ROCC - Ranger Oil: Growth Consolidator Prints Free Cash

Summary

• Ranger Oil is expected to get an FY22 EPS of $10, which could increase to $15 by FY24.
• Eagle Ford consolidator has a history of a high rate of return (60% ROE) by streamlining small operators.
• Oil pricing is expected to get a boost in 2023 from post COVID lockdown recovery in China and Strategic Petroleum Reserve ending its release and possibly reversing to refilling.

Investment Thesis

Ranger Oil ( ROCC ) is an oil and gas exploration company focused on consolidation within the Eagle Ford Basin in West Texas. With over 1,000 identified drilling locations providing high returns for an estimated 20 years, there is significant value over the long-term investment horizon.

ROCC has increased its acreage by 10% year over year and has significantly boosted its cash flow by 210% by consolidating and streamlining smaller operators. Financial performance is trending up, with guidance exceeding 50,000 boe/d in 1H23 . Additionally, debt has been reduced to below 0.75x debt to EBITDA, significantly below the 1.5x target.

With strong financials and an expected recovery in oil prices, we believe that ROCC is a compelling growth candidate.

Estimated Fair Value:

EFV= E2023 EPS times P/E (Price / Earnings Ratio)

EFV = $13.00 X 5.0 = $65.00

Our P/E calculation is at the low end of the typical 5.0x – 10.0x range at which exploration and production companies typically sell.

Mix and Operations

The current reserves mix is estimated at 84% liquids with 75% oil. Full FY22 production is expected to be around 46,000 boe/d. FY23 guidance has not been officially released, but ROCC expects output to break over 50,000 boe/d sometime in 1H23.

Breakeven costs are expected to remain roughly steady through the remainder of the year at $11.84/boe after tax.

Fully loaded breakeven costs for the next 15 years are estimated at $50/bbl WTI with the individual well rate of return exceeding 100% at $80/bbl. Given ROCC is so close to the downstream refining complex its transportation charges are low; hence, ROCC was in the enviable position of realizing a premium of $1.60/bbl delivered.

So far in FY22, ROCC has acquired 8 companies that were bolt-on acquisitions. These bolt-ons added approximately 20,000 acres and were primarily funded through free cash flow. The acquisitions were centered around a 72% oil mix, high-margin area within Eagle Ford, with an estimated 2,000 boe/d in additional output. 3 total full-sized rigs will be completed by the end of FY22 and will provide additional financial momentum given our view that oil prices will increase in FY23.

Roughly 80% of 4Q22 production is hedged and 50% of production is hedged through 4Q23. Most of the collars in ROCC’s WTI structure are between $75-90, with an average fixed price of $74.91 for 4Q22.

Financial Performance

4Q22 drilling and completion costs are expected to be around $160 million. Approximately $30 million is for the construction of a third rig, $55 million is for additional well interest or activity, and an incremental $25 million for the additional working interest acquired through 4Q22.

ROCC Has increased sales of oil products by 20% year over year, growing cash flows by 210% over the same period. This high level of cash flow growth has allowed ROCC to considerably delever from 1.3x Debt to EBITDA down to 0.75x. ROCC has repurchased 5% of total outstanding shares YTD, additionally declaring a token dividend of 0.38%. For the full year this totals $80 million returned to shareholders. As cash flow increases and net debt decreases, the dividend could increase. FY23 shareholder returns are expected to be at a similar level.

Earnings for 3Q22 was significantly better than expected, beating normalized EPS by $3.06 for a total of $6.15. FY22 PE is expected to be 3.8x, decreasing to 3.0x in FY23.

Acquisition targets for FY23 remain focused on accretive assets at compelling prices. ROCC has stated that it is focused entirely on Eagle Ford locations that enhance its economies of scale. Increases in free cash flow more easily finance acquisitions without the debt breaching the 1.5x EBITDA threshold.

Market Dynamics

The price of oil and gas has dropped year to date and has more than retraced its spike around the Russian invasion of Ukraine. We expect the WTI (West Texas Intermediate) price to move back above $100 in FY23. Our number is above the $93 mark that the EIA expects. Our $100 assumption is driven on Russian oil sanctions creating inefficiencies that will increase the price of oil globally. In addition, the SPR (Strategic Petroleum Reserve) depletion is ending, and Chinese demand is coming back online as strict COVID shutdown policies are eased. Both of these additional factors will put significant upward pressure on oil prices as inventories are low and global demand increases.

Risk

Despite our $100 price expectation for WTI, a severe recession would soften demand. The margin of safety on ROCC is solid given their low breakeven costs.

ROCC has a strong pool of assets and does not seek to expand beyond the 1.5x debt target they have set for itself. With that being said, there is geographic concentration risk with operations in one Basin, but this in our opinion, is more than offset by the derived economies of scale.

Conclusion

ROCC continues to delever and streamline and is beginning to gain economies of scale position to bolster its cash flow even further. ROCC has a geographically advantageous position near to the largest export and refinement terminals in the United States, and some of the largest in the world. Even in an adverse economic environment for oil, should it occur, fully loaded break-even costs are at $50/bbl, giving a comfortable margin in most situations. Earnings for 3Q22 was significantly better than expected at the 46 mbbl mark, with record-breaking production for the company expected in FY23. This makes a compelling case for an emerging player in the Eagle Ford area.

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