Description

Trading at $19, WPX is a solid long with a 50-75% upside ($28-34). Since this was written up by hao777 not too long ago, I will focus mainly on valuation of the assets.

(to see the charts, please use https://dl.dropboxusercontent.com/u/7143494/2013-7-24%20WPX%20notes.pdf)  

Valuation is attractive

M&A comps imply a price of $28-36/share. Last year, WPX sold its Barnett Shale and Arkoma Basin assets, which had significantly lower quality than Piceance, Bakken, Marcellus. Those sold at $1.36/bcfe proved reserves implying $28 per share. Using the original purchase price for Bakken’s assets (market transaction) of $1.9bn and applying the Barnett/Arkoma price to the remaining assets, implied value is $33/share. There were two recent transactions in Peceance at the end of 2012 - Bill Barrett sold comparable assets at $1.38/bcfe (implies $34/share for WPX) and Antero Resources sold assets for $7.05 per mcfe of production (proved reserves not disclosed) implying $36/share.

0.75x price-to-tangible book compares favorably to the comps, which range 2.5-3.5x. Net fixed assets are 90% of total assets for WPX. Note that WPX uses “successful efforts” accounting so no exploration and development costs are capitalized.

On a PV10 basis, not that the calculation is something an investor can rely on, the company is estimating value to be as high as $5B, which is much closer to book value

Good asset quality: Piceance, Bakken and Marcellus account for ~90% of reserves and production, even greater proportion of intrinsic value

-          Piceance: largest and most important asset. WPX is the most efficient producer in Piceance by far; structurally lower cost (drill from much lower elevation to reach same formation)

-          Bakken, most prolific oil field in US. Prudhoe Bay, largest US oil field to date, produced 1.5 million b/d of oil for 9 years before going into decline; ND Bakken projected tosustain that rate for 25 years. WPX is in “core of play”

-          Marcelus – it’s too early to tell if the company is in the core as operations have seen many infrastructure issues

-          Recent major discovery in Niobrara shale – WPX’s first well most productive ever drilled in Niobrara formation; additional wells planned this year. Potential to double 3P reserves. Infrastructure is in place – formation lies in Piceance just below where company’s already drilled 4,000 wells

-          Others: San Juan Basin, Powder River Basin (PRB), Apco Oil and Gas(oil-weighted producer in Argentina and Columbia; WPX owns 69%) - Lower-quality properties, directing almost no capital, pursuing disposition of PRB and Apco

The CEO is conservative and highly incentivized. CEO Ralph Hill joined WMB in 1981 and has seen what high leverage can do to the business so he is focused on conservative leverage. WMB nearly went bankrupt in 2002; Hill was forced to sell $1bn of assets in 72 hours to raise cash for parent company. So he manages debt levels and liquidity conservatively. The CEO owns $21 million in WPX shares – 12x 2012 cash compensation  so he should be well aligned with shareholders.

Natural gas prices can be driven up by favorable supply demand dynamic in the medium term, though the thesis is not predicated on higher gas prices

-          Major declines in gas drilling as oil returns are dramatically superior. Natural gas rigs are down to ~420 from near 1,800 in 2008. Oil rigs now account for ~80% of US onshore rigs compared to 25% in 2009

-          Shale boom left many companies with large debt loads

-          Production still stable due primarily to associated gas from shale oiland liquids-rich drilling but this highly unlikely to offset reduced gasdrilling indefinitely

-          Demand is picking up: U.S. utilities are switching to natural gas at the expense of coal; Industrial companies are expanding U.S. capacity to take advantage of cheap gas; LNG terminals will be coming online in the next few years; trucking/public transportation switching to natural gas

Why is WPX trading at these levels?

-          Revenue in 2012 declined 19% due to lower realized natural gas prices as hedges rolled off and production growth flattened

-          Costs for gathering, processing and transportation were higher due to previously negotiated WMB contracts ($1.02 per Mcfe in 2012 vs. $0.75 Mcfe in 2010)

-          WPX was spun out when natural gas was at its lowest point, management cut back the number of rigs it was using, thus reducing revenue, EBITDA and growth prospects

-          The parent shareholders wanted yield and an infrastructure play

-          Its main asset base is in the Piceance Basin, which has been considered a mature natural gas play (no growth and no hot commodity play). 80% of WPX's asset base is dry gas. Bakken Shale is hot area, but not a huge part of the company yet

-          69% stake in Apco was given a 40% haircut after Argentina moved to seize control of YPF (YPF) in 2012

-          Management has less experience in exploration and development than many other public E&P companies, adding execution risk to the ever present commodity price risk

-          No standalone operating results due to affiliation with WMB

-          Capital expenditure funding gap of $600M in 2012 and at least $200M in 2013

Catalysts:

-          Earnings growth by as much as $150m over the next two years driven by cost savings. Because these are legacy contracts from the time the company was part of WMB, investors have not been able to model or understand all of the reasons for the under-earning of EBITDAX and have assigned little value to them. For example. The company is one of several companies who are using the highly touted Rockies Express pipeline to move gas eastward. The current contract expires at the end of 2014 and the company expects to achieve additional revenue for its gas as the current contract deducts a fee relative to natural gas prices for transport. According to company filings, the company has been paying $35-$46m a year in fees because it hasn’t been using all of the allotted space on pipelines that transport its production. The company is "aggressively" negotiating with several parties to buy their unused allotted volume.

Risks

-          Commodity price risk is unavoidable for anyone interested in investing in a natural resource company. Therefore, one must be willing to accept the risk as part of their thesis. If an investor believes that natural gas prices are going to decline, then clearly WPX would not be an investment idea worth considering. WPX certainly would suffer under a scenario of lower nat gas prices. The company currently has about 50% of its 2013 nat gas production hedged at $3.62 and about 50% of its oil production hedged at $100 a barrel. The company has few hedges in place for the next few years. So the company has some cash flow protection this year if prices decline, buy very little for next year and beyond. In addition to slower growth, another consequence of lower prices is asset impairment. This is not a company specific risk, but the company also duly notes the potential in its risk section. From the 10-K… we estimate that approximately three percent could be at risk for impairment if forward prices across all future periods decline by approximately 11 percent to 12 percent, on average, as compared to the forward commodity prices at December 31, 2012. We estimate that approximately 31 percent could be at risk for impairment if forward commodity prices across all periods decline by approximately 16 percent to 18 percent. A substantial portion of the remaining carrying value of these other assets (primarily related to assets in the Piceance Basin) could be at risk for impairment if forward prices across all future periods decline by approximately 23 percent, on average, as compared to the prices at December 31, 2012.

-          Like every E&P company, the company must continue to spend money to offset declining production in its existing reserve base and hopefully replace those reserves at a higher rate and a lower cost. Historically, WPX has outspent its cash flow by $200M to $700M a year. The gap looks to be on the low end of that range in 2013 if all factors remain the same. Combined with the risk of a decline in the price of nat gas, this is a significant risk (look at Chesapeake Energy's (CHK) problems as a result of high leverage), unhedged gas prices and substantial capital expenditures. Lower nat gas prices would reduce the likelihood that WPX will achieve its expected 10%+ growth in production. For the first time in many years, the company is spending money on exploration ($90-$100M). Successful exploration is a much more difficult accomplishment than drilling in known fields for a 100% success rate. If the company is going to expand its potential reserves, exploration is one way to accomplish this. However, at this point there is no way to handicap the company's ability to do this and should be considered a pleasant surprise if it happens. The current valuation doesn't seem to put much hope on success

In summary, the risk/reward profile seems favorable at today’s valuation. The company has good quality assets that are trading below comparable assets and below tangible book value. 

Catalyst