CA - PHX Minerals: Laying The Foundation For A Long-Term Run

Summary

• With PHX Minerals' 2020 hedges completely rolling in early 2023, it should lead to higher realized prices and cash flow, assuming commodity prices in 2023 are what they were in 2022.
• I like the company's acquisition model and explain why it should be a strong tailwind for PHX Minerals going forward.
• The overall strategy for PHX Minerals is to acquire more royalty production with an increased weighting toward natural gas.

PHX Minerals Inc. ( PHX ) hasn't exactly had a compelling chart over the last few years, as it has dropped from about $22.00 per share in early January 2018 to $3.72 as I write in early January 2023.

But a lot of things have changed since then, including having a new management team put in place, a transition to increasing the percentage of royalty production and weighting the company more toward natural gas.

With its unfavorable hedges from 2020 close to completely rolling off in early 2023, PHX Minerals Inc. is poised to get more out of its existing production, as well as grow royalty revenue via acquisition in a way that allows it to fly under the radar of the overall industry.

In this article, we'll look at the latest numbers, the unwinding of the unfavorable hedges, the compelling growth-via-acquisition strategy in place, and why I think PHX Minerals Inc. is poised for sustainable, long-term growth.

Some of the numbers

Revenue in the fourth fiscal quarter of 2022 was $21.8 million, up 12 percent sequentially. Full-year fiscal revenue was $69.9 million, up approximately $32 million from revenue of $37.7 million in revenue for full-year 2021. Losses from derivative contracts were $16.8 million.

Royalty volumes accounted for 71 percent of total production in the reporting period and 65 percent for full-year 2022. Of full-year 2022 production, 78 percent came from natural gas.

Net income in the reporting period came in at $9.2 million or $0.26 per share, and for the full fiscal 2022 net income was $20.4 million or $0.59 per share. That compares to net income of $8.6 million or $0.25 per share in the fourth fiscal quarter of 2021, and a net loss of $(6.2) million, or $(0.24) per share for the full fiscal year 2021.

Adjusted EBITDA in the fourth fiscal quarter of 2022 was $8.4 million, up 64.2 percent year-over-year, and for the full fiscal year 2022 adjusted EBITDA was $25.8 million. Adjusted EBITDA in the fourth fiscal quarter of 2021 was $7.2 million, and $15.7 million for the full fiscal year 2021.

Royalty production volumes for the fourth fiscal quarter of 2022 were up 15 percent to a record 1,842 Mmcfe, and overall production volumes for the fourth fiscal quarter of 2022 climbed 7 percent to 2,592 Mmcfe, compared to the third fiscal quarter of 2022.

Royalty production volumes for the full fiscal year 2022 jumped 49 percent to 6,209 Mmcfe, and overall production volumes for the full fiscal year 2022 increased 6 percent to 9,609 Mmcfe, compared to the full fiscal year 2021.

This points to the ongoing implementation of the company's strategy to increase royalty production as a higher percentage of volume.

Cash and cash equivalents at the end of the fourth fiscal quarter of 2022 was $3.4 million, almost $1 million more than it was in the fourth fiscal quarter of 2022 of 2021.

Long-term debt at the end of the fourth fiscal quarter was $28.3 million,

Hedging being mitigated

In 2020, PHX Minerals Inc.'s lenders required the company to hedge during the pandemic. That resulted in revenue headwinds as energy prices rose. In December 2022, management said within a couple of months the contracts it had entered into during that period of time would totally roll off. If commodity prices remain similar to what they were in 2022, that will result in improved prices and cash flow.

Assuming similar prices, it means in the first calendar quarter the company should have a modest improvement, but in the second quarter and onward it should boost its performance.

To get an idea of the impact, prices received for natural gas, oil and NGL were up 5 percent sequentially, to $8.42 on an Mcfe basis. For the full fiscal year, they were up 75 percent to an average of $7.27 per Mcfe.

Approximately 58 percent of natural gas was hedged at an average of $3.38 in the quarter, as was 62 percent of oil hedged at $44.25. None of its NGL production was hedged.

For full-year fiscal 2022, 62 percent of natural gas was hedged at an average of $3.06, and 72 percent of oil was hedged at $44.25, the same as it was for the fourth fiscal quarter of 2022.

