| 2023 | 2024 | ||||||
| Price: | 43.00 | EPS | 12.59 | 0 | |||
| Shares Out. (in M): | 10 | P/E | 3.4 | 0 | |||
| Market Cap (in $M): | 413 | P/FCF | 4 | 0 | |||
| Net Debt (in $M): | -118 | EBIT | 123 | 0 | |||
| TEV (in $M): | 295 | TEV/EBIT | 2.4 | 0 | |||
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Introduction: Unit has previously been written up by fizz808 and slim. The original writeup by fizz808 was very timely and successful. Of note, at the time of fizz808’s submission, Unit had an enterprise value of $282 million. Since the original submission, Unit has accomplished the following:
Even with these positive developments, the company’s current enterprise value is currently only $295 million (market cap of $413 million less $118 million in net cash post the special dividend), slightly above the value in the middle of 2021. We believe Unit continues to provide attractive upside and a considerable margin of safety to long-term investors.
Company Overview: Unit Corporation (“Unit”, “UNTC”, or the “Company”) is an oil and natural gas company operating in two segments: Oil and Natural Gas and Contract Drilling. The Oil and Natural Gas segment, operating as the Unit Petroleum Company, develops and produces oil and natural gas primarily in Oklahoma and Texas. The Contract Drilling segment, operating as Unit Drilling Company, owns and operates 18 drilling rigs including 14 super-spec BOSS rigs. Unit recently agreed to sell its 50% interest in Superior Pipeline, a midstream company focused on natural gas processing and transportation.
Investment Thesis:
Unit Petroleum Company (Oil and Natural Gas Segment): Unit Petroleum owns oil and natural gas producing assets in Oklahoma and Texas with additional properties in Arkansas, Kansas, and North Dakota. Unit Petroleum operates 1,345 net wells on over 200,000 acres of land and has total reserves of over 63 million barrels of oil equivalent (BOE). In 2022, Unit Petroleum produced 1.3 million barrels of oil, 2.1 million barrels of natural gas liquids, and 24.2 million Mcf of natural gas, generating $315 million in revenue and $124 million of adjusted EBITDA (inclusive of cash outflows from hedges). At the end of 2022, Unit Petroleum had a PV-10 value of $785 million, although this was calculated using above-market prices of $93.67/barrel oil and $6.36/Mcf natural gas.
Following Unit’s bankruptcy, Unit Petroleum enacted a series of price hedges for oil and natural gas through 2023. Unit added some additional natural gas hedges in late 2022 when natural gas prices were especially high. For 2023, Unit is currently hedged on 555,000 barrels of oil (approximately 50% of total production) at an average price of $48.87/barrel. Unit is also hedged on 10 million Mcf of natural gas (approximately 50% of total production) at an average price of $3.22/Mcf. Unit is currently unhedged on natural gas liquids with all of the current hedges rolling off by the end of 2023. We attribute much of Unit’s recent share price weakness to the sharp decline in natural gas prices, which have fallen from over $9.00/Mcf in Q3 2022 to around $2.25/Mcf today. Over half of Unit Petroleum’s production comes from natural gas, and the price decline negatively impacts the Company’s cash flow (excluding the current hedge book). In spite of the decline in natural gas prices, Unit Petroleum continues to be very profitable at current prices with the potential to increase profits and cash flows dramatically should natural gas prices increase.
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We forecast Unit Petroleum’s production to decline at an annualized rate of 11% with little incremental credit given for new wells or other workovers. For 2023, we expect Unit to produce 1.1 million barrels of oil, 1.9 million barrels of natural gas liquids, and 20.2 million Mcf of natural gas. We utilize an average oil price of $71.00/barrel, an average natural gas liquids price of $17.50/barrel, and an average natural gas price of $2.75/Mcf to generate total revenues of $165 million. We subtract total cash operating costs of $81 million ($12.80/Boe) and $5 million in cash hedging costs to generate $79 million in EBITDA. Assuming $20 million in capital expenditures results in $59 million in free cash flow.
In early 2022, Unit engaged Tudor, Pickering, Holt in a process to sell up to all of the oil and natural gas properties of Unit Petroleum. In June 2022, Unit ended its divestiture process after agreeing to sell its Gulf Coast oil and natural gas properties (approximately 16% of total production) for $56 million. While the termination of the sales process likely disappointed investors, we suspect that the decision was in the best interest for long-term investors. Energy prices were at historically high levels during this time period, and it was likely challenging for buyers and sellers to agree on a fair price. Unit Petroleum has continued to generate substantial free cash flow since the sales process concluded. Additionally, potential buyers should now be well aware of Unit Petroleum’s assets base, and we suspect that the assets remain for sale at the right price (once a seller, always a seller).
Unit Drilling Company (Contract Drilling Segment): Unit Drilling operates a fleet of 14 super-spec BOSS drilling rigs and 4 SCR diesel-electric drilling rigs. BOSS rigs originally cost over $20 million to manufacture and the company estimates that they would cost up to $35 million to manufacture today. At the end of 2022, Unit had all 14 BOSS rigs working as well as 3 SCR rigs. Ten of the company’s rigs were operating in the Permian Basin, four were in the Anadarko Basin, two in the Powder River Basin, and one in the Williston Basin. In 2022, Unit Drilling generated $148 million in revenue and $42 million in EBITDA. However, these results were generated with below-market day-rates on the company’s rigs.
