2023-09-11 05:51:04 ET
Summary
- Oil and gas minors are rebounding from 2023 lows due to positive macro and structural factors toward the backend of the year.
- Crescent Energy Company offers diversified exposure to the sector with a diverse portfolio of assets and stable cash flows.
- CRGY is trading at compressed multiples and has more tangible capital than its market value, presenting an asymmetrical risk/reward opportunity.
- Net-net, rate buy.
Investment Briefing
Oil + gas minors are curling up off '23 lows thanks to a number of macro and structural tailwinds that are inflecting positively on spot pricing for both sectors. Brent crude has broken out of a longer-term resistance and now trades back in line with early FY'23 range [Figure 1].
Crescent Energy Company (NYSE: CRGY ) has followed suit across FY'23 [Figure 2]. CRGY can form part of an energy/oil + gas basket for those equity risk budgets seeking diversified exposure to the sector. The company boasts a diverse portfolio of assets located in the some of most productive basins across 48 states. These assets yield a significant amount of cash flow that is further supported by a stable base of production, providing a reliable and predictable source of revenues, even with the underlying market volatility. It pays a $0.12/share quarterly dividend, and its chairman, John Goff, owns 22% of the business alongside private equity giant KKR.
This report will unpack some of the moving parts in the CRGY investment debate. Critically, the stock is trading at overly-compressed multiples in my view, offering asymmetrical risk/reward potential, whilst the company trades at a discount to invested capital. Net-net, I rate CRGY a buy, eyeing a $5.17Bn market value.
Figure 1.
Figure 2. CRGY vs. Brent Crude, 2022—date
Key risks to investment thesis
Investors must realize the following set of risks before proceeding any further:
- Despite hedging of price risk and forward offtake agreements in place, the stock price of oil + gas minors such as CRGY are sensitive to changes in the underlying. Without an accurate forecast on the directional moves of any of its core assets, CRGY's equity stock is also susceptible to such price risk.
- The inflation/rates axis has disproportionate effects on asset-heavy businesses and can impact replacement costs on tangible assets and the cost of financing for the same.
- Macro-level risks should not be ignored in this regard, especially as new oil supply comes onto market from non-OPEC+ suppliers (whom are almost at parity with OPEC+ counterparts according to the IEA ).
These risks should be well understood before making any investment decisions.
Critical facts to CRGY investment debate
Q2 FY'23 insights—reduced CapEx, increased output in oils
- Production/CapEx breakdown
Amidst a volatile and uncertain market, the company put up a reasonable performance in Q2 . Net production of approximately 140,000 barrels of oil equivalent ("BOE") per day was ahead of forecasts, driven by lower market pricing on higher volumes. On this, overall revenues were $492.4mm, down from $908.4mm last year (46% YoY decline all up)—but critically, it spun off $50mm in FCF for the quarter, even with the tighter pricing environment.
It's hard for oil + gas players to differentiate between themselves, regardless of the current market. Each is selling the same 'product', and each are price takers on the market's equilibrium for the underlying[s]. Hence, it's capital efficiency and cost of production that typically drive the longer-term investment value for the public. More productive wells gets you more resource, which gets you more income, and the rate on costs determines what falls to the bottom line. This is one of the standouts for me in the investment debate here. For one, CRGY managed to beat The Street's revenue and earnings expectations with an investment of $150mm during the quarter, which was below the company's internal and Wall Street's estimates. Critically, the stemmed from a combo of streamlined cycle times and optimized completions.
For instance, a significant reduction in cycle times is observed in its Eagle Ford assets, where cycle times have decreased as much as 20% in recent quarters. As a reminder, in July this year, CRGY acquired operatorship and incremental working interests in its existing Western Eagle Ford assets on an all-cash consideration of ~$600mm. Just last week , it sized up the incremental interests with a $250mm consideration. Critically, CRGY acquires $300mm of proved developed PV-10 value (estimates on NYMEX prices from 31st August), bringing its operating control to c.63% working interest and 90% of Eagle Ford in total.
It's no surprise that drilling and completion costs per ft. are down 10% YoY, on a simultaneous reduction in CapEx of 10% (net of all acquisitions). As the CEO put it, CRGY is "doing more with less, generating more production with significantly less capital". The complete list of redeployed cash across the first half of FY'23 is observed in Figure 2(a) below. Buoyed by its H1 momentum, management revised its FY'23 forecasts, and now projects net production to reach 146,000—151,000 BOE/day.
- Specific breakdown across all divisions
As to the divisional highlights, observe the following critical factors from Q2:
- CRGY booked significantly lower oil revenues in Q2 and clipped $209.3mm, marking a 35% decline. This wasn't unexpected, and not something I'm overly concerned about. The resulting per-barrel decrease was 35% as well. Critically, daily sales volumes increased by ~29MBbls YoY to 5,810MBbls, attributed to the productivity of its Eagle Ford and Uinta assets.
- Natural gas revenue also sharply declined, plummeting by $155.1mm or 75% compared to the same period in 2022. Lower natural gas prices led to a per-thousand cubic feet ("Mcf") decrease of 73%. Unlike its oil business, there was an $11.8mm decrease in sales volume, equating to a 21 MMcf/day or 6% YoY drop. The reduction in sales volumes corresponds to the decline within the company's existing asset base.
