Resolute Energy (REN) is a little-known and lightly-followed small-cap oil and gas exploration and production company. Resolute's primary assets are its properties in the Aneth Field, located in the Paradox Basin of southeast Utah, and in the Permian Basin. The company also has smaller operations in the Bakken and Wyoming Powder River Basin. 2012 year-end reserves were 79% oil and 90% liquids. The high liquids content of the reserve base, combined with recent drill-bit results and new production growth in the Permian Basin bode well for its ability to grow production, cash flow, profits, and reserves. Expect a big Q4 earnings surprise, which could easily power the stock back to recent highs of $11.50/share for a near-term 6 month gain of 25%. Longer term (2-3 years), the stock has the potential to double on the basis of its Permian acreage alone.
Asset Base
A January investor presentation gave an overview of the company's production and reserves profile:
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Currently, the majority of REN's reserves are in the Aneth Field. Liquids dominate - only 10% of reserves are dry gas.
The Q3 earnings report gives a good overview of the regional production split and the overall operational and financial health of the company through the first 9 months of 2013:
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The Aneth Field composed roughly 50% of production and was relatively flat year-over-year. Wyoming and Bakken production was also relatively flat YOY. However, note that Q3 Permian production was up 600% over the prior-year quarter and up 900% for the first 9 months YOY. Total Q3 production of 11,504 boe/day was up 23% quarter-over-quarter. For the first 9 months of 2013, total production was up 33%.
However, from the previous slide, it should be noted there was a sequential and significant decline in production from Q2 to Q3: total production was down 1,603 boe/day (-12%) sequentially. The reasons for the decrease in production were many and varied:
- Primarily, a reduction of ~900 boe/day from the sale of the New Home Bakken properties.
- Permitting delays in Aneth were related to safety issues associated with new well completions in a high-pressure area. This led to a temporary reduction in production of ~165 boe/day.
- Completion delays in Gardendale (Permian): of the 14 vertical wells REN completed and started flowing back during Q3, 9 were completed in the second half of the quarter and contributed relatively little to Q3 production.
- A short-term production curtailment of ~175 boe/day in the Denton Field as REN worked on its salt water disposal facility.
If we negate the 900 boe/day due to the Bakken divestment, and take into account the ~340 boe/day short-term curtailments, production would have been down only 363 boe/day (~3% sequentially). It is important to note the company's Q3 release said:
CO2 injection was restored early in the fourth quarter and we have seen production response. Another important factor to note is that, due to the timing of drilling and completion activities, the horizontal wells that we drilled contributed only an immaterial amount of production to third quarter results.
So, while sequential production declines are never nice to see, the reasons for REN's production decline were rational and short-term in nature.
Q3 Financials
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Despite the production decline and net loss posted in Q3 (-$0.04/share), note the company grew revenue nicely. More importantly, EBITDA was up 40% quarter-over-quarter.
For the first nine months of 2013, revenue was up 30% and net income was $3.3 million ($0.05/share). This compares to net income of $19.6 million ($0.32/share) for the 2012 period.
The three and nine months ended September 30, 2013 include a $10.7 million charge to restructure or terminate certain 2013 commodity derivative contracts. For the first 9 months, derivative-related losses equated to $0.49/diluted share - a huge impact on earnings. This issue was addressed by REN CFO and EVP, Ted Gazulis in the Q3 conference call:
As you're probably aware, we restructured certain derivatives contract at the end of August. As a result, our average weighted swap price for oil increased from $79.41 per barrel at the end of the second quarter to $97.02 per barrel at the end of the third quarter. That higher swap price only affected one month of third quarter result, but it will be applicable through the rest of the year.
