CIVI - Civitas: Higher For Longer

2023-12-17 04:29:45 ET

Summary

• Civitas Resources is an acquisition-focused DJ Basin producer with a large asset base.
• The company's strategy focuses on generating free cash flow, maintaining a strong balance sheet, returning cash to shareholders, and demonstrating ESG leadership.
• Civitas expects to generate $850M of free cash flow through 2023 and has returned almost $1B back to shareholders with more to come in 2024.

Company Overview:

Civitas Resources ( CIVI ) emerged in November 2021 following the amalgamation of Bonanza Creek Energy, Crestone Peak Resources, Extraction Oil and Gas, and HighPoint Resources, solidifying its stature as a prominent DJ Basin producer. With strategic forays into the Midland and Delaware Basins through the acquisitions of Hibernia and Tap Rock, Civitas has diversified its portfolio, enhancing asset quality, and bolstering its standing in the Permian region.

The company's robust presence in the DJ Basin has been instrumental in driving strong returns and free cash flow ((FCF)), a trend further augmented by its recent expansion into the Permian Basin. This expansion not only fortifies asset quality but also contributes to greater diversification. With a substantial increase in scale, Civitas is better positioned to generate improved FCF and capitalize on investment opportunities. Despite its added scale, the company's valuation appears attractively priced, displaying a discount relative to industry peers across various metrics, positioning Civitas as an undervalued entity in our exploration and production (E&P) coverage.

Civitas' Strategy Overview

CIVI's strategy is based on the four pillars model of generating free cash flow, maintaining a robust balance sheet, returning cash to shareholders and ESG demonstrating leadership.

Through 2023, the company expects to generate roughly $850M of free cash flow based on analyst consensus with a median figure of almost $900M.

Through 2023, Civitas has returned almost $1B back to shareholders, thereby demonstrating its adherence to its strategy of returning capital back to shareholders. Civitas is set to pay approximately $700 million in combined base and variable dividends. Additionally, the company repurchased around $300 million of its common stock in the first quarter of 2023, followed by an additional $20 million worth of repurchases in the second quarter of the same year.

CIVI has been a serial acquirer of assets. To that end, Civitas successfully finalized its acquisitions in the Permian Basin during the third quarter of 2023 and is in the process of completing the subsequent Vencer acquisition, marking a significant transformation for the company. During a recent call to investors, CIVI highlighted that the integration of Permian assets is progressing faster than expected, and it remains on schedule to achieve its divestiture target of approximately $300 million by mid-2024, with the sales process currently underway.

Q3 Analysis:

Third-quarter results met anticipated targets, leading CIVI to slightly increase its full-year capital expenditure by approximately 5%. This adjustment is due to the acceleration of some activities throughout the year. The production guidance for 2023 was raised by around 1% to reflect these developments. While CIVI maintained its initial projected volume and capital expenditure for 2024 (325-345 mboe/d / 155-165 mbbl/d for capex of $1.95-$2.25 billion), the increased activities in the latter half of 2023 suggest a more optimistic outlook compared to the original plan.

Hedge Book Overview:

Civitas maintains a hedge book which is short-term in nature. It helps the company better plan its production and provides it with the confidence to execute on its plan of shareholder return while also allowing it to deleverage effectively. While the hedge book provides visibility and predictability to its cash flow, it makes it less leveraged to rising price of oil. However, net-net, this strategy does lock in excellent cash flows which in turn drive higher variable dividend payments as well as shareholder buybacks.

A Discussion on Valuations:

CIVI's free cash generation is expected to rise from ~$900M in 2023 to roughly $1.6B based on median analyst projections. This number has a reasonable level of predictability given the aforementioned hedges that CIVI currently maintains as well as the visibility it has provided on the CAPEX front. This level of free cash generation is especially attractive given its Enterprise Value (EV) of ~$10B which translates to a free cash flow yield of ~16%. The attractive free cash flow for next year is no fluke. I expect the company to maintain stable production over the next three years as well as stable CAPEX. This should allow the company to generate roughly the same cash flow over the next three years, barring a significant decline in the price of oil.

Furthermore, as CIVI has already demonstrated before, one cannot rule out additional M&A which in turn would drive higher levels of production and thereby higher levels of free cash generation. Thus far, M&A has not come at the expense of shareholders, which bodes well for upside associated with future M&A.

The company currently has 1238 BCF of proven developed gas reserves and 2221 BCF of undeveloped gas reserves. In addition, it also has 261 mmbl of proven developed oil reserves and 591mmbl of undeveloped reserves. The value of these oil and gas assets is ~$124/share, which I derive using its current production costs and associated CAPEX to develop the non-producing reserves. I arrive at a NAV of ~95/share and adjusting ~$29/share of net debt currently carried on its balance sheet. CIVI currently trades at $69/share versus a $95/share NAV.

Assuming a moderate level of success in delineating more reserves and continued level of operations, it is easy to derive an even higher share price. From an EBITDA perspective, CIVI currently trades at 4x EBITDA. However, after adjusting for a higher level of EBITDA which is made possible due to its recent acquisition, that multiple drops to a mere 2.4x in 2024. Assuming a steady state EBITDA multiple of 4x, I arrive at a share price of $115/share which is nearly 67% higher versus today.

What Could Go Wrong?

There are five primary risks for Civitas. Firstly, the company operates in Colorado, subject to stringent regulatory protocols that could influence well permitting. Secondly, Civitas faces exposure to inflation, potentially impacting its overall cost framework. Thirdly, similar to other Exploration and Production (E&P) entities, Civitas is susceptible to the broader fluctuations within the oil and gas market, significantly influencing its financial standing. Fourthly, a substantial decline in commodity prices could elevate the company's leverage. Lastly, there exists a risk of acquiring less favorable assets or encountering difficulties in integrating newly acquired assets.

Conclusion - CIVI is an attractive buy at today's levels

The company has all the right ingredients to be a winner in the oil and gas sector. I rate Civitas as a strong buy for a number of reasons.

• the company has a clear and well-articulated strategy, which it has been successfully executing
• The company has the necessary scale to be able to acquire meaningful assets and produce them efficiently
• Considering its 2024 estimates, the company trades at a modest 2.4x EV/EBITDA ratio
• The company currently generates substantial cash flow, with expectations of a significant increase in free cash flow generation in 2024, amounting to approximately a 16% FCF yield.
• The company is focused on shareholder returns through dividends and buybacks

For further details see: