Clayton Williams Energy, Inc (
) is an independent oil and gas company engaged in the exploration
and production of oil and natural gas, primarily in Texas,
Louisiana and New Mexico. CWEI's portfolio of oil and natural gas
reserves is weighted in favor of oil, with approximately 77% of
proved reserves at December 31, 2011, consisting of oil and natural
gas liquids (NGLs) and approximately 23% consisting of natural gas.
CWEI has two reportable operating segments, which are oil and gas
exploration and production ($408MM in revenue for FY11) and
contract drilling services ($6MM in revenue for FY11).
CWEI's security price has taken a beating in 2012, declining 52%
from a closing price of $95.88 on 2/27/12 to a closing price of
$46.01 as of 8/10/12. To figure out if the decline fairly
represents a decline in the actual value of the company, let's
consider the principal discounted cash flow ((DCF)) variables that
impact this security's value. We will later take a look at some
comparable analysis variables to figure out whether or not the
price as of 2/27/12 was overstated in the first place, thus
bringing the correction more in line with fair value.
Revenue is a product of price and quantity. CWEI sells crude oil
and NGLs (~76% of 2012 projected revenue) and natural gas (~24% of
2012 projected revenue). Oil, NGL, and natural gas sales comprise
99% of the 2012 projected revenue with the remaining 1% due to
drilling rig services and natural gas services. We will focus on
the 99% core business of selling oil and natural gas. WTI crude
prices have been volatile in 2012, reflecting increased political
tension in Iran, the continuing debt crisis in the eurozone, and a
sluggish macro economy in general, with the second two reasons
outweighing the first in recent months pushing crude oil prices
lower. As reflected in the below chart, price can rationally
explain about 14% of the security price decline. Aside from hedging
production, there isn't much management can do about price variance
impact to revenue.
Click to enlarge images
As for product sold, which is something management is able to
control over the long-term, CWEI has increased production of oil
and NGLs while reducing its focus on natural gas, and rightly so
given the oil price premium compared to natural gas that has held
since December 2005. The four year price compound annual growth
)) is 1.1% for oil and 25.6% for natural gas (using futures prices
from cmegroup.com for the remainder of 2012). The four year average
daily production CAGR for CWEI is 8.6% for oil and NGLs and (18.0%)
for natural gas. What this demonstrates is management's long-term
strategic effort to adjust production with the better priced
commodity (refer to chart below for illustration). If the oil and
gas price relationship were to change dramatically overnight and
the change were viewed as long-term, management would need to
figure out how to ramp up production of natural gas but in the
current price environment, the company is selling more of the
higher priced commodity.
In addition, CWEI has increased proved reserves for oil and NGLs
significantly more than natural gas. Growth in total production and
reserves and just as important, the mix of that growth between oil
and gas, is favorable. It appears that the product quantity and
product quality would partially offset instead of contribute to the
decline in price.
CWEI's Q2 2012 earnings call
that took place on 7/26/12 and
updated guidance provided by management
on 8/7/12, let's take a look at some other value-driving variables
and how those impact the security price.
Q2 2012 Earnings Call & Updated Guidance Points of
Production costs have been steadily increasing as a result of
higher lifting costs due to more producing wells and the rising
costs of field services. According to CWEI's CFO Michael Pollard,
the rising costs are a result of the lack of infrastructure in
Reeves County in the Delaware Basin where the firm is principally
focused on drilling. Pollard said "we're experiencing higher than
normal lifting costs, particularly costs associated with salt
water disposal. We're nearing completion of an SWD system, which
should significantly reduce our costs in Reeves County as we go
- Using updated guidance provided by management on 8/7/12, the
DCF valuation decreased by about $5/share due to the rising
costs. I think the decrease in value from costs alone will be
tempered with CWEI's forecasted reduction in costs due to its SWD
system and renegotiation of fracking contracts. Nonetheless, the
rising costs have a significant short-term impact to valuation
and here's a summary of guidance changes since the last guidance
cost numbers were issued.