For Q3, total lease operating expenses increased 18% to $25.1 million, but decreased 4% on a boe basis compared to the year-earlier period. For the first 9 months, total production taxes increased by $2.2 million, or 8% percent, to $30.5 million (12% of revenue) as compared to $28.3 million (15% of revenue), but decreased on a boe basis, from $11.40 per boe in 2012 to $9.24 per boe in 2013. Bottom line is that lease operating expenses and production taxes are trending in a favorable direction. G&A expenses were up on a per boe basis due to increased salaries and wages (including share-based compensation) necessary to meet growth demands as well as increased professional services costs associated with the March 2013 Permian Basin acquisition. Nothing too unusual on the G&A front.
Debt
Outstanding indebtedness at September 30, 2013 consisted of $400 million of senior notes (8.5% due in 2020) issued during 2012 and $285 million in credit facility debt. During Q2, REN sold 13.3 million common shares in a public offering at $8.00/share and received approximately $101.8 million of net proceeds. In connection with the stock offering, the $40 million non-conforming tranche of the borrowing base on the credit facility was automatically terminated, thereby reducing the borrowing base from $485 million to $445 million. In July 2013, the borrowing base under REN's revolving credit facility was further reduced by $30 million to $415 million as a result of the $72.9 million received from the sale of the New Home Properties.
Capital Expenditures
During the first 9 months of 2013, Resolute incurred oil and gas-related capital expenditures of ~$186.9 million. This does not include the $258 million paid to acquire additional oil and gas assets in the Permian Basin in March 2013. This acquisition was financed with borrowings under the Company's revolving credit facility, cash on hand, and proceeds from the sale of assets in the Aneth Field. Year-to-date capital expenditures were offset by capital divestitures of $50.2 million received related to the sale of certain working interest in the Aneth Field Properties and $72.9 million of proceeds received from the sale of the New Home Properties.
The capital investments were directed toward REN's ongoing tertiary recovery and drilling projects in the Aneth Field and drilling and completion projects in the Permian Basin, North Dakota, and Wyoming.
Go Where The Growth Is: The Permian Basin
While CO2 and water flooding in the giant Aneth Field accounts for the majority of REN's production and cash flow, it is obvious REN's near-term growth strategy is focused on its operations in the Permian Basin. As I mentioned earlier, REN's Q3 production out of the Permian was up 600% over the prior-year quarter and up 900% over the first 9 months year-over-year. For this reason, I will focus on the company's drill-bit results in the Permian Basin.
Resolute's Permian stats:
- 24,000 net acres, 60% proved developed
- Q3 net production 3,662 boe/day; 67% oil
Recent drill-bit results are shown on the following slide from the January presentation. The next slide in the presentation deck (not shown here) displayed as good or better results from various operators in the acreage immediately adjacent to REN's property.
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You can read more about the Gardendale drilling program in an operations update the company released last December. Suffice it to say that REN's most recent 3-well foray into the Gardendale play of the Permian has shown very good to excellent results. The first two wells having available 30-day IP data averaged 823 boe/day, with an 80%+ oil split over the first 24-hour; 30-day IP rates averaged 549 boe/day. The economics of the wells are shown below. REN has 28 more drilling locations in Gardendale, with multiple horizons. These initial three wells were all drilled into the Wolfcamp B zone, but there is stacked play potential here, with secondary plays in the Wolfcamp A and Basal Spraberry zones. Overall, REN believes the gross resource potential (unrisked) in Gardendale is 17-67 million boe, an admittedly wide range, but one that shows the potential running room the company has exposure to.
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Resolute also drilled 18 vertical wells in the Gardendale during 2013, all of which have been spud and are in various stages of completion. Only 13 of these wells contributed to production in Q3.
REN also has 11,700 net acres in Reeves County (Delaware Basin of the Permian), and currently has two horizontal wells in progress. Resolute's acreage here is surrounded by operators like EOG Resources (EOG) and Cimarex (XEC), both of whom are showing excellent oil and gas yields (see slide 20 of the January presentation). EURs in this play are in the 500,000 to 1 million boe range, and Resolute has 50 drilling locations here - each with multiple horizons. Wells are in the $7-$8 million range and IRRs are 20%-40%. The gas is rich.
