BRY - Berry Corporation: Significant FCF Generation Despite Increased Operating Expenses

Summary

• Berry increased its full-year guidance around operating expenses by approximately $5 per BOE.
• This wasn't surprising since operating expenses had trended well above guidance over the first half of the year.
• Despite higher operating expenses, Berry could still generate over $2.35 per share in free cash flow (before cash income taxes) at $84 Brent in 2023.
• I estimate its value at $12 per share in a long-term $75 Brent environment.

Berry Corporation ( BRY ) made a significant upwards revision to its guidance for operating expenses, increasing its full-year operating expense expectations by around $5 per BOE . This was due to a combination of cost inflation and continuing high energy costs.

I had expected Berry to increase its operating expense guidance and had been a bit puzzled why it hadn't done so before given that its operating expenses had trended well above guidance during the first half of the year.

That being said, despite the increased operating expenses, I believe Berry can be worth around $12 per share in a long-term (after 2023) $75 Brent environment. At that commodity price, Berry should be able to maintain production levels and generate a bit over $2 per share (before income taxes) in unhedged cash flow.

Guidance On Operating Expenses

I previously thought it would be difficult for Berry to hit its full-year guidance of $20 to $22 per BOE for operating expenses, after its first half operating expenses averaged $25.80 per BOE. Thus, I was a bit perplexed that Berry still maintained its full-year guidance for operating expenses at $20 to $22 per BOE after its Q2 2022 earnings report.

I estimated that in an optimistic scenario, Berry might end up with full-year operating expenses of a bit over $23 per BOE, although I had typically modeled its operating expenses at $24 per BOE since May.

Berry ended up significantly revising its full-year guidance for operating expenses to a range of $25.75 to $26.50 per BOE after its Q3 2022 earnings report. In Q3 2022, its operating expenses increased further to $26.46 per BOE.

Berry probably should have revised its guidance earlier, given that costs were already trending well above the high end of its original guidance range during the first half of the year.

Berry noted that its non-energy operating expense increased in Q3 2022, primarily due to inflationary pressures, while its energy operating expenses decreased by $1 per BOE in Q3 2022 compared to Q2 2022, primarily due to realizing additional gas hedges during the quarter.

Potential 2023 Outlook

Berry has accelerated its development plan and increased its 2022 development and production capex budget slightly from a range of $125 million to $135 million to a new range of $140 million to $145 million. This is expected to mostly impact 2023 production. As a result, I am now modeling Berry's 2023 production at 27,000 BOEPD.

Berry's realized price for its California oil has taken a temporary hit due to a third-party pipeline outage that is resulting in Berry selling 25% of its California oil at a discount. Berry expects the outage to extend into Q1 2023, so this may have a modest (probably less than 1%) on its overall realized prices for 2023.

With 2023 Brent Strip around $84, I estimate that Berry can generate $712 million in revenues after hedges. Berry has swaps covering approximately 57% of its oil production at $76.67 Brent, and these swaps have an estimated value of negative $38 million. I've assumed that its net well servicing and abandonment segment results remain the same as 2022.

I've modeled Berry's 2023 operating expenses at $25 per BOE. Fuel gas is on track to be cheaper in 2023, but Berry has hedged a significant amount of its consumption with swaps at a fairly high price ($5.48 NWPL).

This results in a projection that Berry will generate $183 million in positive cash flow in 2023 at $84 Brent.

Berry's fixed dividend adds up to around $18 million per year currently. Based on its capital return framework, it may put around $99 million (around $1.29 per share with its current share count) towards variable dividends and $66 million towards share repurchases and growth capex.

Valuation Estimates

Despite the increased operating costs, Berry has reduced its share count and net debt enough to maintain its estimated value at $12 per share in a long-term (after 2023) $75 Brent environment.

At $75 Brent, 27,000 BOEPD in average production and $25 per BOE in operating expenses, Berry should be able to maintain production levels and generate approximately $160 million in unhedged free cash flow before income taxes. This would be approximately $2.08 per share with Berry's current share count.

This would be around a 17% FCF yield (before income taxes) at $12 per share, and around a 13% to 14% FCF yield once full cash income taxes are factored in. This seems reasonable for Berry's equity given that its unsecured bonds due 2026 are yielding 9% to 10% to maturity.

Conclusion

Despite operating expenses remaining elevated, Berry still appears capable of generating around $183 million in positive cash flow in 2023 at current strip. With $25 per BOE in operating expenses, it can also generate $160 million per year in unhedged free cash flow (before cash income taxes). Berry's FCF yield (at its current share price and factoring in full cash income taxes) would be approximately 19% at $75 Brent, and I believe that a $12 per-share price for Berry would be a better reflection of its actual value.

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