BLACK HILLS CORP BKH
November 27, 2013 - 9:36pm EST by
matt366
2013 2014
Price: 50.46 EPS $2.34 $2.51
Shares Out. (in M): 44 P/E 21.6x 19.4x
Market Cap (in $M): 2,240 P/FCF 0.0x 0.0x
Net Debt (in $M): 1,336 EBIT 0 0
TEV ($): 3,575 TEV/EBIT 0.0x 0.0x

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  • Oil and Gas
  • Utility
 

Description

Investment Thesis

 

Black Hills Corporation (“BKH” or the “Company”) represents a stable and growing utility asset that holds a significant potential oil and gas asset in the Mancos shale.  Only a small portion of the Mancos Shale assets have been proved out.  BKH and other drillers are in the process of delineating the prospect.  Initial drilling results have been positive and have led to increased drilling activities.  Historically, BKH has successfully monetized other oil and gas assets, including the sale of itsWillistonBasinassets to QEP in 2012 for a premium price.  BKH is pursuing a similar deliberate strategy in the Mancos.  BKH’s current share price reflects only a small portion of the optionality associated with increased drilling in the Mancos with downside protection from the utility asset base.  Utility risk can be hedged out against the XLU.

Company Overview:

BKH has three business segments.  First its traditional utility business operates inColorado,Iowa,Kansas,Montana,Nebraska,South DakotaandWyoming.  Second, its non-regulated subsidiary produces and sells electricity and coal under long-term contracts to the utility and operates in a utility-like fashion.  Third, its oil and gas operations described in more detail below.   

Valuation

 

Low

High

Utility EPS

$2.55

$2.55

Multiple

15.5x

16.5x

Utility/Utility-Like EPS

$39.53

$42.08

PV-10 Value

4.73

4.73

Equity Value

$44.25

$46.80

 

 

 

Implied Value Mancos

$6.21

$3.66


Excludes the optionality associated with an increase in proved reserves, which represents the source of upside here.

Mancos Shale Opportunity

            Drilling activity in the Mancos is picking up steam with Encana, WPX and BKH represent the largest acreage holders and drillers.  WPX drilled two wells in the target areas in 2013 with impressive reported results.  BKH and Encana drilled a number of wells, but have yet to report the results.  In 2014, WPX and BKH both elected to expand their drilling programs to drill another 12 and 6 wells, respectively.  Both companies are sharing drilling data to reduce overall development costs and WPX has stated that by end-2014 it should have delineated 80% of the field.  WPX has also indicated that should its drilling program continue to be successful it would double the company’s gas reserves from 18tcf to 36tcf.

WPX has only found gas in its wells to date.  WPX two wells to date have shown impressive IP rates:

 

 

Initial IP Rates

Current Operation

1st 180 day Production

Vertical Depth

Well #1

16 MMcf/d @ 7,300 psi

4.4MMcf/d @ 2,300 psi

1.4Bcf

10,200ft

Well #2

11.8 MMcf/d @ 5,700 psi

8 MMcf/d @ 5,400 psi

NA

9,062ft

 

BKH has indicated that its current and prospective drilling activity is in areas where it believes NGLs are present.  Encana has alluded to NGL production in its current drilling activities, but has not yet released its drilling results.  The potential presence of NGLs is supported by BKH’s election to enter into an agreement with Summit Midstream (SMLP) for gas processing: “Red Rock is continuing to develop the 20 MMcf/d cryogenic DeBeque processing plant which will process liquids-rich Mancos shale production under a long-term, fee-based agreement with Black Hills Exploration & Production, Inc. The DeBeque plant is on schedule to commence operations by the end of 2013.” (SMLP Q3 ’13 Conference Call).  While BKH’s wells may be in areas where gas flow rates are lower than WPX’s results, they offer the opportunity for NGL upside. 