- Similarly, NGL revenues were down $50.0mm or 60% compared to Q2 last year. Lower realized NGL prices were the primary driver as well, resulting in a per-barrel decrease of ~59%. Additionally, sales volumes were down 1 MBbls/day, 5% YoY. As with natural gas, the reduction in sales volumes is primarily related to the natural decline in CRGY's existing base of assets in these two segments.
- Lastly, midstream and revenues were down 11% to $13.2mm. The complete scope of quarterly totals, disaggregated by segment, avg. prices taken and volumes is observed in Figure 4 (note: all realized prices are net of hedges in place).
- CRGY now well capitalized after upsized offering
Last week, CRGY issued $150mm of senior 9.250% notes due in FY'28 (the original offer was $125mm, so there must have been more interest at the $150 level in my view). This was an additional offering under its $700mm of indentures issued in February and then July this year. These notes have substantially similar terms to the previously issued ones, except for (i) the issue date, (ii) issue price, and (iii) first payment date on the principle (first payment will be February '24). The coupon is 9.25% as mentioned, in line with many other high-yield offerings.
CRGY said it will use proceeds to finance additional interests in oil and gas properties. In my view, the company is now well capitalized to do so, and having redeployed surplus cash flows into developments earlier this year, it could be a strong year of production—perhaps even beyond the 146,000 BOE/day forecast by management.
Technicals balanced on short-term/LT time frames
Depending on your time horizon, there are different perspectives on CRGY's price structure. This is shown via the daily and weekly cloud charts in Figure 5 and 6 respectively. On the daily, the stock is running a bullish setup, in continuation of the longer-term uptrend. It crossed the cloud in July and has caught a bid on each pullback. Both price an lagging lines are above the cloud.
The key risk is that it continues pushing sideways, backing and filling along the way. This could see it push into the cloud and enter a more 'neutral zone'; so a bid above $13.00 before the end of October is essential to remain within the uptrend.
Figure 5.
On the weekly, price structure isn't as constructive. The recent cycle off '23 lows is indeed noted, but there's not enough thrust in the move to see it break above the cloud. The lagging line is below the cloud and you'd need bids put up at $15.00 in my mark to see the lagging line cross to the upside. But say it does continue turning higher, the price line may cross anytime in November—December. So you'd be looking to heavy buying volume (demand) around its current levels to warrant a move to these levels in my opinion.
Figure 6.
As a potentially bullish point, we have upsides to $18/share on the daily P&F studies, with the stock having broken out above a number of 45 degree resistance lines as of late.
This is certainly constructive, but the critical point is—and I'll say it again—a break from its current levels is absolutely essential to activate this objective. So, should it thrust further to the upside, I'd potentially be looking to $18/share as the next technical target. If it continues sideways, or to the downside, I'd abandon this mark and look to a lower level.
Figure 7.
Valuation and conclusion
There is immense value to be realized in buying CRGY today. Its equity stock sells at 8.3x forward earnings, 3.8x trailing EBIT, is priced at a 0.62x discount to net asset value, and you're buying a 42% forward cash flow yield at its current levels. These multiples are not the drivers of value, but rather the result of value.
Much of the upside hinges on what oil does from here, for sure. But you simply cannot overlook these compressed multiples and the asymmetrical upside they offer. What's more, these are backed by robust economics that support a buy rating. CRGY spun off $13.90/share in cash to its shareholders in the last 12 months, including all dividends paid up. Around $71/share of capital deployed produced $15.50/share in NOPAT to get to this payout, an attractive c.22% return on capital at risk.
At 3.8x trailing EBIT, this gets you to $4.54Bn in enterprise value as I write. But its incremental returns on capital at risk were 37% last quarter (TTM values), and carrying this forward, this gets you to $1.61Bn in pre-tax earnings. Presuming the same multiple, CRGY looks fairly priced at $5.17Bn, 14% value gap.
Figure 8.
CRGY is also in a unique situation where it has more in invested capital (measured in core tangible assets and working capital here) than it does in market value. It therefore trades at a discount to the capital at risk in its operations. Normally this would imply the market expects negligible earnings power from a firm's capital commitments. But this doesn't square of with the economics here—at ~22% return on capital, my estimation the market only has ~46% of the growth potential priced into CRGY's current market values. This supports the asymmetrical risk/reward calculus on offer here in my view
In short, CRGY sells at compressed multiples and has more in tangible capital (including NWC) than it does in enterprise value—a rare situation. Critically, the company's core assets are turning up productivity on a more efficient base, whilst investors are reaping the rewards on dividends and growth in free cash flow. Oil is now curling up off lows with macroeconomic tailwinds driving inflows and a repricing out of an extensive downtrend. Combined with a higher projected output for FY'23, a more efficient and broader capital base, plus the perceived valuation disconnect, I rate CRGY a buy, eyeing a $5.17Bn market value.
For further details see:
Crescent Energy: Curling Higher, With Cash Dividends + ROIC In Situ, Rating Buy