As a result of the company's aggressive drilling and lease
acquisition capital program, CWEI's debt has increased with
respect to proved reserves, proved developed reserves, EBITDA,
and daily production. As long as management pulls back capital
spend to remain within cash flows from operations over the
long-run, I'm comfortable with the increase in debt in 2012.
- CWEI's 2012 capital spend program is now at $429.3M, an
increase from $405.2M previously modeled. The increase per
management is primarily due to "higher drilling and completion
costs in the Delaware Basin due in part to our bearing a higher
percentage of drilling and completion costs in wells in which
Chesapeake elected not to participate for its 25% retained
working interest." Per my DCF model, CWEI will have about $65M in
revolver availability by the end of 2012. When asked if
comfortable with the given level of liquidity with respect to its
current drilling program, the Chief Operating Officer Mel Riggs
voiced comfort with the current cash availability and is seeking
ways to improve liquidity in 2013.
The primary wild card operationally is how successful CWEI is in
the Eagle Ford shale, where the company has 120,000 acres.
According to CWEI's CEO Clayton Williams, the early results are
encouraging although there is not yet enough information to
determine whether or not the wells drilled in the Eagle Ford are
commercial. The main operational focus continues to be in the
Delaware basin, specifically in Reeves County, where CWEI has
drilled 63 vertical Wolfbone wells and eight horizontal Bone
Springs / Wolfcamp wells.
- Using updated downward revisions for 2012 production, CWEI's
value decreased by about $3/share based on my DCF model. Here is
a summary of the production change to guidance.
As part of my review practice, I assessed more than 30
valuation, efficiency, liquidity, profitability, capital structure,
and industry ratios and compared CWEI to five of its peers. I won't
go into the detail of each ratio but I will provide a few
interesting observations gathered from a few ratios.
CWEI's P/E TTM ratio was the lowest among its five peers (as
provided by cnbc.com) with a ratio at 5.6x. When looking at the P/E
using 2012 analyst projected mean earnings, CWEI has a forward P/E
ratio = 13.2x, with two peers with lower ratios and three peers
with higher ratios. The company was not an outlier when looking at
the other ratios, although it was clear CWEI carries the most debt
with respect to enterprise value and EBITDA, an issue previously
When viewing profitability ratios, CWEI was strong among peers
with the highest net profit margin and ROE. I believe the company's
strong earnings are in large part due to the high percentage of oil
revenue as a percentage of total production. The strong earnings
power is needed to offset the risk of carrying a high percentage of
debt to equity.
Regarding capital structure ratios, CWEI carries more debt with
respect to equity, capital, and assets than all but one of the five
peers compared although interest coverage was favorable at 8.4x due
to EBITDA equal to $284M for FY2011.
Based on the ratio analysis, CWEI is higher risk compared to
each of its peers, given the level of debt, but I maintain that its
earnings power from concentration on oil production provides enough
of an expected return (probability of success multiplied by
successful outcome), given the risk.
Using what I consider are reasonable assumptions, I believe
CWEI's fundamental value per share is about $48 in the current
price environment. Lower commodity prices, lower guidance, and
lower economic growth expectations have certainly pushed this stock
lower. CWEI was likely overvalued at the end of February 2012 and
is likely undervalued as of the price on 8/10/12. However, the
security has been volatile and waiting for a lower price than the
8/10/12 COB price of about $46/share provides a better margin of
safety. Waiting for a lower price is realistic considering CWEI
recently traded hands below $40/share and the security has enjoyed
a recent run of 8%+ in the last five trading sessions. It's worth
noting that Executive Vice President and COO Mel Riggs purchased
200 shares at $44.25 on 7/16/12.
CWEI is a risky security given its level of debt combined with
recent downward revisions to FY2012 production and upward revisions
to FY2012 costs. The company still seems cheap compared to recent
valuations in the low $40s per share considering its earnings
potential, which is driven from one proven productive oil basin in
the Delaware Basin where the company is currently focused and one
high potential basin in Giddings (the Eagle Ford shale
I am long CWEI and purchased at a price of $45.15/share.
You may find the appendix to this report, which includes many of
the DCF model assumptions,
I am long [[CWEI]].
John Paulson's Favorite Value Stocks