BATL - Battalion Oil: Too Debt-Heavy

Summary

• Battalion Oil Corp. is a $160 million market cap company built from the assets of the former Halcon Resources, which went through bankruptcy in 2019.
• Its net long-term (and high-cost) debt of $179 million on September 30, 2022, outweighs its current market capitalization of $160 million by 12%.
• With an amine treater soon online, the company is addressing common Delaware Basin gas quality issues.

Battalion Oil Corporation (BATL) is a small oil producing company that emerged from bankruptcy (it had been Halcón Resources) in early 2020.

Higher-valued oil production is about half of total production.

Thinly traded and with a liability-to-asset ratio of 81%, the company's first priority is paying off high-cost debt. On September 30, 2022, Battalion had a term loan credit facility of $204 million. In November 2022, it amended the credit agreement and is currently paying interest at the secured overnight financing rate (SOFR) PLUS 7.5%. At present the SOFR is 4.55% , which means the company's interest costs on its credit facility are a high 12.05%.

Although Battalion is making interesting drilling and production progress, its straitened circumstances and first-priority high-cost debt make it unappealing to equity investors. And--obviously-it does not offer a dividend.

Results for 4Q22 and full year 2022 are expected the week of March 6-10.

Third Quarter 2022 Results and Guidance

In the third quarter of 2022, Battalion's operating revenue was $99 million, 70% from crude oil. Operating expenses were $55 million to give income from operations of $44 million.

However, quarterly net income was an outsized $106 million, or $6.42/diluted share. This was due to a $67 million gain on derivative contracts, a gain unlikely to be repeated in future quarters.

Cash provided from operations was $25.5 million for 3Q22 and $53.8 million for the first nine months of 2022.

During the quarter, Battalion produced an average daily net of 16,200 barrels of oil equivalent/day (BOE/day), 50% oil.

The average price received before derivatives in 3Q22 was $66.11/BOE, compared to $49.36/BOE in 3Q21. However, with derivative settlements included, the realizations were closer: $43.02/BOE in 3Q22 compared to $35.63/BOE in 3Q21.

For full-year 2022, the company projected production to average between 14,000 and 17,000 BOE/D, about half oil. Capital expenditures for the year were projected at $130-$150 million.

Operations

Battalion has interests in 40,400 net acres in the Delaware sub-basin in the west Texas counties of Pecos, Ward, Winkler, and Reeves (shown above).

The company's primary assets are in the Monument Draw, West Quito, and Hackberry areas of west Texas.

Because some of its natural gas production has high levels of hydrogen sulfide, Battalion and Caracara Services joint ventured (5% Battalion-95% Caracara) to build an amine treating facility. This is due to come online in 1Q23. Initial capacity will allow the capture and sequestration of over 50,000 tons per year of hydrogen sulfide and carbon dioxide, enhancing reserve access for Battalion.

US Oil and Gas Prices

The February 17, 2023, oil futures price for March 2023 delivery was $76.34/barrel for West Texas Intermediate ((WTI)) crude oil. The natural gas futures price that day, also for March 2023 delivery, was $2.275/MMBTU.

While oil supply is on the tight side, much depends on China's recovery and demand. Natural gas pricing is expected to be looser until new (not just the Freeport restart) US LNG plants come online in 2024.

Ironically, or maybe not, the Biden administration's across-the-board war on hydrocarbons results in higher oil prices since companies are returning capital to shareholders rather than amping up spending on domestic production.

The Energy Information Administration's (EIA's) Short Term Energy Outlook (STEO) projects 5-95 confidence intervals for oil and gas prices through the end of 2024 as shown below.

Hedges

In its November 2022 investor presentation , Battalion noted an aggressive hedging strategy for base production. For 2023, among its positions are 6900 BPD of WTI oil swaps at $69.62/bbl and 13,760 MMBTU of Henry Hub gas swaps at $3.70/MMBTU.

Reserves

At December 31, 2021, Battalion's total estimated proved reserves were 95.8 million BOEs. This may increase at the year-end 2022 assessment due to higher hydrocarbon prices. Of the total, oil was 58.2 million barrels (61%), natural gas liquids were 16.3 million barrels (17%), and natural gas was 125.0 billion cubic feet (22%).