Consequently, realized hedge losses in the fourth fiscal quarter of 2022 were $7 million, and $22 million for all of fiscal 2022.

Again, assuming prices are close to where they are today, this is going to be a tailwind for PHX Minerals Inc. starting in the latter part of the first calendar quarter of 2023 and going on from there.

Why I like its acquisition model

The acquisition model of PHX is to acquire smaller assets in the $1 million to $5 million range in order to continue to grow. Management has incorporated that strategy since the latter part of 2019 and early 2020. So far, it has effectively worked for PHX, and I expect it to continue to do so.

As the company said, because of its current size, these types of deals make sense because they move the needle on its performance. In that way, it's also able to fly under the radar of its larger competitors looking for much larger deals, so they will have an impact on their growth trajectory.

With the current fragmented energy market, this provides numerous opportunities to acquire quality assets. I agree with management that the type of deal flow it now has should continue on for a long time.

As of the end of 2022, PHX Minerals Inc. had closed approximately $48 million in acquisitions for the year that entailed over 30 different deals. Combined, they continue to increase royalty volume and royalty reserve levels.

The major reason I like the acquisition model is because of other companies using the same model to grow their business over time. One example outside the sector is Constellation Software (CNSWF). It used the same strategy of buying up specialty software businesses in small niches that its larger competitors weren't interested in because they wouldn't have any meaningful impact on their growth trajectory.

This will continue to work for PHX until it scales to a point where these smaller deals won't make sense. Constellation Software eventually reached that point after many years and had to compete with its larger competitors for deals of a larger size. PHX Minerals Inc. will eventually have to do that, but I think it's probably at least several years before it has to make a decision on that.

By that time, it'll also have a larger cash base and capital war chest to successfully acquire larger companies if it chooses to do so.

Royalty production and reserves

Royalty production volumes for the fiscal fourth quarter of 2022 were up 15 percent to a record 1,842 Mmcfe. Total production volumes for the fiscal fourth quarter of 2022 climbed 7 percent to 2,592 Mmcfe year-over-year. The importance of that is royalty production is increasing as a percentage of total production volume, in alignment with the stated strategy of PHX.

For the full fiscal year 2022, royalty production volumes jumped 49 percent to 6,209 Mmcfe, while total production volumes for full fiscal 2022 were up 6 percent to 9,609 Mmcfe.

As of the end of the fourth fiscal quarter of 2022, the company had net total of proved royalty interest reserves increased by 45 percent to 52.8 Bcfe, compared to 36.4 Bcfe at the end of the fourth fiscal quarter of 2021.

The royalty production and royalty reserves in the fourth fiscal quarter of 2022 represented all-time highs for the company. That is likely going to improve in 2023 and beyond, as the company continues to divest of its "remaining legacy non-operated working interest assets."

Once that transition is completed, royalty volumes will account for over 90 percent of total volumes. As it works on achieving these goals, PHX Minerals Inc. is going to have a heavier weighting of natural gas.

Conclusion

PHX Minerals Inc. is transitioning to primarily a company focusing on royalty production and reserves with natural gas as the predominant commodity it's seeking. Looking ahead, management still has the goal of using cash flow to acquire more royalty assets weighted heavily to natural gas.

With the company expecting supply and demand for natural gas to continue to be favorable, PHX Minerals Inc. feels it should be able to leverage the price to improve its profitability and cash flow.

Since the company has more than enough scale to outperform its smaller competitors and the expertise to successfully execute its strategy, it's sitting in a nice place when considering it should be able to acquire quality assets within the geography it desires, with little or no competition from larger competitors that have little if any interest in them.

With a lot of momentum and a favorable natural gas environment, PHX Minerals Inc. should be able to accelerate growth in a market niche that has little competition in relationship to its size.

For that reason, I think PHX is going to continue to scale far past its smaller competitors while growing into somewhat of a mid-size company in the years ahead.

The caveat there is the level of cooperation it'll receive from natural gas prices in the short and long-term future.

As for the near term, with unfavorable hedges rolling off, the selling off much of its legacy assets, and the transition to the bulk of its production and reserves being associated with royalties, it looks to me like PHX Minerals Inc. could be positioned for long-term upward growth.

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