By
Braden
Holt
:
Like many natural gas companies, QEP Resources' (
QEP
) stock price has struggled during the past several years. Since
peaking at $45.20 on July 26, 2011, the company's stock has tumbled
36% to $28.80 at market close on August 24, 2012. Also like many
natural gas companies, QEP has been looking for ways to increase
its oil/liquids production cut in response to a depressed natural
gas price environment. For the most part, the company's transition
to liquids production has occurred internally, with a shift in
focus to the liquids portion of its midcontinent acreage, the
continued development of its legacy Bakken acreage, and the
completion of its Black Forks II NGL processing plant in Wyoming.
QEP recently proved it's not opposed to
making a bold acquisition
in an oil play, and did so by spending $1.38 billion to acquire
27,600 net acres in the Bakken, bringing its total to 118,000 net
acres in the play.
While the company's shift to liquids may seem like a logical
move for a natural gas company at present, it's an expensive
endeavor and not without risk, just ask Chesapeake Energy (
CHK
) and GMX Resources (
GMXR
) who've both experienced financing difficulties during their
respective transitions. Of course, both CHK and GMXR were highly
levered before they bought into oil plays, leaving them with
inadequate cash flow to finance their capital budgets. By contrast,
Permian operator Approach Resources (
AREX
) emerged from its transition to oil with minimal debt and has
subsequently had success developing its assets. So where does QEP
stand amongst these companies?
Pre-acquisition, the company had a responsible debt-to-market
cap of 36.3% and an interest coverage ratio of 13.1x. QEP financed
the Bakken acquisition with its credit facility, increasing its
debt level 68% to $3.2 billion in the process. Its debt-to-market
cap ratio increased to 61.5% (see table below) and its interest
coverage ratio declined to 10.3x. The company did mention in its
acquisition conference call that it plans to deleverage soon;
however, unless deleveraging comes in the form of a large
divestiture, this process will take some time. In the near-term, we
have a highly levered company whose production was 80% natural gas
during the six-months ended June 30, 2012.
(click to enlarge)
Note regarding calculations: LOE, G&A and DD&A margins
were computed as a percent of sales.
While QEP is highly levered, it's a well-run company that's both
cost-effective and adept at extracting cash flow from its
production. The company's LOE margin is average for its peer group,
but its G&A and DD&A margins are actually lower. Its cash
margin of $4.07 ranks second in its peer group, indicating the
company is efficiently extracting cash flow from production despite
its leverage to natural gas. It's worth noting that QEP's costs
have been trending up as the company has increased its liquids
production cut (the main culprit is transportation and handling
costs), and this will be something to monitor as the company
continues its transition to liquids. Its cash margin improved to
$4.17x during this span, but will take a hit post-acquisition due
to higher interest payments.
Effect on Credit Facility
QEP was undrawn from its $1.5 billion credit facility prior to
this acquisition, which will draw approximately $1.4 billion. The
company paid 2.05% on its credit facility draw during the first
half of 2012, which translates to an increase in quarterly interest
payments of $7.4 million ($29.5 million annually) based on its new
balance. By my estimation, QEP will still have a strong interest
coverage ratio of 10.3x post-acquisition. Approximately $55 million
remains undrawn on the facility at present; however, the company
does have an option to increase its draw to $2.0 billion. The
facility matures in 2016 with options to extend to 2018, presumably
at a higher interest rate.
Considering low gas prices and high financial leverage, should
we be worried about QEP's ability to finance its capital
expenditures? The company will be getting a modest bump in oil
production of 10.5 thousand barrels of oil equivalent per day
(MBOEPD) from its Bakken acquisition. This has bumped the company's
full year production guidance by 5 Bcfe (midpoint of guidance) or
833 MBOE, which translates to a $20.4 million increase in operating
cash flow (assuming current cash margin) by the end of 2012. During
the six-months ended June 30, 2012, operating cash flow was $694.3
million. If the company keeps its current production (including new
properties) flat, I estimate QEP will generate $1.5 billion in
operating cash flow for 2013. If the company keeps its capital
budget at $1.525 billion in 2013 (the company will announce
guidance at Q3 conference call), it will have a budget shortfall of
$25 million. Now QEP increased operating cash flow by $66 million
year-over-year during the six-months ended June 30 despite low
natural gas prices. With more liquids production coming online
during the next year, operating cash flows will continue to
increase. I do expect the company to divest assets during the next
year to relieve its financial situation, and spinning of its
low-margin marketing arm might make some sense.
QEP's reserves prior to the Bakken acquisition were 76.1%
natural gas and had a reserve life of 13.1 years (see table below).
The company has been steadily growing its oil percentage from
reserves to 76.1% from 91.9% in 2009 and has done so at a strong
three-year finding and development cost of $1.75 per Mcf. QEP added
125 MMBOE of proved and probable reserves with the transaction (81%
oil, 9% NGLs, 10% natural gas) and didn't break-out the proved and
probable split, meaning the market doesn't know how the company
should be trading on an EV/Reserve basis post transaction.
One thing we do know is that QEP's reserves are going to get
even oilier over the next year for the following reasons: 1) 91% of
its capital budget was spent on liquids plays in 2012, meaning the
company is investing to increase its production and proved reserves
from these plays 2) QEP plans to grow its rig count in the Bakken
to eight rigs by next year from three currently, meaning more rigs
and capital will be spent in oil plays moving forward. What does
this mean for the company's valuation?
(click to enlarge)
Pre-acquisition, QEP was trading at a slight premium to the peer
group on a production basis and a 14% discount on a reserve basis.
Based on the trading multiples of these peers, QEP should have been
trading at a share price of $31.64 or 10% higher than on August 24,
2012 when its stock closed at $28.80. If we give the company credit
for daily production from the new assets and 50% of its proved and
probable reserve total (62.5 MMBOE) while adjusting EV accordingly,
I find QEP should be trading at a share price of $28.03 or 3% lower
than the company's stock closed at on August 24, 2012. So where
does all this leave us?
QEP's current value is being muted by two factors: its high debt
level and uncertainty surrounding the reserves associated with its
new Bakken acquisition. In spite of paying a premium for the Bakken
acreage, I believe the company has the liquidity available to
finance its capex; however, it will need to monetize an asset to
pay down its debt levels. I believe $28.03 represents a floor for
the company moving forward and if it's able to reduce its debt to
pre-Bakken acquisition levels, I estimate a target share price of
$35.28. QEP is setting itself up to have a balanced portfolio of
oil and gas assets with plenty of upside once natural gas prices
recover.
Disclosure:
I have no positions in any stocks mentioned, and no plans to
initiate any positions within the next 72 hours. I wrote this
article myself, and it expresses my own opinions. I am not
receiving compensation for it. I have no business relationship with
any company whose stock is mentioned in this article.
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