XOM - Riley Exploration Permian: Good Company But Wait For Price Action To Calm

2023-05-10 19:33:23 ET

Summary

• Riley Exploration Permian, Inc. is an independent E&P that operates in the Permian Basin of Texas and New Mexico.
• The company is poised to deliver very strong production growth this year, due heavily to an acquisition that it completed a few weeks ago.
• The company should be able to deliver reasonable free cash flow this year, even though crude oil prices will probably decline a bit when the recession hits.
• The company has a reasonably strong balance sheet and an attractive valuation.
• The Riley Exploration Permian stock price has been very volatile for the past month, so it is probably best to wait for it to calm down unless you like wild price swings.

Riley Exploration Permian, Inc. ( REPX ) is an independent exploration and production company that operates primarily in Texas and New Mexico. The company, therefore, fits its name, as the center of its operations is the Permian Basin located in that area. The company has certainly seen some rather impressive performance in the market recently, as its shares have gone up 49.30% over the past twelve-month:

This is confusing, as crude oil and natural gas prices have both declined over the period, which has caused just about every other energy company to see share price declines over the same time period. In fact, this performance reminds me somewhat of the meme stocks that occasionally delivered incredible performances back in 2021 due to somebody posting something on the Internet.

In the case of this one, though, Riley Exploration Permian, Inc. stock does have a number of strongly bullish articles here on Seeking Alpha and actually looks somewhat undervalued based on its forward earnings, so it deserves a closer look. The stock also pays an attractive 3.91% dividend yield, so it certainly has a very viable business behind the incredible stock performance. Overall, a cursory look at the company reveals a lot to like about it, so let us drill deeper into the company to see if it could make sense to buy today.

About Riley Exploration Permian

As stated in the introduction, Riley Exploration Permian is an independent exploration and production company based in the Permian Basin of West Texas and New Mexico. The company owns about 40,000 net acres in the basin, which is definitely less than most of the major players in the region that we have discussed in past articles. This small size is also reflected in the fact that the company's market capitalization is only $719.88 million at the current price, which is clearly much less than peers such as Diamondback Energy ( FANG ) or Matador Resources ( MTDR ). However, small companies can sometimes prove to be very good investments, so that alone should not be a dealbreaker.

The Permian Basin itself is a very good place for an oil producer to base its operations due to the general mineral wealth of the area. According to the U.S. Energy Information Administration , the basin contains proven reserves of five billion barrels of crude oil and nineteen trillion cubic feet of natural gas despite the fact that it has been producing resources since the 1920s. The resource wealth of this region is reflected in Riley Exploration Permian's own reserves.

As I have mentioned numerous times in the past, an energy company's reserves are frequently overlooked by investors, but they are critically important. This is because the production of crude oil and nature gas is by its nature an extractive process. The companies in this business literally obtain the resources that they produce by pulling them out of reservoirs in the ground. As these reservoirs contain only a finite quantity of resources, an energy company must continually discover or acquire new sources of crude oil and natural gas, or it will eventually run out of products to sell. As a company is not guaranteed to be successful in this necessary endeavor, its reserves dictate the length of time for which it can operate without discovering new sources of resources.

As of December 31, 2023, Riley Exploration Permian had total proven reserves of 72 million barrels of oil equivalents. This certainly does not sound like very much, but the company's guidance is only for daily production of 20,000 to 21,000 barrels of oil equivalents per day for the full-year 2023 period. Its reserves are sufficient to produce the larger of those two numbers for 9.39 years, which gives it a reserve life that is relatively in line with most of the supermajor energy companies like Exxon Mobil Corporation ( XOM ). Thus, it does appear that the company's reserves are sufficient for the scale of its operations.

The company's reserves are invariably larger than this today. Last month, Riley Exploration Permian purchased oil and gas-rich acreage in New Mexico from Pecos Oil & Gas LLC for $330 million.

Curiously, the company did not state how much acreage is included in this purchase. All it says is that the property includes roughly one hundred potential drilling locations. This supports the company's repeated statements that it is a "growth-oriented" independent exploration and production company since the acreage is currently producing about 7,000 barrels of oil equivalents per day that will be directly accretive to the company's production. The price for this acquisition appears to be very reasonable too as it should pay for itself in about 3.4 years given current resource production. The property also has a 15% free cash flow yield, which works out to approximately $49.5 million annually given current crude oil and natural gas prices. This amount should be directly accretive to Riley Exploration Permian's cash flow, and we should see this amount boost the company's free cash flow starting in the second quarter of 2023. This is certainly a much better situation than if the company were to buy land for speculative purposes, as many independent energy producers did prior to the pandemic.

