|Shares Out. (in M):||15||P/E||0||0|
|Market Cap (in $M):||525||P/FCF||0||0|
|Net Debt (in $M):||65||EBIT||0||0|
Penn Virginia (PV) is an Eagle Ford focused E&P Company which emerged from bankruptcy on September 12, 2016. Its shares currently trade over the counter by distressed debt desks but are expected to become exchange listed during H1 of 2017.
As with many post-restructuring equity opportunities, Penn Virginia’s valuation is very low, market awareness is scant and current commentary from the Company is quite limited. That said, the benefits of the restructuring are quite clear and quite extraordinary. Specifically we believe that the company will benefit greatly from improved management and a vastly improved balance sheet and cost base – and importantly, we believe that these benefits are not currently understood by the market. Longer term, we believe that Penn Virginia’s strong operating leverage and limited financial leverage provides a very compelling oil-focused investment opportunity in a commodity environment that is likely to improve over time.
Extreme Makeover – Oil & Gas Edition
When investing in oil and gas companies, we have found that it pays to be selective. Specifically we have learned to look for the following traits:
Very few companies meet these criteria and, prior to restructuring, Penn Virginia scored quite poorly on these measures. In particular, the company was run by an entrenched and largely ineffective management team from their headquarters in suburban Philadelphia. The board was weak and unable to make material changes even in the face of shareholder activism. The valuation, which peaked at an EV of over $2.5B was out of line with the Company’s opportunity set and the balance sheet, with net debt of over $1.25B greatly hindered investment.
With this as a starting point, the restructuring process for Penn Virginia represents an extreme makeover. In the following sections we will briefly address how the company meets each our criteria.
Net debt has been reduced from a recent peak of $1.25B to $65M as of emergence (consisting of $75M drawn on a new revolver and $10M of cash). The pre-petition debt was shed by converting $1,075M of unsecured bonds into new equity while the old shares were cancelled along with nearly $200M of perpetual preferred shares. Based on our estimates, current leverage is less than 1x 2017 EBITDA placing PV among the very best in class for balance sheet strength.
While the Eagle Ford is one of the most prolific and economic plays in the country, PV’s inventory has historically been subject to debate. While still unsettled, the inventory question is far less relevant today than it was two years ago as a result of the drastic reduction in the Company’s scale.
In Q2 2015, PV’s production peaked at approximately 25 Mboe/d following capex spending in 2014 of $775M under a development program that ramped up to 8 rigs and drilled 94 wells during that year. At this pace, it was clear that the best acreage would be developed rather quickly and that investors were making a significant bet on acreage that was either lower in quality or not as well understood. Today, the company’s disclosed business plan contemplates a single-rig development program which effectively extends the higher quality / higher confidence runway by a factor of 8.
It is also worth noting that the inventory of economic drilling locations increases as oil prices increase, Drilling and Completion (D&C) and operating costs drop and drilling and completion techniques improve. For instance, EOG Resources recently estimated that a 10% improvement in well cost or productivity would more than double their economic inventory in the Eagle Ford. While historically the Company has not wrapped itself in glory with regard to D&C innovation or well productivity, they have begun to implement changes (such as using higher intensity completions) that have produced significant improvements for offset operators. The Company’s most recent wells utilize these techniques and the resulting production has been consistent with some of the best wells in the play.
As with PV’s inventory, its growth profile has been dramatically improved by its reduced scale. The company’s base level production is less than half of its peak and the decline rate has improved as little of the current production is coming from recently drilled wells. With this smaller denominator, significantly lower decline rate and the benefit of far lower D&C costs, we believe that mid-teens production growth can be generated without increasing leverage - all based on prices that are consistent with the current forward curve. This expectation is also borne out by the Company’s internal projections.
Under a 1-rig scenario, as disclosed in the company’s Form 8-K filed on May 12, 2016, production should bottom in Q4 of 2016 at 9.6 Mboe/d, average 13.7 Mboe/d in 2017 and increase to 16.1 Mboe/d in 2018. Importantly, this growth is projected to occur with a cumulative negative FCF of only $7M over the 2+ year period – a radically different proposition than the debt-fueled hyper-growth that was targeted by the Company prior to the collapse in oil prices. Mid-teens production growth within (or nearly within) cash flow places PVA among the best of its peers.
