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Third Avenue Management Comments on EP Energy Corp

As the energy markets churned weaker over the quarter, we continued to look for attractive investment opportunities, as it was our sense that many investors were shooting first and asking questions later on their sales. We continue to believe that the current price weakness is a supply driven shock, and not what we believe would be a more worrisome lack of demand driven sell off.

The one?two punch of higher Saudi Arabian production and potential future Iranian production have pushed oil down to the low $40 per barrel range, well below what we believe is a realistic industry wide break?even level in the mid?$60's or higher, even with the benefit of recent service cost reductions that are likely not sustainable over time. In the near term we have seen a strong demand response in higher oil use and over the medium term we would expect a drop in production of higher cost barrels, which would reduce supply and lead to higher oil prices .

As we sifted through the sell?off looking for good companies, we identified EP Energy Corp. ( NYSE:EPE ) as it has similar characteristics to our investment in Rosetta Resources with high quality acreage in two of the most attractive shale regions in North America in the Eagle Ford and the Permian.

EPE is an independent oil and gas exploration and production company that was previously owned by El Paso Energy. The company was sold in May 2012 to private equity investors Apollo Global Management, Riverstone Holdings, Access Industries and Korea National Oil Corporation (KNOC) for $7.2 billion. EP Energy began trading publicly in January 2014 and the private equity sponsors continue to own 85% of the shares outstanding. EPE operates in four areas: the Eagle Ford Shale in Southern Texas, the Wolfcamp Shale in the Permian Basin in West Texas, the Altamont field in the Uinta Basin in Northeastern Utah and the Haynesville Shale in North Louisiana.

EPE's management has an excellent track record of growing oil and gas production at a 27% compound annual growth rate over the past five years and proven reserves increased by 14% last year. The company's Eagle Ford acreage is its most economic area in the current oil and gas price environment with break?even (a company?defined 10% return on capital) at an oil price of $40 per barrel. EPE's Permian Midland Basin acreage holds significant growth potential. The Wolfcamp wells have a 10% return at $44 per barrel oil which is almost as economic as the Eagle Ford acreage as a result of lower costs and improved drilling results. The Permian acreage provides EPE with long term growth opportunities with more than twice the acreage as the Eagle Ford and over 3,000 potential drilling locations. In addition the Wolfcamp is six?times thicker than the Eagle Ford with at least 6 potential producing zones versus one in the Eagle Ford.

Although EPE has $4.9 billion of debt and a Net Debt to EBITDA ratio of 1.9 times, which is at the high end of our comfort zone, we are very comfortable with the financial strength of the company since none of the debt is due prior to 2018. In addition EP has an enviable hedge position with 95% of 2015 expected oil production hedged at a floor of $88 per barrel and 75% of estimated 2016 oil production hedged at a floor of $80 per barrel which will allow the company to live within cash flow without having to add additional debt. EP's hedges have a current market value of around $875 million which if monetized could be used to repay debt and bring the Net Debt to EBITDA ratio down to 1.6 times.

We are confident that management's history of improving drilling results across all of their acreage positions as well as continued cost reductions will support continued earnings improvement despite weak oil and gas prices. We also think that EPE could be an attractive acquisition target for a mid?sized E&P that wants to enter or add to its position in the very attractive Eagle Ford and Permian plays. In addition EPE may consider divesting its Altamont or Haynesville acreage at the right price.

From Third Avenue Management's third quarter Small-Cap Fund shareholder letter .

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.


The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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