|Shares Out. (in M):||180||P/E||21.0x||17.0x|
|Market Cap (in $M):||5,400||P/FCF||9.0x||9.0x|
|Net Debt (in $M):||3,759||EBIT||0||0|
Long QEP Resources
QEP is an efficiently run oil and gas explorer whose stock has gone nowhere since 2011, owing mostly to its dependence on natural gas. Since natgas prices collapsed amidst higher supply and a warm winter in 2011/2012, QEP has been diversifying into crude and NGL’s. From 90% natgas in 2010, QEP should produce roughly an equal mix of natgas and liquids in 2014. To diversify, the company has made 2 large acquisitions, one in the Bakken Shale in North Dakota in 2012, and just last month (Dec 2013), for assets in the Permian Basin.
Since announcing its $1BB deal in the Permian, QEP has lost some $500mm of market cap. Jana has been a big buyer of shares amidst the selloff, almost doubling their stake from 9mm to 17mm shares, or 9.5% of the company (recent purchases at $29.75). They are pushing for a separation of QEP’s Midstream business, and management has also announced that they are on board with a split. Assuming a spin off within the next 6-9 months of Midstream, QEP’s sum of the parts discount should disappear. At $30, the stock offers $2-3 dollars of downside risk against $5-10 of upside. Any sustained improvement in gas prices could add another $5 of upside.
|Debt from Permian Acq||1,000|
|Total Debt, net||3,759|
|Co estimated pf EBITDA||1,709|
|Implied EBITDA 2014 Perm acq||164|
|TEV excl Field Svcs||7,316|
|TEV / mmcfe||2.17|
|TEV / mmcfe exc Field Svcs||1.74|
|TEV / EBITDA multiple||5.75|
Leverage is low proforma for the Permian deal at 2.2x Debt/EBITDA. There are no meaningful maturities as its bonds are longer dated out to 2018-2022. The company, despite its large cash deals totaling $2.4BB, has not issued stock, and funded them with Revolver capacity. QEP intends to upsize its revolver near term to increase capacity too. I have been told that the recent Permian deal (expected to close end of January), could already be flipped today at a higher price.
Exploration and Production Segment:
QEP today focuses on 2 oil plays, the Williston Basin (in the Bakken Shale) and the Permian Basin. Its liquids rich gas plays are in the Uinta Basin and the Pinedale in Utah/Wyoming. QEP intends to sell its mid-con assets. EBITDA overall will run around $1.5BB next year in the E&P segment.
Slides here are useful: http://media.corporate-ir.net/media_files/IROL/23/237732/QEP%20December%20Presentation.pdf
Since announcing the Permian Basin acquisition, management announced their intention to finance the deal with revolver capacity, then with proceeds from the sale of its Mid-Continent assets. Generally QEP is not the operator in the Woodford shale, and its Granite Wash play is one that lacks contiguous acreage. Not to mention that these are gas heavy reserves. Net of taxes, QEP can likely sell the Mid-Con assets for somewhere between $700 and $1BB. (Happy to provide M&A comps to support that).
As for QEP’s remaining basins, they are larger more contiguous blocks of acreage and so benefit from scale efficiencies. Its numbers generally support the fact that operating costs and Finding & Development costs are lower than industry averages by a fair margin.
QEP’s 3 year average F&D costs are approximately $2/mcfe ($2.20 all in, and $2 excluding price revisions). QEP’s lifting costs/OH run in the $2.50 range, also impressive. With net revenue per mcfe around $6.80 today (based on its mix of oil/NGL’s/gas), that means that the company is earning $2.30/mcfe in economic profit. Healthy numbers especially considering that comps tend to run around $3-3.50 in lifting costs range, with F&D costs in the $2-3 range.
Where management fails here is in capital allocation. The 2 deals to buy oil assets (the Bakken shale acquisition for $1.4BB, and the Permian acquisition for $1BB) have both been near term dilutive. QEP has no dividend to speak of or share buyback plan in place for an obviously undervalued stock. And it took an activist to get management to consider a separation of its Midstream from its E&P assets.
Over time, QEP has built out its own midstream assets to complement its E&P operations. That includes gathering lines and processing plants in its acreage. These are great MLP-able assets, and really have little value buried inside an E&P business. Williams, Targa, Chesapeake are just a few examples of E&P companies that separated their midstream operations from their E&P businesses, creating plenty of value for shareholders in the process.
In QEPs case, the company IPO’d a portion of its midstream assets in August 2013, keeping 58% of the equity post deal (including a GP with IDRs). They dropped $88mm of EBITDA assets to QEP Midstream (ticker QEPM), keeping roughly $150mm of EBITDA at the parent. The typical playbook is to drop down assets over time, capturing the higher EBITDA multiple sales proceeds and GP IDRs at the parent.