Since 2014, D&C costs have been radically reduced across the industry and they continue to improve. However, with no rigs currently running, the magnitude of this benefit to PVA is unclear. We look forward to data on this point once the new drilling program is initiated.
The two most obvious improvements that can be quantified are interest expense and G&A. Regarding the former, annual interest expense of approximately $87 per year has been eliminated due to the equitization of approximately $1B in bonds mentioned above. This number rounds up to nearly $100M per annum when the coupons on the preferred shares are included. Regarding the latter, PV spent approximately $43M and $49M on G&A in 2015 and 2014, respectively, while projected G&A is expected to total only $17M per annum. We believe these projections appear to be quite credible given the Company’s significant headcount reduction and cash flow performance during the restructuring process. Based on these projections, unit G&A for 2017 is expected to be less than $3.50 per Boe and less than $3.00 per Boe in 2018. This would rank PV’s overhead costs among the best of its oil-focused peers.
An additional significant improvement in PV’s cost structure relates to its midstream contracts. Importantly, PV’s oil gathering and marketing agreement (which was signed near the peak of the market and peak of PV’s growth expectations) was rejected during bankruptcy and subsequently renegotiated. Under the new terms, the minimum volume commitments have dropped from 15 Mbbl/d to only 8 Mbbl/d while the fees per barrel have been reduced. Going forward, we expect PV’s differentials to be among the best in the basin.
The company has yet to announce who will be running the company now that it has emerged. It is clear that the former and interim CEOs will not be involved and so we shift our prior view on the quality of management from negative to neutral while we wait for further information.
With regard to the new board, three members have been announced and each gives us good reason to be confident in the direction of the Company. They are as follows:
Harry Quarls (COB): MD of a large, energy-focused private equity fund who previously ran the global energy practice for Booz Allen.
Darin Holderness: Former CFO of Concho Resources (CXO) and CAO of Pioneer Natural Resources (PXD), two highly-regarded, large-cap operators in the Permian Basin.
Marc McCarthy: Senior MD of Wexford Capital, a highly successful, energy-focused, public and private investment fund that backed the development of Gulfport Energy (GPOR) and Diamond back Energy (FANG), two of the most successful E&P companies of this decade.
We believe that these three individuals bring a great deal of operating and financial savvy as well as keen understanding of how to create value for shareholders. Based on court filings, Wexford was a large holder of PV’s distressed bonds that have now converted to the new common shares. We will be looking for indications that other board members and the future management team will be similarly aligned with the interests of shareholders.
Penn Virginia is not just cheap, it is excessively so – even within the context of being a very recent post-bankruptcy equity opportunity.
Shares Outstanding: 14,992,018 2017 EV/EBITDAX: 5.2x
Price: $35 2018 EV/EBITDAX: 4.0x
Market Cap: $525M Net Debt / 2017 EBITDAX: 0.6x
EV: $590M Net Debt / 2018 EBITDAX: 0.4x
The Eagle Ford peer group trades at over 8x 2017 EBITDA with nearly 4x leverage while oil-oriented E&P Companies with better balance sheet trade at closer to 9x. And, Oil-oriented companies that can support double-digit production growth within cash flow trade at even higher multiples.
There is no peer group for oil-focused E&P companies that (1) have less than 1 turn of leverage; (2) enjoy basin leading differentials and best-in-class unit G&A; (3) have highly economic drilling opportunities and can grow production within cash flow in the current oil price environment; and,(4) have an engaged and shareholder oriented boards. If there was such a peer group, it would not trade at 5.2x estimated 2017 EBITDAX.
Years ago, I read about the amazing opportunities that can come from investing in post-bankruptcy companies in the investing classic You Can Be A Stock Market Genius. We believe PV exemplifies the transformation that can take place through bankruptcy and the low valuations that can accompany stocks once companies emerge from bankruptcy.
Post bankruptcy equity
National listing in H1 2017