In the Mancos, BKH maintains a large, relatively, unproven position for which it gets little credit.  The Piceance produces liquids rich gas opportunity and theSan JuanBasinis dry gas.  In its investor presentation, BKH has laid out its potential reserves as follows:

 

 

            

 

 

 

Net Acreage

 

# Potential Wells

 

Implied Acreage Spacing

 

 

Average Royalty

 

# Test Wells Completed

Gross Resource Potential (BCF)

Net Resource Potential (BCF)

San Juan Potential

19,000

120

160

20%

1

720

576

Piceance Potential

54,700

340

160

20%

2

2,040

1,632

Total Mancos Potential

73,700

460

 

20%

3

2,760

2,208

 

            BKH’s description of its potential reserves under represents the potential opportunity, due to its failure to update its core operative assumptions.  First, it assumes well spacing of 160 acres; however, WPX and BKH have indicated that well spacing will likely be much tighter than this figure and closer to 80 acres, if not lower.  Second, it assumes EURs per well of 6bcf per well based on the results of prior 2011 test wells.  BKH’s production guidance for 2014 of 13.4 – 14.4Bcf points to higher EURS, which supports management comments at its recent analyst day where it pointed to EURs of between 8-9bcf per well.  The increase in prospective EURs is driven by the knowledge gained through its scientific drilling activities which has led it to increase frac stages from 5,000ft to 10,000 ft, consistent with the drilling strategies employed by WPX.  Third, BKH does not include 20,000 net acres it acquired in the Piceance in 2013 through a drill to earn arrangement.  BKH will complete the two wells required to earn these incremental 20,000 acres.  If one adjusts BKH’s potential reserve presentation, the results would be as follows:

 

 

 

 

 

Net Acreage

 

# Potential Wells

 

Implied Acreage Spacing

 

 

Average Royalty

 

# Test Wells Completed

Gross Resource Potential (BCF)

Net Resource Potential (BCF)

San Juan Potential

19,000

238

80

20%

1

1,900

1,520

Piceance Potential

74,700

934

80

20%

4

7,470

5,976

Total Mancos Potential

93,700

1,171

 

20%

3

9,370

7,496

 

Sensitizing this data and applying a conservative price per potential mcf of between $0.25, one can see the huge leverage in the Mancos opportunity.

 

 

 

Implied Value per Share

 

 

40

80

120

160

Bcf

6.0

46.49

40.07

37.93

36.86

per

7.5

49.70

41.67

39.00

37.66

Well

9.0

52.91

43.28

40.07

38.46

 

10.5

56.11

44.88

41.14

39.27

 

The results are still significant even if one assumes a fully-taxed scenario with a $200mm tax basis:

 

 

 

 

Implied Value per Share

 

 

40

80

120

160

Bcf

6.0

31.79

27.62

26.23

25.53

per

7.5

33.88

28.66

26.93

26.06

Well

9.0

35.97

29.71

27.62

26.58

 

10.5

38.05

30.75

28.32

27.10

 

The opportunity in the Mancos is significant for BKH and would represent a 2nd step in its E&P monetization strategy.  On August 27th, BKH sold itsWillistonBasin oil and gas assets for $227mm vs. their PV-10 value of $56mm.  BKH has indicated that it will pursue a similar deliberate approach to proving out its Mancos assets prior to monetizing the asset in the most tax-advantaged manner possible.

 

Risks:

 

  • Gas Price Decline – Given the predominant gassy nature of the assets, declines in natural gas prices could have two effects.  First, BKH could elect to slow down its drilling program, which would extend the development timeline.  Second, declines  in gas prices would also have negative implications on value and the economic viability of the field.  The potential presence of NGLs provides a small offset.

 

  • Limited Information – BKH is currently completing the drilling of two wells.  Both of these wells were situated on fields that it recently acquired in a drill to earn program.  These drilling programs are subject to strict confidentiality.  While it will be possible to see some of the results through changes in their financials in 2014, full details on the well results will only be known around mid-2014.

 

  • Drilling Failures – Any failures in its drilling program would raise questions regarding the viability of the field.

 

  • Acquisitions – BKH continues to have an appetite for acquisitions.  It has been involved in a number of utility auction processes (Missouri Gas and New Mexico Gas) of fairly significant scale (approx. $1bn).  Any such acquisition would like be funded at least in part with equity.    