Riley Exploration Permian is guiding for approximately 80% year-over-year production growth in 2023 compared to 2022. That is almost certainly the reason for the strong stock price performance that this company has delivered over the past year relative to its peers. After all, an 80% production increase is more than sufficient for the company to overcome the fact that energy prices have been lower this year than last year. This acquisition alone also comes pretty close to achieving this goal, since the addition of 7,000 barrels of oil equivalents per day boosts Riley Exploration Permian's production by 53.16% over the first quarter production level of 13,169 barrels of oil equivalent per day. The completion of this acquisition has also boosted the company's production by 106% over the 9,791 barrels of oil equivalent per day that it produced on average during the first quarter of 2022. It also should be noted that this acquisition alone brings the company's production up to the 20,000 to 21,000 barrels of oil equivalents per day that it expects to achieve this year.

Over the past few years, we have seen a significant shift in the way that independent American energy producers conduct business. This was largely driven by the pandemic-driven energy price collapse and the rising importance of environmental, social, and governance factors in investment decisions at several of the nation's largest asset managers. These two factors have forced fossil fuel companies to reduce their reliance on the market and fund their operations internally. This is one of the reasons why Diamondback Energy has not been trying to increase its production despite the high energy prices and numerous other companies like Pioneer Natural Resources ( PXD ) have generally been following suit. The goal is to generate free cash flow that can be distributed to shareholders or used to repay debt.

This is in direct contrast to the prior business model of growth at all costs, which caused many shale operators to have negative cash flow and be among the largest issuers of junk bonds in the market. Riley Exploration appears to be doing this too as the company had a positive free cash of $2 million in the first quarter of 2023. As might be expected though, the company's cash flows tend to vary with energy prices. Here is its full-year 2023 free cash flow guidance at a variety of crude oil prices:

While it is still early enough in the year that anything could happen, I am currently expecting crude oil prices to average closer to $60 or $70 per barrel this year than either of the higher figures. This is mostly because it seems very likely that the United States will enter a recession during the second half of this year. Those economic events typically cause the demand for refined products to decrease sharply, which has a negative impact on energy prices.

Fortunately, Riley Exploration Permian has some production against declining energy prices. This is due to the fact that the company employs a hedging strategy that allows it to lock in prices for the crude oil and natural gas that it sells. This is a strategy that most energy companies employ to some degree in which they use derivative contracts such as futures and forwards to ensure that some percentage of its products basically generate a set amount of revenue no matter what energy prices do. Here are the derivatives that the company currently owns for this purpose:

As mentioned earlier, Riley Exploration Permian expects to produce approximately 20,500 barrels of oil equivalents per day over the course of 2023. Of that, about 70% will be crude oil, and the remainder is expected to be natural gas. Using those figures, Riley Exploration has 58% of its full-year 2023 oil production hedged at $67.32 to $67.68 per barrel, which is a bit below today's price. The company also has 42% of its natural gas production hedged at prices ranging from $2.60 to $3.23 per thousand cubic feet, which is a bit above today's prices. This is a reasonably decent hedging profile that does still leave the company exposed to potential upside or downside. There is still some protection either way though so the company should not be devastated in the unlikely event that crude oil prices fall well below $60 per barrel.

Financial Considerations

It is always important that we look at the way that a company is financing its operations before making an investment in it. This is because debt is a riskier way to finance a business than equity because debt must be repaid at maturity. That is normally accomplished by issuing new debt and using the proceeds to repay the existing debt. This can cause a company's interest expenses to go up following the rollover depending on the conditions in the market. This is quite important today as interest rates are currently at the highest levels that we have seen since 2007. In addition to interest rate risk, a company must make regular payments on its debt if it is to remain solvent. Thus, an event that causes its cash flow to decline could push it into insolvency if it has too much debt. That is something that is a very real concern with energy companies like Riley Exploration Permian due to the inherent volatility of commodity prices.

