Oil & gas E&Ps are a mess right now. Sentiment is terrible in both the equity and high yield markets. There is concern about oversupply, lower demand and capital allocation, among other things. Many others have pitched oil & gas equities on VIC. This write-up is different because the focus is on bonds yielding 8%-12%. In my view, current bond "creation" multiples provide a good margin of safety for an equity-like return. These multiples look cheap compared to both historical trading levels and private market valuations.
What are the catalysts? Well, you get a big dividend payment (i.e. coupon) and maybe sentiment will improve after the JP Morgan conference (today and tomorrow) where we will hear about how cheap every company’s stock trades and how many will cut back on drilling below $50/bbl oil. Additionally, I believe some companies (GPOR / CNX) will halt (or at least limit) buybacks in favor of debt reduction and balance sheet improvement. Hopefully, these management teams see the writing on the wall – equity valuations are being constrained by debt levels.
From a bond perspective, I like the names with public equity and production of 50,000 bbls/d or more. A publicly-traded equity results in better disclosure and provides a company with more optionality in the form of share issuances to raise cash or for de-levering asset purchases, or even debt exchanges. From a seniority perspective, each of these companies have limited secured debt ahead of the bonds. Since I’m presenting five companies here, the summaries will be short. The companies are Whiting (WLL), Gulfport (GPOR), CNX Resources (CNX), Chesapeake (CHK) and Unit Corporation (UNT).
WLL is an E&P with assets in the Williston Basin and Colorado (Redtail – winding down). The oil percentage is in the mid-to-high 60s and total daily production is in the 130,000 bbls area (and growing). At the current 2020 strip, I calculate EBITDA of $1.1 billion for leverage of 2.6x. This assumes no debt paydown in 2Q-4Q 2019. Using the current strip, I estimate over $200 million of FCF in 2020 and production continues to grow. If oil falls to $45/bbl, I calculate FCF neutrality (assuming a small cut to capital expenditures). Management is very focused on debt reduction. Ample secured debt capacity provides a refinancing safety valve for the 1.25% converts and the 5.75% senior notes due in 2020 and 2021.
One private market data point is Halcon’s July 2017 sale of Williston assets to Bruin E&P. At a time when oil was in the $40s, Halcon sold its Bakken assets at $48,000 per flowing barrel. On a flowing barrel basis (at face), the WLL bonds imply $21,500/bbl/d.
Besides lower commodity prices, a risk is added leverage from an acquisition. Previous reports discussed a potential QEP purchase but this would fly in the face of everything management has been saying so I believe the likelihood is very low. Management has spoken about buying incremental acreage so I could see small bolt-on deals.
The longer-dated bonds here yield 8%. The stock also looks cheap considering my FCF estimate of >$2.25 for 2020.
GPOR is an E&P with assets in the Utica and SCOOP (purchased in late 2016 for $1.85 billion). This is a gassy play (90% of volumes) operating in a maintenance mode to focus on cash generation. Unfortunately, management is misguided and overly focused on share buybacks. Given the trajectory of the stock and commodity prices, I believe (hope) the emphasis will shift to debt reduction.
The company is well-hedged for 2019 at $2.83/MMBtu. This results in cash generation of >$100 million. I also have GPOR generating ~$100 million of cash in 2020 at the current strip. Assuming no debt reductions, this implies 2020 leverage of 2.7x. At market, this number is closer to 2x if I strip out the $60 million value for the company ownership in TUSK. Besides a change in corporate policy, one other catalyst is a sale of the its water midstream assets. These assets generate $10-$12 million of EBITDA and should be worth >$100 million based on recent transactions. Management mentioned 20 parties have indicated interest in the asset and $50 million or possibly more of the proceeds will be used to retire debt. This would pay off the revolver and could result in some below-par purchases of bonds, reducing debt further.
From a private market value perspective, I would point to the CHK sale of its Utica assets for 4.4x EBITDA. Yes, it was a different time and these are different assets. Ascent also recently bought some Utica acreage at decent prices.
