Description

Quick Summary: Unit Corp. (“UNTC” or “Unit”) is a post-reorganization E&P company that also owns drilling rigs, excess real estate, NOL assets, and out-of-the-money “equity” on a gathering and processing business. UNTC is one of the few 2020 E&P bankruptcies that emerged with the unsecured as the main equity holder, whereas in most other recent E&P bankruptcies first or second lien bank loan holders took control. At current commodity strip prices, the post-reorg equity is worth ~$28 / share. What makes this investment even more attractive is that UNTC has significantly hedged reserves and a short reserve life (~5 years), which should translate into lower commodity price risk relative to other E&Ps. This means even at $30 / barrel WTI and $2 / mmbtu Henry Hub (compared to current spot of $70 and $3.50), UNTC is still worth ~$12 / share.

Investment Ideas:

Commodity Hedges: UNTC has hedged ~60-80% of its production for the next 3 years at prices significantly above its breakeven price. This leaves them with ample margin for spot prices to decline and provides us with a floor value that is only ~38% lower than the current stock price.

Recently Constructed BOSS Rigs: UNTC owns 14 BOSS rigs that cost ~$20 million to build per rig (~3-4 years average age). Before the 2020 downturn the number of active rigs fell by 60%, these rigs were fetching $5-10mm. They have written down these rigs to $64mm as part of fresh-start accounting on the emergence date (early Sept 2020).

Temporary NGL Takeaway Bottleneck: UNTC has been selling its NGL at ~15-25% of WTI, while historically they have netted much closer to 30-35%. The rapid shut-in in Q2 2020 and lack of pipeline capacity to transport the NGL last year caused the netback to plummet. It has since recovered to high 20s as shortages in pipeline capacity seemed to be abating and propane demand has recovered close to pre-covid level. However, UNTC’s NGL realization still is not back to historical levels. My valuation assumes NGL stays depressed, but if the realization improves it could add ~$4 / share to the NAV ($1.25 / share of FCF).

Better Corporate Governance & Capital Allocation: As part of the bankruptcy, almost all the c-suite has been replaced and the new CEO and COO seem better than the prior team. They are evaluating more cost cutting, are more financially disciplined, and do not seem concerned with declining volumes to the extent they cannot drill wells at attractive IRRs. In addition, the subordinated ad hoc bond group appointed 5 out of the 7 board members, with Prescott one of the plan steering committee members sitting on the board. In June, the company successfully negotiated with the pre-petition 1L lenders to repurchase the shares (5% of outstanding or 600,000 shares) those lenders received as part of the bankruptcy refinancing cost, at $15 / share.

Cost Saving Opportunity: The company plans on divesting one-off uneconomic wells to neighboring property owners. After years of unchecked spending acquiring acreage and non-working interest wells, today UNTC has ~6,000 excess wells, which require ~100 admin and direct employees plus to maintain despite its low volumetric and EBITDA contribution.  Selling these wells to adjacent property owners or the main working interest owner would further reduce UNTC headcount by 15% and could crystalize ~$50-60mm of the reserve value.

Additional / Other Smaller Sources of Upside:

o Development & Drilling Upside: the company has significantly written off its E&P book and I am only valuing it based on their currently producing assets, without giving credit for any future developments.

o    Corporate G&A / Liquidation: UNTC’s corporate G&A is running at ~$24mm annually. If the company is broken apart and liquidated, a significant portion of this could go away. That said, they have reduced their G&A from ~$40mm pre bankruptcy to the current level. As a sanity check, Evercore’s bankruptcy liquidation valuation, which used gas and oil prices roughly at the company’s hedge strike prices and assumed minimal G&A burden, valued stock at ~$16 / share.

o    Midstream JV Option Value: UNTC owns a 50% “subordinated” stake in Superior Drilling. Their financial JV partner will receive all the distributions from the JV until UNTC has fulfilled its ~$120mm drilling commitment in the JV’s dedicated acreage. However, UNTC does not foresee that it will meet that commitment unless gas prices stay meaningfully higher after their gas hedges expire. In 2018, when gas was at ~$3 / mmbtu, UNTC sold 50% of its stake in Superior for $300mm. Even after adjusting for the drilling commitment, this could still translate to an extra ~$15 / share.

Valuation: In the low case, I value UNTC at an adjusted PV-10 assuming all time low netbacks (high differentials) for NGL, and $2 / mmbtu for gas and $30 / barrel for oil. While in the base and high case, I assume strip and spot prices, respectively. I value contract drilling at a combination of estimated scrap / sale value and multiple of current EBITDA. For midstream I assume minimal net value because of a large remaining drilling commitment (non-recourse but prevents UNTC from receiving any distribution proceeds from the midstream JV). I have not included in my valuation ~$15 / share in Superior JV value (out-of-the money option), ~$4-5 / share from additional savings in G&A or breaking up the company, and ~$4 / share from improvement in NGL differentials. 

Risks:

·         Continued Industry Weakness (oil and gas price, and NGL netback)

·         High-Cost Basin: UNTC E&P assets are primarily located in lower quality areas with higher breakeven and higher decline rate relative to average US onshore assets.

·         Record Level DUCs Inventory: US onshore is awash with DUCs (drilled uncomplete wells). This gives many cash-strapped players little incentive to drill more wells. Consequently, this has led to the stacking of many rigs, including UNTC rigs. Most of its active rigs are still contracted under contracts signed before the industry downturn. As their average contract is only ~2 years, a prolonged low drilling activity would hurt their drilling cash flow.

Catalyst

- Divestitures of excess wells and reduction in G&A

- Monetization of other excess assets: excess headquarter space, older SCR rigs, among others

- Further normalization in NGL netbacks

- Uplisting to a major stock exchange