2023-11-10 18:28:52 ET
Summary
- Evolution Petroleum reported disappointing results for the second straight quarter.
- Production declines in the Barnett basin were once again the main culprit, hurt by 3rd party gathering and compression issues.
- The stock yields 8.4%, and the dividend currently looks safe for now.
Evolution Petroleum Corporation ( EPM ) has continued to struggle after I raised my rating to "Strong Buy." With the company once again reporting disappointing quarterly results, I'm going to lower my rating to "Buy" as the company needs to regain investor trust. Let's take a closer look at the name.
Company Profile
As a refresher, EPM owns non-operated interests in several oil and natural basins. About 59% of its average daily production is projected to be natural gas, 25% oil, and 16% NGLs. The Barnett is its largest basin by proved reserves, representing 40%, followed by Jonah Field at 21%, the Williston at 18%, the Delhi Field at 13%, and Hamilton Dome at 8%.
The company entered into a strategic partnership in the Permian in September. Unlike with its other assets, this property needs to be developed, which EPM will help pay for while PEDEVCO will be the operator.
Fiscal Q1 Results
For the quarter, EPM saw revenue decrease -48% year over year to $20.6 million. Sequentially revenue increased 13%. That came in below the $21.9 million analyst consensus.
Crude revenue dropped -17% to $12.6 million, as realized oil prices fell from $90.26 last year to $78.36. Sequentially, crude revenue rose 15%.
Natural gas revenue plunged -72% to $5.6 million, while NGL sales sank -49% to $2.4 million. Sequentially, natural gas revenue rose 11%, and NGL sales climbed 9%. Realized natural gas price dipped from $7.96 per MCF last year to $2.74 per McF, while NGL prices dropped to $25.61 a barrel from $41.62 a barrel.
Average daily production fell -15% to 6,457 BOE/D from 7,598 BOE/D. Oil volumes sank -4% to 161 MBbl. Natural gas volumes declined nearly -19% to 2,025 MMcf, and NGL volumes fell -17% to 95 MBbl. Sequentially volumes were flattish, down under -1%
Its largest basin, the Barnett Share, saw production decline -26% to 2,641 BOE/D from 3,576 BOE/d, while production for its second largest basin, the Jonah Field, declined -6% from 1,967 BOE/d to 1,848 BOE/d. Sequentially, Barnett volumes fell -4%, while Jonah Field volumes rose 2%.
The company blamed the continued production declines in the Barnett to a number of issues, including compression issues due to extreme summer heat, "excessive" downtime of EnLink Midstream, LLC's ( ENLC ) gathering and processing system, and the operators' decision to shut-in some low margin wells that were brought online when natural gas prices were higher.
Production costs improved to $20.01 per BOE from $27.35 per BOE a year ago.
EPM recorded adjusted EBITDA of $6.7 million, down -61% from $21.7 million, and up 43% sequentially from $4.7 million.
Operating cash flow was $4.3 million, while free cash flow was $2.5 million.
Net income for the quarter was $1.5 million, or 4 cents per share. That missed analyst estimates by 3 cents.
The company declared a 12-cent dividend for the quarter. It will be paid on December 29th to shareholders of record on December 15th.
Looking at the balance sheet, the company ended the quarter with zero debt and $9.4 million in cash.