Besides silly corporate policy, GPOR runs higher-than-average negative working capital. One could argue this adds another 0.2x-0.3x to leverage relative to others.
GPOR bonds yield mid-to-high 11%.
CNX is an E&P with assets in the Marcellus and Utica basins and some legacy coalbed methane properties. Production is mostly natural gas (94%). Similar to GPOR, management repurchased shares at far higher prices than current trading levels. Unlike the other companies mentioned, CNX owns a stake in a publicly-traded midstream business (CNX Midstream LP) along with the IDRs.
CNX will outspend in 2019 but this will be mostly offset by above-market hedges, dividends from CNXM and AMT tax refunds. Going forward, the company is well-hedged in 2020-2021 at prices of $2.93 and $2.90. Another $100 million (total) of tax refunds will also hit in 2020 and 2021.
As there is $514 million drawn on the credit facilities, there is priority debt ahead of the bonds but this is less than 1x EBITDA. Using management’s 2020 guidance, I calculate total leverage of 2.4x on unhedged EBITDA using the forward curve. This leverage ratio falls below 1.5x if I strip out the MTM on the hedges (post 2019), additional tax refunds and the value of the LP and GP stakes. Additionally, the water infrastructure is a potential drop-down or sale candidate – likely worth >$200 MM at YE 2019.
The longer term CNX bonds yield >9%.
CHK is an E&P with assets in the Powder River Basin, Eagle Ford, Mid-Con, Gulf Coast (Haynesville) and Marcellus. Many put CHK in the natural gas bucket but this is more of an liquids play as oil and NGLs should exceed 28% of total production in 2020. The acquisition of Wildhorse served two functions – increased oily acreage in the Eagle Ford and acted as a de facto equity raise and de-leveraging due to Wildhorse’s relative low leverage compared to CHK.
CHK is a big capital structure with lots of options, such as asset sales, secured debt raises, new debt exchanges and even equity issuances. Leverage is higher here at 3.5x 2020E but I believe this should decline as the PRB continues to ramp. Last year, the WSJ ran an article suggesting CHK's Haynesville asset could be of interest to an LNG exporter. I think CHK will continue to extend its liquidity runway as opportunities present themselves and should see FCF generation in 2020.
The longer dated CHK bonds yield 10%.
UNT is a hybrid. The company has midstream assets, drilling rigs and E&P operations in the Gulf Coast (Southeast Texas) and Mid-Con (Western Oklahoma and Texas Panhandle). Production is 54%, 28% and 18% natural gas, NGLs and oil. UNT is an off-the-run name. A year ago, the company sold 50% of its midstream operations for $300 million. The company maintains operational control of the midstream entity (67% fee-based / 33% commodity-based and 61% third party volumes). The total number of rigs include 13 BOSS rigs which are high spec and contracted. The BOSS rigs cost ~$20 million to build.
Total 2019E EBITDA of $275 million is split 73%, 17% and 10% between E&P, drilling rigs and midstream. Total debt is $690 million for 2.5x leverage This declines slightly in 2020. Another way to look at UNT is to strip out the value of the drilling rigs and midstream to get a creation value for the E&P through the bonds. Conservatively assuming 4x for the rigs and 7x for the midstream implies in a 1.1x multiple for the E&P. Realistically, I think the creation value is <1x if the company were to sell the rigs and the midstream stake.
The UNT bonds mature in under 2yrs so duration is limited. While the HY market is difficult to access for E&Ps right now, I believe a combination of secured debt, equity or asset sales and holders rolling into a new security will get them over the line. The bonds yield 11%.
So what are the big risks besides lower commodity prices and production shortfalls? One big risk is the management teams. They all want to drill, drill, drill and deal with the consequences later. Some have waited to refinance bonds and now the market is more difficult to access or not open at all. As mentioned above, some are even buying back stock which is asanine for a levered entity with finite-lived assets.
As a generalist, some of the technical questions may be difficult for me to answer.
I do not hold a position with the issuer such as employment, directorship, or consultancy. I and/or others I advise hold a material investment in the issuer's securities.