HPK - HighPeak Energy: Safer Than Many New Issues

2023-06-09 10:58:53 ET

Summary

• HighPeak Energy, Inc. went public at a time of very hostile industry conditions.
• The company came into being when it combined with a blank check company.
• Howard County appears to be an unusually profitable location.
• The combination of management experience and when it went public lowers the new company risk of investment considerably.
• Production growth and associated cash flow are rapidly climbing.

HighPeak Energy, Inc. ( HPK ) broke a lot of traditions to go public when not many companies go public. In fact, they went public when there was a widely regarded assumption that oil and gas companies could not go public because they would not get a good deal. HighPeak Energy came into being back in fiscal year 2020. The company was the combination of a blank check company with another organization having interests in Howard County. This process combined cash with some very good acreage. Companies that go public "when no one goes public" often beat the new issue odds by a considerable margin.

Most new issue come public at the top of markets when things get "frothy." At that time, insiders believed that they can get good value for shares sold. But the odds of any new company surviving more than five years are often 5% or sometimes less. But a company that goes public "when no one else does" is generally a far higher quality company because going public at an unusual time often means the company has to be higher quality to surmount the usually hostile environment perceived by the market. Because of that consideration, such a new issue often will survive when many others fail.

The company has operations in very lucrative Howard County. Vital Energy, Inc. ( VTLE ), for example, is only developing its Howard County acreage at the current time, probably because management considers that the most profitable acreage to develop. Then, when one comes across a company with only Howard County acreage, that is likely to prove to be a very profitable company.

Further confirmation on the possible quality of the acreage comes from the neighboring operators. Seeing companies like Diamondback Energy, Inc. ( FANG ) in the area would tend to confirm that this acreage is likely to be superb.

Management has rapidly turned the acreage into a positive cash flow situation after only a couple of years of development. The robust commodity prices at the beginning of fiscal year 2022 certainly helped the process along. But free cash flow this quickly is another sign of very good acreage.

It should be noted that this latest guidance is somewhat more subdued than the original guidance. But that hardly subtracts from a very rapid growth story using some excellent acreage.

This company clearly has a goal to build a company and then likely sell it at some point. Therefore, dividends are likely to prove to be a secondary (at best) consideration. Reinvestment of the cash flow to grow the company will be the priority.

The other consideration about a company that goes public when few others would consider doing that is shown above. The stock not only has gains since going public, but the price-earnings ratio is still very reasonable. The industry is still really towards the beginning of a recovery and is perceived by many as historically cheap. Therefore, this issue, like many others in the industry probably has a lot of potential appreciation ahead just to reach historically normal price-earnings ratios.

The stock has pulled back some from recent highs on weaker commodity prices. Now whether the current Saudi Arabia strategy will affect the price going forward is anyone's guess. However, the best time to acquire a company like this is during a time of pricing weakness. This company has a good enough strategy that it will be back.

Many times, new issues that go public at the top of the market are often very much "on sale" within 18 months after going public at 50% of the offering price or less. As David Dreman mentions in his latest book "Contrarian Investing: The Psychological Edge" several times, something like 90% to 95% of all new issues fail within about 5 years or so. That kind of failure rate does not apply when a new issue goes public at an unusual time for the industry.

The company demonstrates why it is important to get production to a profit-maximizing level. The lower levels shown above are just expensive to operate until that profit maximizing minimum is achieved.

But once the company is there, then a lot of cash will roll in under a wide variety of industry environments. The lease operating expenses shown above are far more typical of a natural gas company. But the revenue stream is heavily weighted towards oil. Therefore, margins are likely to be very wide and signal a very low breakeven point for the wells drilled.

One unusual feature of this company is the very low general and administrative costs. I very seldom find costs as low as shown above in the industry. Costs that low are an important competitive advantage. Typically, I find costs that range in the couple of dollars per barrel and sometimes as high as five dollars per barrel.

Outlook

This company is likely to remain one of the fastest growing companies that I follow in the oil and gas industry.

The free cash flow could certainly vary from the projection because the projection is often based on a guess of the future. The industry is notoriously low visibility with extremely volatile commodity prices.

What is important here is that the low breakeven point of the wells allows the company to grow under a fairly wide variety of industry conditions. Should commodity prices unexpectedly weaken, the company has low enough costs to simply idle the rigs and sit back to cash checks until a pricing recovery begins. Management may well elect to hedge should something like that appear on the horizon.

But the expected prices in the future allow for a robust growth plan in an industry preoccupied with balance sheet repair. A company that grows at the rate shown above should be priced at least 10 times earnings and probably 15 times earnings.

The growing production will limit downside risk in a downturn. The company will very likely return to a growth pattern sooner than many in the industry because of the very profitable acreage.

There are not many growth stories in this very cyclical industry. HighPeak Energy, Inc. appears to be one of the few stories that should lead to decent capital appreciation even considering the cyclical nature of the industry.

The fact that it is a new issue is somewhat mitigated by the management experience in building and selling companies as well as the time at which this company went public. An investment here in HighPeak Energy, Inc. appears to be a better bet on long-term industry conditions than is the case for more established companies that I follow.

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