ESTE - Permian Resources: Earthstone Energy Acquisition Should Close Soon

2023-10-25 07:33:07 ET

Summary

• Permian Resources is expected to close on its acquisition of Earthstone Energy soon.
• The combined company is projected to generate $1.67 billion in free cash flow in 2024 at current strip before any cash income taxes.
• It may also be able to maintain production at 315,000 BOEPD (estimated 2024 levels) and then generate $1.6 billion in free cash flow at $75 WTI oil.

Permian Resources' ( PR ) acquisition of Earthstone Energy ( ESTE ) is expected to close soon. The two companies are each holding special shareholder meetings on October 30 to vote on the deal, and the transaction should close soon after that.

I currently estimate that Permian can generate $1.67 billion in free cash flow in 2024 at current strip prices and before the impact of cash income taxes. This also assumes mid-single digits production growth from proforma Q2 2023 production.

It appears that the market is leaning towards valuing Permian (post-acquisition) at similar multiples to pre-acquisition Permian, rather than as a blended valuation between Earthstone and Permian. Based on pre-acquisition Permian multiples, I estimate its value at $16 per share at long-term $75 WTI oil.

Permian's Potential 2024 Outlook

I am modeling Permian's 2024 production at around 315,000 BOEPD (46% oil) currently. This is a 5% increase from its pro-forma Q2 2023 production. Permian will provide more details about its 2024 expectations later on. The current strip for 2024 includes roughly $80 WTI oil and $3.40 Henry Hub gas. At those commodity prices, Permian may be able to generate $5.399 billion in revenues during 2024 before hedges. Permian's proforma 2024 hedges have approximately negative $59 million in estimated value, resulting in a projection of $5.34 billion in revenues after hedges.

At last report Permian had hedges covering approximately 18% of 2024 oil production (based on my projections) and approximately 13% of its 2024 natural gas production.

I am currently modeling Permian's combined lease operating, cash G&A and GP&T costs at $8.20 per BOE for 2024. Standalone Permian reported $8.11 per BOE for these costs in Q2 2023, while Earthstone's costs for 2H 2023 were expected to be above $10 per BOE.

Permian expects to save $30 million in G&A costs from combining operations though, while also identifying ways to save money on production expenses.

I have also estimated that Permian's 2024 capex will end up around $2.05 billion. It expects to provide detailed guidance for 2024 early next year, although it expects to put around 90% of its budget towards the Delaware Basin and the other 10% towards the Midland Basin.

This leads to a projection of $1.67 billion in 2024 free cash flow for Permian before any impact from cash income taxes.

Notes On Dividend

Permian noted that it continues to be committed to returning 50+% of its free cash flow (after its base dividend) to shareholders via variable dividends and share repurchases.

After the Earthstone deal closes, Permian may have around 777 million outstanding shares. It will increase its quarterly base dividend to $0.06 per share in Q1 2024, resulting in around $186 million in base dividend payments per year.

This would result in $742 million being put towards debt reduction in 2024 and $742 million being put towards variable dividends and share repurchases if there is a 50% post-base dividend payout ratio. This also assumes that there are no cash income taxes, and I am uncertain about Permian's expectations around cash income taxes next year.

Notes On Valuation

I continue to value companies based on long-term $75 WTI oil and $3.75 NYMEX gas. I believe Permian can generate $1.6 billion in unhedged free cash flow (before cash income taxes) at those commodity prices while maintaining production at around 315,000 BOEPD.

Based on a 12.5% free cash flow yield (before cash income taxes), that would translated into a $12.8 billion market cap for Permian, or approximately $16 per share if its convertible notes were also converted into shares (putting its share count near 800 million).

A 12.5% free cash flow yield (before cash income taxes) would translate into a slightly under 10% free cash flow yield if Permian was a full cash income tax payer. This is a couple percent higher than what Permian's notes are currently yielding-to-maturity, which seems appropriate to me.

I had previously valued Permian at approximately $13.50 per share based on blended Permian/Earthstone multiples, as Earthstone has typically traded at a lower multiple to EBITDA and free cash flow than Permian. However, if the market decides to value the combined company similar to pre-acquisition Permian, then it would be worth approximately $16 per share at long-term $75 WTI oil.

Conclusion

Permian Resources is expected to close its Earthstone acquisition soon and the combined company is projected to generate $1.67 billion in free cash flow before income taxes in 2024 at current strip prices. This would cover its increased base quarterly dividend of $0.06 per share as well as allow it to put $742 million towards variable dividends and share repurchases.

Permian's estimated value is approximately $16 per share at long-term $75 WTI oil and $3.75 gas if the market values it post-acquisition at similar to its pre-acquisition multiples. Based on the bond prices and its recent share price, it does appear that Permian is being valued similarly to pre-acquisition announcement.

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