By
Braden
Holt
:
Forest Oil (
FST
) hails from the lineage of noble companies who attempted to
increase shareholder value by using financial leverage to increase
natural gas reserves during the bull gas market that was from 2005
to 2008. Unfortunately for this lineage, the prolonged period of
low natural gas prices that ensued has companies like itself, along
with Chesapeake Energy (
CHK
), Quicksilver Resources (
KWK
) and GMX Resources (
GMXR
), et al selling off assets to finance debt like they're Nicholas
Cage. As an analyst and investor, these are the stories I find
exciting because of their potential as a value stock. I'm not
looking for the best run company with the best assets, I'm looking
for the best run company with the best assets at the best price.
With that said, screw a sexy company like EOG Resources (
EOG
), let's delve into the world that is *cough* Forest Oil.
My research for this piece began with
FST's third quarter 2012 earnings call
, which was held on Tuesday October 30, 2012. I don't think I've
listened to a more melancholy earnings call during my admittedly
brief analyst career. Debt aside, at least on paper, I think
there's a lot to be excited about with this story. The company has
40k net of solid Eagle Ford acreage, 109k net in the Texas
Panhandle where it has drilled eight monster Hogshooter wells and
an East Texas gas asset that provides its portfolio with plenty of
natural gas upside. I do understand Forest's attitude, a
debt-to-market cap of nearly 200% will keep even the most
optimistic financial teams up at night. So, what is it doing to
manage its debt levels?
If you aren't familiar with Forest's debt levels, it had total
debt of $2.1 billion as of September 30, 2012. The company is
taking a common sense approach to lowering its debt, the first step
of which was to refinance half of the six-hundred million it owes
in 2014 by issuing lower rate notes which will mature in 2020. This
frees up some near-term liquidity for FST, whose next principal
payment isn't due until 2019 (the company is on the hook for $1.5
billion during 2019 and 2020). FST will also net approximately $270
million from non-core asset sales which it expects to close on in
November and use to lower its debt. After the refinancing and asset
sales, the company will have approximately $1.8 billion in debt
outstanding which translates to a debt-to-market cap of 190%.
The remaining $300 million the company will pay in principal in
2014 should be covered through the divestiture of its 114,500 net
acres in the Delaware and Midland Basins of West Texas/SE New
Mexico. As shown by the table below, the average acreage value for
assets in this area is $4,316 which values FST's acreage at $494
million. Even if the company receives a valuation near the lower
bound of the sample size, it will still cover its expected
principal payments in 2014. It's my view that this company should
be soluble through the end of fiscal year 2018, but surviving
beyond that will require the type of fiscal austerity that would
impress even the Greeks.
Recent Permian Transactions
(click to enlarge)
Forest seems to have finally figured out that it doesn't have
daddy's credit card anymore and needs to start showing some
financial constraint. Its Q4'12 capital budget is approximately $84
million, down 50% from Q3. For fiscal year 2012, spending will be
an estimated $624 million, $59 million less than in 2011. Next
year, spending figures to decrease significantly as the company
attempts to spend within cash flow. It only generated $286 million
in cash flow during the nine months ended September 30, 2012 and if
cash flow is flat year-over-year (conservatively speaking), the
company will have $381 million to spend next year. While that's not
the type of spending trajectory we want to see for a potential
investment, at least Forest is taking its medicine.
The company's survival beyond 2018 will be dependent upon its
ability to develop its existing asset base while spending within
cash flow. On paper, it has a great asset in the Eagle Ford with
40k net in Gonzales County, but its results there have been
disappointing to date. Based on the data I saw from the Texas
Railroad Commission, the company has one good well in Holmes 1H
which has produced more than 100k barrels of oil in just under a
year, a handful of economic wells and just as many poor wells. It's
not unusual for a company to have inconsistent results at the
beginning of a drilling program, but I would have liked to see a
few more good wells from its Eagle Ford program. I still think this
acreage will turn out to be productive for the company, but FST's
struggles there to date are something to monitor.
The company has had much more success in the mid-continent,
where according to its Q3'12 earnings call it has recovered nearly
one million barrels of oil equivalent (~70% oil) from eight
hogshooter wells during the past year. This acreage is the
company's prized asset, but it's going to need its Eagle Ford
acreage to be economic for it to survive.
The company's reserves are currently trading at an EV/Mcfe of
$1.46, which is quite a bargain considering its assets. However,
I'm not sold on its ability to develop its existing assets at this
point and, to be honest, I don't need to be as this company's stock
doesn't look to be moving up anytime soon. Also, management seems
to be comfortable with maintaining a debt level circa $1.5 billion,
which would still put its debt-to-cap north of 150%, a little too
high for me. If you already own the stock, there's probably no
reason to sell as it's already trading near its bottom. I'm not
touching Forest, but if the debt doesn't bother you, it might be a
stock to keep an eye on down the road.
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.
See also
Reynolds American Inc. - Analyst/Investor Day
on seekingalpha.com