In a statement , CEO Kelly Lloyd said:
" We are very pleased to have moved past many of the operational issues that directly affected our production and revenues during the previous quarter. Sequential production was up at our Jonah Field, Williston Basin, and Delhi Field properties. Current quarter versus prior quarter production at Hamilton Dome was flat, and Barnett Shale production was down by approximately 4% over the same time period. Overall, we achieved a net zero percent decline rate, which allowed us to benefit significantly from increased price realizations and grow revenue, net income, earnings per share, and Adjusted EBITDA in the current quarter as compared to the prior quarter. As we move forward throughout the fiscal year, continued improving operational conditions and incremental production from multiple capital projects should continue to benefit our shareholders, including the successful completion of two downdip-producing wells in the Delhi Field. During the quarter, we added another strategic property to our diverse portfolio of non-operated assets, the Chaveroo Field. Redevelopment of the Chaveroo Field horizontally has the potential to unlock significant value for our shareholders as the Chaveroo Field has an estimated original oil in place (OOIP) of over 700 million barrels with less than 5% recovered vertically to date. Importantly, this adds an economically advantaged, organic growth component with the potential to meaningfully add to cash flow and production. "
The continued issues in the Barnett are very disappointing, especially after EPM management said the issues looked resolved last quarter. Clearly, they were not. The Barnett is an older basin that is typically just in low decline run-off mode. There generally isn't any new drilling or well development in the basin, so there shouldn't be big production drop-offs outside of its low natural decline. Given that there wasn't a rebound closer to FQ3 production levels is a disappointment.
Prices did rebound sequentially, but that was not enough to overcome the continued production issues in the Barnett, its largest basin. Obviously, gas prices were much higher last year, which impacted the year-over-year comparisons.
The redevelopment of the Chaveroo field with PEDEVCO using modern technology looks promising, but there is still a lot to be proven out. Each well is projected to produce a payout in about 16 months at $75 oil on its $3 million in net D&C costs. The companies are projecting to be able to complete 8 wells a year. This will lift EBITDA if everything plays out by $16-18 million a year with 8 wells coming online, but it will initially hurt free cash flow due to the D&C costs. As such, this is definitely a higher return, but higher risk venture for EPM.
Valuation
EPM trades at about 4.9x EBITDA based on fiscal year 2024 (ending June) analyst estimates of $39.2 million. Of course, the price of natural gas and oil can change the actual results immensely.
From a P/E perspective, it trades at just under 10x the 2024 consensus of 57 cents.
The stock trade at a higher valuation has most small-cap E&Ps, but lower than larger independent E&Ps. It has some cost advantages as a non-operator while smaller E&Ps don't have the scale to absorb higher service costs. However, larger E&Ps can control their own destiny, while EPM is at the mercy of its operating partners.
The stock currently yields around 8.4%. The dividend is covered by cash flow from operations, but it was tight this quarter and the company needs to see better results. I'm going to place a $7.50 price target on the stock, which is about a 6x EBITDA multiple on the current consensus, and good for an over 40% total return including the dividend. This is meaningfully lower than where I originally thought the stock could trade, but I'm going to take a more conservative view on a production recovery as well as natural gas prices. If both turn out to be stronger than expected, there could be more potential upside. I'm also not including any upside from its strategic partnership with PEDEVCO, as that also needs to be proven out.
Conclusion
Moving forward, the issues in the Barnett are supposedly fixed, with ENLC's system back up and running and heat no longer impacting compressors. ENLC tried to optimize the system after taking over last year and in doing so appears to hurt some of its producers. However, EPM management has been a bit opaque about where volumes will return to moving forward, saying just the big declines should be over. If that means big year-over-year declines are over, that would put Barnett's production back to over 3,000 BOE/d. Barnett production was 3,300 BOE/d last fiscal Q2 and 3,100 BOE/d fiscal Q2 2022.
EPM should benefit from continued strengthening natural prices compared to 2022 levels. However, it does face some tough price comps in the next two quarters, as Jonah got some huge prices last winter as West Coast differentials blew out starting last December. Differentials for winter are pretty good above $5 based on current futures, but well below last winter when prices went over $20. So expect sequential improvement, but not year-over-year improvement.
The company should also get a bit of a lift from its Chaveroo partnership with PEDEVCO. It also has some cost savings and carbon capture credit opportunities with Exxon Mobil Corporation ( XOM ) taking over some operations from Denbury.
Until EPM can prove its production issues in the Barnett are finished, I am going to reduce my rating to "Buy." It sounds like the issues are resolved, but I mistakenly thought that last time as well.
For further details see:
Evolution Petroleum Q1: Barnett Production Issues Persist (Rating Downgrade)