Resolute also has 2,200 acres in the Big Spring play, where vertical wells are much cheaper ($2-$3 million), EURs are lower, but IRRs are still very respectable at 25%-30%.
While REN's total pro forma 2012 Permian reserves are only 24 million boe, the net resource potential is in the range of 48-183 million boe. At the midpoint of that range (115 million boe), and at $90/bbl, we're looking at a potential $10 billion resource and 5x+ more than current proved reserves (as of year-end 2012).
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And that brings us to REN's current enterprise value of $1.39 billion and the profile shown below. While the company certainly has more debt than I would like to see (4x debt-to-EBITDA), and the majority of debt is relatively high-priced at 8.5%, the company certainly seems to be undervalued in terms of the relatively low-risk assets it is exploiting in both the Aneth and Permian Basin. As shown above, the Permian basin acreage alone could easily be a $10 billion resource for the company. Even if I cut that by 75% to account for overhead expenses (development costs, lease expense, G&A, etc.), we still get a $2.5 billion resource value, which is almost double the current EV. And remember, these numbers are starting from the midpoint of the potential resource range.
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Summary & Conclusion
Resolute issued 13.3 million common shares in Q2 2013 at $8.00/share. That diluted existing shareholders by 22%, and at the same time raised ~$102 million, which helped pay down debt and fund operations. The secondary offering was successful in that the company's stock today ($9.19) is solidly above the $8/share price offering.
Q3 2013 looked bad in that REN posted a loss and production declined sequentially. However, as this article discussed, there were rational reasons behind the quarter's performance, and I believe it presents a great opportunity for investors. Indeed, as the company's December update informed us, CO2 operations in the Aneth are back on track, wells are coming online in the Permian with very good to excellent results, and field-level production for October and November averaged more than 12,500 boe/day. Note that is 1,000 boe/day above the prior quarter's 11,504 boe/day (+8.7%). December is likely to see even higher average production as more wells come online in the Permian.
Q3 also showed a huge derivatives loss of $21.5 million ($0.30/share), yet the company posted a loss of only -$0.04/share. However, as the CFO explained, this issue was put to bed and realized prices in Q4 will be higher. We should see significantly higher realized prices per boe in Q4 (over Q3's terrible derivatives-induced $63.53/boe), as WTI prices have been very firm over the winter and are currently over $102/bbl.
Otherwise, operationally, the company is performing very well: new drilling results in the Permian are very good to excellent, while lease operating expenses and production taxes are falling on a per boe basis.
The big long-term upside with REN is the asset base in the Permian Basin, which solid and dependable cash flow from the company's Aneth Field operations can fund. While it is early in the play, and capital expenditures are robust, eventually the Permian operations will be self-funding. As a result, REN's enterprise value could easily double due to upside in its Permian acreage resource base alone.
Bottom line: expect a big earnings beat in Q4. Current consensus analyst estimates are expecting just $0.04/share. REN could easily come in at 2-5 times that amount, and the stock could rally back to recent highs of $11.50/share (up 25%) over the next 6 months (a 50% annualized gain). Longer-term (2-3 years), the stock could easily double. Downside is rather limited, especially over the short term due to significant increases in production levels and realized prices, unless we see sub-$90/bbl WTI for an extended period of time. REN's Permian acreage produces an 80%+ oil split, is largely proved developed, and is validated by both its own drilling results and those of nearby bigger companies like EOG and Cimarex.
REN is a STRONG BUY based on expectations for big Q4 production and earnings surprise.
NOTE: Q4 earnings are due out on Monday, March 10th at 3:30 CST. You can access the conference call here.
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(Source: Yahoo Finance)
Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in REN over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. (More...)
Additional disclosure: I am an engineer, not a CFA. The information and data presented in this article was obtained from company documents and/or sources believed to be reliable, but has not been independently verified. Therefore, the author cannot guarantee its accuracy. Please do your own research and contact a qualified investment advisor. I am not responsible for investment decisions you make. Thanks for reading and good luck!
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