is a stimulating China and a resilient US (which also needs to fill its SPR)
  • USD strength destroys energy demand in energy importing emerging markets
  • On a relative basis a strengthening USD is a double wammy for emerging markets. This is the primary mechanism in which the Federal Reserve can impact energy demand.
• General E&P risks
• Supply chains for E&P’s unclog and Texans do what Texans do > Subsidize the world’s energy needs with Wall Street’s capital.

DISCLAIMER: This does not constitute a recommendation to buy or sell this stock. We have a position in this company, and we may buy shares or sell shares at any time.

Catalyst

Balance Sheet and Capital Return