 

I do not hold a position of employment, directorship, or consultancy with the issuer.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

Catalysts:

 

  • BKH Drilling Results: BKH has not yet released its drilling results from the two wells it drilled in 2013.  The release of these results will be delayed to around June 2014, due to confidentiality agreements with the seller.  The decision to significantly increase capital spending into the Mancos anecdotally points to positive results.   Investors will potentially be able to determine results before June by looking at the quarterly financial statements which should show a significant increase in gas production.  NGL production will be more difficult to determine given likely increases in NGLs from some of BKH’s other assets.  Data from partners, such as SMLP, could provide additional data points through the year.
  • WPX Drilling Results - WPX continues to drill in the Mancos shale and is stepping up its drilling program  It has no restrictions on its data releases and should be continue to release drilling results over the next year.
  • Asset Monetization – BKH has a demonstrated ability to monetize its asset base.  The Company has publicly stated that the asset base is too large for it develop on its own and it will seek to monetize the asset in a manner that retains the significant underlying option value.  BKH’s historically track record is constructive.
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    Description

    Investment Thesis

     

    Black Hills Corporation (“BKH” or the “Company”) represents a stable and growing utility asset that holds a significant potential oil and gas asset in the Mancos shale.  Only a small portion of the Mancos Shale assets have been proved out.  BKH and other drillers are in the process of delineating the prospect.  Initial drilling results have been positive and have led to increased drilling activities.  Historically, BKH has successfully monetized other oil and gas assets, including the sale of itsWillistonBasinassets to QEP in 2012 for a premium price.  BKH is pursuing a similar deliberate strategy in the Mancos.  BKH’s current share price reflects only a small portion of the optionality associated with increased drilling in the Mancos with downside protection from the utility asset base.  Utility risk can be hedged out against the XLU.

    Company Overview:

    BKH has three business segments.  First its traditional utility business operates inColorado,Iowa,Kansas,Montana,Nebraska,South DakotaandWyoming.  Second, its non-regulated subsidiary produces and sells electricity and coal under long-term contracts to the utility and operates in a utility-like fashion.  Third, its oil and gas operations described in more detail below.   

    Valuation

     

    Low

    High

    Utility EPS

    $2.55

    $2.55

    Multiple

    15.5x

    16.5x

    Utility/Utility-Like EPS

    $39.53

    $42.08

    PV-10 Value

    4.73

    4.73

    Equity Value

    $44.25

    $46.80

     

     

     

    Implied Value Mancos

    $6.21

    $3.66


    Excludes the optionality associated with an increase in proved reserves, which represents the source of upside here.

    Mancos Shale Opportunity

                Drilling activity in the Mancos is picking up steam with Encana, WPX and BKH represent the largest acreage holders and drillers.  WPX drilled two wells in the target areas in 2013 with impressive reported results.  BKH and Encana drilled a number of wells, but have yet to report the results.  In 2014, WPX and BKH both elected to expand their drilling programs to drill another 12 and 6 wells, respectively.  Both companies are sharing drilling data to reduce overall development costs and WPX has stated that by end-2014 it should have delineated 80% of the field.  WPX has also indicated that should its drilling program continue to be successful it would double the company’s gas reserves from 18tcf to 36tcf.

    WPX has only found gas in its wells to date.  WPX two wells to date have shown impressive IP rates:

     

     

    Initial IP Rates

    Current Operation

    1st 180 day Production

    Vertical Depth

    Well #1

    16 MMcf/d @ 7,300 psi

    4.4MMcf/d @ 2,300 psi

    1.4Bcf

    10,200ft

    Well #2

    11.8 MMcf/d @ 5,700 psi

    8 MMcf/d @ 5,400 psi

    NA

    9,062ft

     

    BKH has indicated that its current and prospective drilling activity is in areas where it believes NGLs are present.  Encana has alluded to NGL production in its current drilling activities, but has not yet released its drilling results.  The potential presence of NGLs is supported by BKH’s election to enter into an agreement with Summit Midstream (SMLP) for gas processing: “Red Rock is continuing to develop the 20 MMcf/d cryogenic DeBeque processing plant which will process liquids-rich Mancos shale production under a long-term, fee-based agreement with Black Hills Exploration & Production, Inc. The DeBeque plant is on schedule to commence operations by the end of 2013.” (SMLP Q3 ’13 Conference Call).  While BKH’s wells may be in areas where gas flow rates are lower than WPX’s results, they offer the opportunity for NGL upside. 