The SEC PV-10 value of reserve s on December 31, 2021, was $1.08 billion, 5x the value of year-end 2020.

Competitors

Battalion competes with the majority of US public and private oil and gas companies since most have Permian operations. Also, like most, it is headquartered in Houston, Texas.

Governance

At February 1, 2023, Institutional Shareholder Services ranked Battalion Oil's overall governance as a 5, with sub-scores of audit (8), board (5), shareholder rights (1), and compensation (8). In this ranking a 1 indicates lower governance risk and a 10 indicates higher governance risk, so Battalion's overall governance ranking is neither weak nor strong.

On January 31, 2023, short shares were 8.95% of float and insiders held 1.51%.

Battalion's beta is 1.18, surprising tame given its small size and oil's price volatility.

At December 30, 2022, the top four holders of Battalion's stock were Luminus Management, a hedge fund (38.0%), Oaktree Capital-alternative investments (18.6%), LSP Investment Advisors (fund holding mainly energy and utility stocks), (14.6%), and Goldman Sachs (5.7%).

In late January 2023 the company announced the appointment of Kristen McWatters to be executive vice president, chief financial officer, and treasurer, replacing Kevin Andrews.

Financial and Stock Highlights

A February 17, 2023, closing price of $9.77/share gives a market capitalization of $160 million. The 52-week range is $7.42-$21.85, so the closing price is only 45% of the 52-week high.

Trailing twelve months' ((TTM)) net income (through September 30, 2022) was $52.1 million, for an earnings per share of $3.11. Operating cash flow was $75.2 million and levered cash flow was -$16.9 million.

The TTM price/earnings ratio suggests considerable value at just 3.1.

Also on September 30, 2022, liabilities were $386 million, of which net long-term debt was $179 million and total (current and noncurrent) liabilities from derivative contracts were $64.7 million. The high interest cost of 12.05% is described above. Assets were $477.5 million. Most of the assets, $369.6 million, were the NET value (gross less depletion) of oil and gas properties, appraised using full cost method.

Overall, this gives a steep liability-to-asset ratio of 81%.

Total (current and noncurrent) debt of $204 million at September 30, 2022, compared to market capitalization of $160 million now gives a debt/market cap ratio of 1.28, that is, debt substantially outweighs the market capitalization. Net long-term debt of $179 million still exceeds market capitalization.

Battalion Oil does not pay a dividend.

Only one analyst follows the company: that analyst rates BATL a "buy."

In addition to its small market cap, another factor is thin trading. For example, out of 6.11 million shares floated (16.34 million outstanding), on February 17, 2023, the stock traded a small 4,900 shares. Average trading volume is only 10,600 shares. Thin volume results in high-friction sudden stock price moves.

Notes on Valuation

The company's enterprise value ((EV)) is $338 million. With trailing twelve months' EBITDA of $118 million, the enterprise value/EBITDA is a very bargain level of 2.9.

Battalion's market capitalization per flowing BOE is low at $9900 while its market cap per flowing barrel of oil is also low at $19,700.

Summarizing, the company has an enterprise value on February 17, 2023, of $338 million and market capitalization of $160 million. On September 30, 2022, total assets were $478 million, and liabilities were $386 million. For year-end 2021, the SEC PV-10 value of reserves was $1.1 billion.

Positive and Negative Risks

Potential investors should consider their inflation expectations as these will affect Battalion's operating and interest costs. Investors should also weigh their oil and natural gas price expectations as key factors in Battalion Oil's future results.

The increased seismicity of the Permian is also a risk for all companies there.

Recommendations for Battalion Oil Corporation

Battalion Oil is likely to report higher reserve values for year-end 2022. Its EV/EBITDA ratio and trailing price-earnings ratios both indicate bargains at very low levels of 2.9 and 3.1, respectively.

However, high-cost (currently 12.05%) debt that now outweighs market capitalization means debt holders call the shots.

Among equity holders, the three largest investors own 70% of equity. This means they, too, will have considerable say-especially Luminus Management-in Battalion's operations.

Battalion's stock is thinly traded, does not pay a dividend, and its upside is limited due to hedges and heavy leverage.

I recommend against investing in Battalion Oil stock.

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