One metric that we can use to evaluate the financial structure of a company is the net debt-to-equity ratio. This ratio tells us the degree to which a company is financing its operations with debt as opposed to wholly-owned funds. It also tells us how well a company's equity will cover its debt obligations in the event of bankruptcy or a liquidation event, which is arguably more important. As of March 31, 2023, Riley Exploration Permian had a net debt of $86.7 million compared to shareholders' equity of $359.5 million. This gives the company a net debt-to-equity ratio of 0.24 today. Here is how that compares to some of the company's peers:

As we can clearly see here, Riley Exploration Permian compares pretty well to other independent companies operating in the Permian Basin. This is a sign that the company is probably not employing too much debt to fund its operations and is thus not exposing its investors to an outsized level of risk in this respect. Thus, we should not really have to worry too much here.

Dividend Analysis

One reason why we like investing in energy companies is that many of them possess pretty attractive dividend yields. Riley Exploration Permian is certainly no exception to this as the stock yields 3.91% at the current price. The company has been reasonably good about its dividend over the years, as it has steadily increased it since 2021:

For some reason, Seeking Alpha's quant system says that the company has only had one consecutive year of dividend payments and one consecutive year of growth:

This is a bit confusing to me as the company has increased its dividend twice over the past two years. It has also paid its dividend for two years. When we consider that the company only started trading on March 1, 2021, its dividend history is actually pretty good. As is always the case though, it is critical that we ensure that the company can actually afford the dividend that it pays out. After all, we do not want to be the victims of a dividend cut since that would reduce our incomes and almost certainly cause the stock price to decline.

The usual way that we judge a company's ability to afford its dividend is by looking at its free cash flow. The free cash flow is the money that was generated by a company's ordinary operations and is left over after it makes all of its capital expenditures and pays all of its bills. This is therefore the money that can be used to reduce debt, buy back stock, or pay a dividend. For the first quarter of 2023, Riley Exploration Permian reported a free cash flow of $2 million, which was nowhere close to enough to cover the $7 million that the company actually paid out in dividends. This is certainly concerning as it is a sign that the company is not generating enough cash to cover its dividend.

However, exploration and production companies sometimes use an alternate measure of cash flow that they call adjusted EBITDAX. This is a non-GAAP measure that theoretically tells us the amount of cash that was produced by a company's ordinary operations excluding financing costs, taxes, and exploration expenses. It is sometimes considered a more accurate way of expressing cash flow since it allows the companies to capitalize on costly exploration costs when a new source of crude oil or natural gas is discovered. During the first quarter of 2023, Riley Exploration Permian reported an adjusted EBITDAX of $43.508 million. That was far more than enough to cover the dividend with a great deal of money left over. The company's dividend is probably pretty safe, especially considering the production growth that it should experience over this year.

Valuation

It is always critical that we do not overpay for any asset in our portfolios. This is because overpaying for any asset is a surefire way to earn a suboptimal return on that asset. In the case of an independent exploration and production company like Riley Exploration Permian, one metric to use to value it is the forward price-to-earnings ratio. This ratio basically tells us how much we are paying today for each dollar of earnings that the company will make over the next year.

According to Zacks Investment Research , Riley Exploration Permian has a forward price-to-earnings ratio of 4.04 at the current price. That is substantially lower than the 17.85 ratio of the S&P 500 Index (SP500) today. However, as I pointed out in a recent blog post , pretty much everything in the traditional energy sector looks substantially undervalued today. Therefore, let us compare Riley Exploration Permian to its peers to see which stock offers the most attractive relative valuation:

As we can clearly see, Riley Exploration Permian looks very attractively valued relative to its peer group at today's price. This is likely because this company is expected to deliver much greater growth than its larger peers, as we discussed earlier in this article.

Conclusion

In conclusion, there are definitely some things about Riley Exploration Permian, Inc. that make it look reasonably attractive today. The company is almost certainly going to deliver remarkable production growth this year that should result in strong earnings growth even if energy prices decline somewhat when the recession hits. Riley Exploration Permian also has a respectable balance sheet and an attractive dividend yield.

My big concern here is the Riley Exploration Permian, Inc. stock price volatility, which has been much greater than most other energy companies over the past month. Riley Exploration Permian stock is down 4.87% today compared to a 0.16% decline for Matador Resources and a 0.63% decline for Diamondback Energy. My suggestion here is to wait until the price stabilizes before buying in as seeing a stock swing by a few hundred basis points a day makes it difficult to sleep well at night. Riley Exploration Permian, Inc. is definitely worth following, though, as the underlying company seems pretty solid.

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