Sweet 16 Update - Nov 21
Posted: Sat Nov 21, 2020 9:42 am
10 of our Sweet 16 Growth Portfolio companies were trading below book value based on the November 20th closing prices and their 9-30-2020 balance sheets. All 16 companies have survived the worst of the pandemic (Q2) and are now generating solid cash flow from operations. Keep in mind that their balance sheets have absorbed record high impairment charges. Natural gas and NGL prices are much higher today than they were on September 30 and oil prices appear to have gotten over a key resistance level, which means their balance sheets are understated. Most of the Sweet 16 are using free cash flow to pay down their debt, which will also increase net book value. The Sweet 16 is up 69.5% since Good Friday, April 10 (the date that I picked as the bottom of this cycle), but the group is still trading at a 64.3% discount to my valuation.
Upstream oil & gas companies are required to use the Full Cost Method or the Successful Efforts Method of accounting. Both methods require upstream companies to write-down or "impair" their oil & gas fixed assets to market value. Full Cost rules look at the entire pool of assets using a ceiling test based on average commodity prices over the last twelve months. Because of the pool concept, higher valued assets can "cover" for some of the lower valued assets for Full Cost companies, therefore the Successful Efforts Method is more conservative since all significant properties must be marked-to-market on an individual basis under FAS 21. The problem that I have with the impairment accounting rules is that writedowns cannot be reversed. So even if oil, gas and NGL prices were to double over the next six months, the upstream companies cannot mark-to-market their balance sheets back to reality. I hate these "One Way" accounting rules because they mislead investors. Just keep in mind that impaired assets are not abandoned. The companies still own the properties.
In my opinion, the true value of any company is the operating cash flows that it will generate in the future. The positive cash flows can be used to pay down debt, invest in building the business, or returned to investors as dividends and/or stock buybacks. Today the Wall Street Gang discounts the companies that are spending most of their cash flow on growth. This is why we've seen a record drop in the active rig count, which in turn will result in falling oil & gas production. Today we are running less than half the number of completion crews necessary to hold U.S. oil production flat.
When falling production is combined with rising post-pandemic demand growth we have the recipe for higher oil, gas and NGL prices. We have already seen higher natural gas and NGL prices (despite the recent pull back on short-term mild weather) and natural gas is just weeks from a big increase in demand.
Under Tab 1 of the main Sweet 16 spreadsheet, which is updated each Saturday, you can see which companies are trading below book value.
The three largest discounts go to:
> Antero Resources (AR) that is trading at just 15.3% of net book value.
> Callon Petroleum (CPE) that is trading at just 26.4% of net book value, despite a nice stock price increase last week.
> Talos Energy (TALO) that closed on Friday at just 46.9% of net book value. < Finally able to get all of their hurricane related shut-ins back on-line. Talos has told the market that it expects to ramp up December production to more than 71,000 Boe per day, from actual production of 48,583 Boe per day in Q3. Their producing platforms in the Gulf of Mexico sustained only minor damage from four hurricanes that impacted the Central GOM, Laura being the worst. Talos has huge upside offshore Mexico, which we will highlight in our updated profile late this month.
All of the Sweet 16 forecast/valuation models have been updated on the EPG website. Log on, click on the Sweet 16 tab and check out the operating cash flow that Antero Resources is going to report for Q4. ~93% of Antero's Q4 natural gas is hedged at $2.87/mcf.
Updated profiles for CPE, XEC, CRK, CLR, EQT and PDCE can also be found under the Sweet 16 tab.
The rest of the profiles will be updated by the end of November. EOG, OVV, FANG, MTDR and PXD are sitting here waiting on my final review.
Upstream oil & gas companies are required to use the Full Cost Method or the Successful Efforts Method of accounting. Both methods require upstream companies to write-down or "impair" their oil & gas fixed assets to market value. Full Cost rules look at the entire pool of assets using a ceiling test based on average commodity prices over the last twelve months. Because of the pool concept, higher valued assets can "cover" for some of the lower valued assets for Full Cost companies, therefore the Successful Efforts Method is more conservative since all significant properties must be marked-to-market on an individual basis under FAS 21. The problem that I have with the impairment accounting rules is that writedowns cannot be reversed. So even if oil, gas and NGL prices were to double over the next six months, the upstream companies cannot mark-to-market their balance sheets back to reality. I hate these "One Way" accounting rules because they mislead investors. Just keep in mind that impaired assets are not abandoned. The companies still own the properties.
In my opinion, the true value of any company is the operating cash flows that it will generate in the future. The positive cash flows can be used to pay down debt, invest in building the business, or returned to investors as dividends and/or stock buybacks. Today the Wall Street Gang discounts the companies that are spending most of their cash flow on growth. This is why we've seen a record drop in the active rig count, which in turn will result in falling oil & gas production. Today we are running less than half the number of completion crews necessary to hold U.S. oil production flat.
When falling production is combined with rising post-pandemic demand growth we have the recipe for higher oil, gas and NGL prices. We have already seen higher natural gas and NGL prices (despite the recent pull back on short-term mild weather) and natural gas is just weeks from a big increase in demand.
Under Tab 1 of the main Sweet 16 spreadsheet, which is updated each Saturday, you can see which companies are trading below book value.
The three largest discounts go to:
> Antero Resources (AR) that is trading at just 15.3% of net book value.
> Callon Petroleum (CPE) that is trading at just 26.4% of net book value, despite a nice stock price increase last week.
> Talos Energy (TALO) that closed on Friday at just 46.9% of net book value. < Finally able to get all of their hurricane related shut-ins back on-line. Talos has told the market that it expects to ramp up December production to more than 71,000 Boe per day, from actual production of 48,583 Boe per day in Q3. Their producing platforms in the Gulf of Mexico sustained only minor damage from four hurricanes that impacted the Central GOM, Laura being the worst. Talos has huge upside offshore Mexico, which we will highlight in our updated profile late this month.
All of the Sweet 16 forecast/valuation models have been updated on the EPG website. Log on, click on the Sweet 16 tab and check out the operating cash flow that Antero Resources is going to report for Q4. ~93% of Antero's Q4 natural gas is hedged at $2.87/mcf.
Updated profiles for CPE, XEC, CRK, CLR, EQT and PDCE can also be found under the Sweet 16 tab.
The rest of the profiles will be updated by the end of November. EOG, OVV, FANG, MTDR and PXD are sitting here waiting on my final review.