The average spot day-rate for super-spec rigs increased from around $20,000/day in early 2022 to well over $35,000/day in early 2023. Unit Drilling’s average contract length is around 6 months, leading to a lag in the segment’s operating results versus spot levels, with Unit’s Q4 2022 average super-spec day rate averaging $28,385. We forecast Unit’s average day-rate to increase to $31,000/day in 2023 with Unit averaging 15.7 working rigs resulting in total revenues of $187 million. We forecast $103 million or $18,000/day in operating costs, resulting in 2023 Unit Drilling EBITDA of $83 million. We subtract $12 million of capital expenditures for forecasted free cash flow of $71 million.
The recent sharp decline in natural gas prices and moderate decline in oil prices has led to a reduction utilized drilling rigs, especially in natural gas basins. Helmerich and Payne (HP) and Patterson-UTI (PTEN), the two largest operators of North American land-based drilling rigs, recently stated that they have no intention of lowering day-rates as they focus on generating an appropriate return on their investment. Helmerich & Payne announced plans to lay-down approximately 10% of its North American drilling rig fleet rather than decrease price. While the recent reduction in rig count is concerning, the willingness of the largest players to maintain current prices is quite positive for Unit Drilling as the largest competitors choose not to compete on price.
Consolidated Results and Free Cash Flow: In addition to the Natural Gas and Contract Drilling segments, Unit also reports corporate expenses which were $24 million in 2022. We forecast corporate expenses to fall to $22 million in 2023 as the company reduces costs. On a consolidated basis in 2023, we forecast Unit to generate $139 million in EBITDA and $108 million in free cash flow. Unit has no interest expense and has $331 million of Federal NOLs to shield cash taxes. Unit is trading at 2.2x forward EBITDA and at a 25% free cash flow yield. Additionally, Unit’s free cash flow should be sufficient to sustain the Company’s current quarterly variable dividend of $2.50/share ($96 million in cash on an annual basis) even before dipping into the Company’s current cash balance of $118 million or the expected proceeds from the Superior Pipeline sale.
Sale of Superior Pipeline: In February 2023, Unit agreed to sell its 50% stake in Superior Pipeline for $20 million. Unit expects to receive $12 million at closing (expected in Q2 2023) and the remaining $8 million one year from closing. While the final amount is less than hoped for, the sale will supplement the company’s cash balance and can serve as an additional return of capital to shareholders.
CEO Change: In February 2023, Unit announced that CEO Phil Smith would be stepping down. Mr. Smith will continue to be active with the company and will retain his position as Chairman of the Board. Mr. Smith will be replaced on an interim basis by Phil Frohlich. Mr. Frohlich is the Managing Partner of Prescott Capital Management. Prescott Capital Management is Unit’s largest shareholder with a 37% stake in the company. We do not expect to see any major changes in the strategy or direction of the company, as Mr. Frohlich has been heavily involved in Unit’s operations since it emerged from bankruptcy. Our team met with Mr. Frohlich earlier this year and found him to intelligent, honest, and focused on shareholder returns. We understand that Unit Corporation is Prescott Capital Management’s largest individual position and believe Mr. Frohlich is highly incentivized to maximize value for shareholders.
Balance Sheet: Unit Corporation has a strong balance sheet with $118 million in cash ($214 million as of 12/31/2022 less $96 million that was paid in January 2023 as part of the $10.00/share special dividend). Unit also continues to own significant real assets including its producing oil and natural gas assets and 18 drilling rigs. We suspect that either the Company’s Oil and Natural Gas segment or Contract Drilling segment could be sold at or near the Company’s current enterprise value.
Capital Return: Since emerging from bankruptcy, Unit has generated significant free cash flow and has returned a large amount of capital to shareholders through share repurchases and dividends. Unit repurchased nearly 2.5 million shares (22% of outstanding stock) at an average price of $32.09/share, effectively returning almost $80 million to shareholders. Unit has also paid a $10.00/share special dividend ($96 million in cash) and has implemented a $2.50/share variable quarterly dividend (current yield of 23%). We expect Unit to continue to return most free cash flow to shareholders through its variable dividend while also utilizing share repurchases to reduce the Company’s share count when the stock price falls to levels the board finds attractive. We also expect the Company to return capital to shareholders when it receives proceeds from one-time asset sales (including the sale of Superior Pipeline).
Price Target: We value Unit utilizing a discounted cash flow model to derive a target enterprise value of $570 million. We add $118 million of cash and $20 million from the expected sale of Superior Pipeline to reach a target value of $710 million or $74.00/share, representing 72% upside from the current share price. The Company’s large cash balance of $118 million (29% of its market cap) as well as owned oil and natural gas operating properties and drilling rigs provide a significant margin of safety should our forecasts prove too optimistic.
Free cash flow generation. Return of cash to shareholders through special dividends, variable dividends, and share repurchases.
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