Ring Energy (REI) - Update May 10

[dan_s]

I received a note from John White this morning.

"Our valuation is based on a net asset value (NAV) analysis which produced $21.98 per share which we rounded higher to $22.00 per share."

In conversations with investors after the REI conference call, we learned there were some concerns regarding the lack of announced results on the North Gaines test well. We address this herein.

We know market participants have been waiting on results from the two test wells being drilled, termed the North Gaines test well and the Brushy Canyon well. Management commentary in the press release was brief, as follows: “The North Gaines and Brushy Canyon wells are on track with encouraging results that will be released in the near future.”

On the conference call, management advised the frack job on the Brushy Canyon well has been completed and is flowing back frack water, with results expected to be announced in July on the 2Q 2018 conference call.

Management then detailed operations on the North Gaines test well, explaining that they intend to try four different frack jobs, with the primary variable being proppant load. We think market participants were disappointed that this well was not announced as a completed well and not what is, in effect, a science well. For this misunderstanding we feel management is the culprit, as, in our opinion, this was not clearly communicated as being a science well. The operations update for 1Q 2018 stated: “The first horizontal well on the North Gaines Property has been drilled, and management is determining the most optimum completion technique.” We think more clarity was needed.

Having cited management as the culprit in communicating the plans for the North Gaines test well, we will now applaud management for tacking, in our opinion, the correct course for this well and the northern portion of the play in general.

As we have written and as our industry contacts have taught us, there are many differences between the Hz San Andres, which is a conventional dolomite reservoir, and the Wolfcamp or Spraberry shale, which are mudstones and unconventional reservoirs.
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My Take: I have known the founders of Ring Energy for more than ten years. They are super conservative, which explains why they hate debt. They take their time and do things the "right way". They are now moving into full "development mode" on their San Andres horizontal play. I want them to move slowly on the North Gaines prospect and do it the "right way". Finding the best completion method makes sense to me. - Dan

[dan_s]

I have updated my forecast/valuation model for Ring Energy (REI) and I have posted it to the EPG website.

My valuation increases by $1.00 to $25.00/share, primarily because I have increased my oil price assumption to $65/bbl for WTI for all future periods.

All you need to do is look at Ring's top line revenue growth (row 8 on the forecast model) to see why this one is in our Small-Cap Growth Portfolio.
> In 2017 Ring increased production by 64% YOY
> They are on-track to increase production by 70% to 80% YOY in 2018 and this now looks like a very conservative forecast.

Ring's current assets exceed current liabilities by 2 to 1 and it has NO LONG-TERM DEBT. Cash on hand and cash flow from operations should fund their entire capex budget this year.

[wilmawatts]

agreed, good management

[ChuckGeb]

Does Ring have any takeaway issues getting their oil and gas out of the basin or do they have firm commitments for transport?

[dan_s]

The takeaway issues are more a problem in the Delaware Basin, but I will confirm this week as Ring is now at the top of my To Do List. Also, the takeaway issues are being solved by the midstream companies. It is a short-term problem, a year at most.

[dan_s]

I just got off of the phone with Ring's IR manager. He's getting lots of calls about the Permian Basin takeaway "concerns".

He told me:
> Ring has a five year contract with a division of OXY to take all of their CBP production.
> It is a sour crude and OXY wants it to blend with sweet crudes at their Gulf Coast refinery.
> Today Ring is selling oil at a $3 to $4 discount to WTI and they do not see that changing anytime soon.

I am taking this into consideration in my forecast model.

If I assume a $10 discount to WTI for 2018 and 2019, my valuation is $21.60/share.

[ChuckGeb]

Good work fleshing that out!