    In the Mancos, BKH maintains a large, relatively, unproven position for which it gets little credit.  The Piceance produces liquids rich gas opportunity and theSan JuanBasinis dry gas.  In its investor presentation, BKH has laid out its potential reserves as follows:

     

     

                

     

     

     

    Net Acreage

     

    # Potential Wells

     

    Implied Acreage Spacing

     

     

    Average Royalty

     

    # Test Wells Completed

    Gross Resource Potential (BCF)

    Net Resource Potential (BCF)

    San Juan Potential

    19,000

    120

    160

    20%

    1

    720

    576

    Piceance Potential

    54,700

    340

    160

    20%

    2

    2,040

    1,632

    Total Mancos Potential

    73,700

    460

     

    20%

    3

    2,760

    2,208

     

                BKH’s description of its potential reserves under represents the potential opportunity, due to its failure to update its core operative assumptions.  First, it assumes well spacing of 160 acres; however, WPX and BKH have indicated that well spacing will likely be much tighter than this figure and closer to 80 acres, if not lower.  Second, it assumes EURs per well of 6bcf per well based on the results of prior 2011 test wells.  BKH’s production guidance for 2014 of 13.4 – 14.4Bcf points to higher EURS, which supports management comments at its recent analyst day where it pointed to EURs of between 8-9bcf per well.  The increase in prospective EURs is driven by the knowledge gained through its scientific drilling activities which has led it to increase frac stages from 5,000ft to 10,000 ft, consistent with the drilling strategies employed by WPX.  Third, BKH does not include 20,000 net acres it acquired in the Piceance in 2013 through a drill to earn arrangement.  BKH will complete the two wells required to earn these incremental 20,000 acres.  If one adjusts BKH’s potential reserve presentation, the results would be as follows:

     

     

     

     

     

    Net Acreage

     

    # Potential Wells

     

    Implied Acreage Spacing

     

     

    Average Royalty

     

    # Test Wells Completed

    Gross Resource Potential (BCF)

    Net Resource Potential (BCF)

    San Juan Potential

    19,000

    238

    80

    20%

    1

    1,900

    1,520

    Piceance Potential

    74,700

    934

    80

    20%

    4

    7,470

    5,976

    Total Mancos Potential

    93,700

    1,171

     

    20%

    3

    9,370

    7,496

     

    Sensitizing this data and applying a conservative price per potential mcf of between $0.25, one can see the huge leverage in the Mancos opportunity.

     

     

     

    Implied Value per Share

     

     

    40

    80

    120

    160

    Bcf

    6.0

    46.49

    40.07

    37.93

    36.86

    per

    7.5

    49.70

    41.67

    39.00

    37.66

    Well

    9.0

    52.91

    43.28

    40.07

    38.46

     

    10.5

    56.11

    44.88

    41.14

    39.27

     

    The results are still significant even if one assumes a fully-taxed scenario with a $200mm tax basis:

     

     

     

     

    Implied Value per Share

     

     

    40

    80

    120

    160

    Bcf

    6.0

    31.79

    27.62

    26.23

    25.53

    per

    7.5

    33.88

    28.66

    26.93

    26.06

    Well

    9.0

    35.97

    29.71

    27.62

    26.58

     

    10.5

    38.05

    30.75

    28.32

    27.10

     

    The opportunity in the Mancos is significant for BKH and would represent a 2nd step in its E&P monetization strategy.  On August 27th, BKH sold itsWillistonBasin oil and gas assets for $227mm vs. their PV-10 value of $56mm.  BKH has indicated that it will pursue a similar deliberate approach to proving out its Mancos assets prior to monetizing the asset in the most tax-advantaged manner possible.

     

    Risks:

     

     

     

     

     

    I do not hold a position of employment, directorship, or consultancy with the issuer.
    I and/or others I advise hold a material investment in the issuer's securities.

    Catalyst

    Catalysts:

     

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