In this case however, Jana has pushed the company to completely separate its midstream business (aka Field Services). Management caved (likely fearing a proxy battle), and I am told have significant resources working on the details of a spin off of Field Services including the company's stake in QEPM. Their letter last November is a good read:
While I am far from a tax expert, and initially assumed that the company could not spin off Field Services followed by a drop down of Midstream assets into QEPM, I have been told otherwise by the company. That is, they could preserve the tax free spin even with drop downs post.
This deal has caused a drop of $3 in the stock in just a month. The $1BB transaction, priced at 6.7x 2014 EBITDA and 4.0x 2015 EBITDA, seems fair. Capex will exceed EBITDA in 2014 by $110mm, and will roughly equal EBITDA in 2015. That means, CF accretion will be delayed until 2016, and probably caused a fair number of unhappy shareholders.
However, given management’s history of success in exploiting larger contiguous blocks of acreage, and the fact that they intend to quadruple production in the Permian by 2017 from today’s levels, indicate that long term this deal probably will generate decent returns (I get a 10% IRR on cash flows out 10 years assuming flat oil/gas).
Admittedly, the company has not operated in the Permian basin before, but the oil shale wells required mimic what they have done in the Williston Basin in the Bakken Shale. The acreage is also prime, with deep intervals exactly the same as Pioneer’s prolific shale intervals in the Permian (Atoka, Wolfcamp, Spraberry). Generally I am not worried about the reserves here.
Sum of the Parts
In my base case, I assumed a 10x multiple on the Field Services business, and then used the EBITDA multiple for WPX Energy (5.6x) to value the E&P assets. I consider WPX the best comp with both Bakken and Rocky Mtn assets.
|2011||2014||Base Case||Bull Case|
|EBITDA mix||EBITDA||EBITDA||Multiple||Multiple||Value Range|
|Total Debt, net||$3,759||$3,759|
|Value to Equity||$6,302||$7,442|
|Fair Value Range||$35.01||$41.34|
QEPM trades at 13x EBITDA. The public gathering & processing energy MLPs trade at 14.3x on average (including DPM, MWE, EEP, QEPM, RGP, SXE, NGLS). QEP has in its past traded as high as 7.0x EBITDA, so the upside case of a 6.0x multiple for E&P and a 13x multiple on the Field Services (which holds the GP of QEPM mind you), offers 37%+ upside. I view the bull case assumptions here as quite acheivable. The C-Corps that own GP interests trade at 18x EBITDA on average.
Note: My 2014 EBITDA figures were essentially Q3 runrate figures, less hedging gains, net of MI from QEPM, and adding in 2014 EBITDA from the Permian Deal. Overall organic production growth has been down slightly this year, with higher production in oil offsetting declining production in gas, but leading to better margins. I think the company can gradually build back up to its low double digit production growth rates going forward.
Finally, there is an argument that SG&A, which is allocated to the different segments, overly penalizes the EBITDA at Field Services. There could easily be $30mm of OH at Field Services that more appropriately should reside at E&P. That would add $1-2 to the value here.
Conclusion / Risks
With a near term catalyst (divesting the Midstream business), its hard to see the sum of the parts discount not disappearing. Even at 5x and 10x EBITDA on the E&P and Midstream businesses, levels I consider trough multiples, the stock would be worth $30. Naturally if gas and/or oil prices fall, this downside could be lower. At the bottom in Spring 2012, when gas traded at $2, the stock fell to $25. Mitigating this is the fact that the company plans to hedge “aggressively” its future Permian production, and for 2014 has hedges for around 30% of its volumes.
Looked at it from a free cash flow perspective, the company will generate FCF (excluding growth capex), in the $3.00 to $3.60 range per share in 2014, indicating upside of 30%+ at 8% FCF yields. (I excluded growth capex, used $2.20 F&D costs on current production as a proxy for maintenance capex at E&P and $50mm of maintenance capex at Field Services).
The stock did trade over $45 in 2011 when natgas prices ranged from $3.80 to $4.80 (and at 7.0x EBITDA). Today’s strip prices are 4.20/mcf, levels not far off from 2011. There seems an unwillingness to "buy into" higher gas prices by investors, so consider it a free option. By the way, natgas inventory numbers this week were quite bullish (at 5 year lows).
|5 Yr Avg||2,952|
Regaining confidence in management will take time, and there is risk to divesting the Midstream business (an outright sale might imply tax leakage, or inability to spin off the Midstream business tax-free). The tax basis in Midstream is very low. The board may conclude that keeping the GP and continuing to drop down assets into QEPM rather than hiving off Midstream altogether is a better plan. That may imply a continued conglomerate discount. A proxy fight could also cause uncertainty in the stock.
In any case, risks to commodity prices, recession, additional acquisitions, continued oversupply of natural gas, all could weigh on the stock.