Home Substantial portion W&T Offshore’s first quarter earnings: unique approach to hedging (NYSE: WTI)

W&T Offshore’s first quarter earnings: unique approach to hedging (NYSE: WTI)

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I am currently exploring stocks whose prices are exposed to the energy market, particularly thermal coal and natural gas. Both baseload energy sources have seen dramatic price increases since the invasion of Ukraine, yet the market still seems to discount the possibility of a prices close to current levels. I found cheap and limited bearish action in Unitary company (OTCPK: UNTC) but kept looking for something with more torque on the upside. The name that caught my attention is W&T Offshore (NYSE: WTI), in part due to their unique approach to cover.

Insight

To frame WTI’s story, consider their production forecasts and hedges for FY22:

WTI Guidance

WTI Guidance (WTI Q1-22 Press Release)

WTI hedges

WTI hedges (WTI Investor Presentation)

WTI hedges

WTI hedges (WTI Investor Presentation)

WTI was to hedge a substantial portion of its natural gas production in cooperation with its current loan agreements; however, to maintain market price exposure, they purchased a natural gas call bundle through 2025 for around $20 million. Only the current quarter portion is now worth more than $40 million at current spot prices. In their own words:

For the remainder of 2022, W&T is 28% hedged for oil and fully hedged for natural gas. The Company has also purchased natural gas call options with a weighted average strike price of $3.78 per MMBTU covering approximately 88% of its expected natural gas production for the remainder of 2022; these call options help offset the Company’s other natural gas hedges and allow W&T to capture a significant portion of natural gas price increases.

WTI did not benefit as much from the repricing of these calls in Q1 as it did in Q2 (see natural gas spot price table below) and futures prices:

Natural Gas Spot Pricing

Natural Gas Spot Pricing (Looking for Alpha)

The WTI production forecast also reflects that the first quarter will be its weakest production of the year, partly due to recent acquisitions.

Let’s take a look at the WTI forecast for the second quarter at the midpoint of the forecast above:

Q2-22

  • 1,388,000 barrels of oil, including 238,000 sold forward at $48.20 and 236,000 sold at $55.28. We can assume that the balance is sold at $110.

  • 390,000 barrels of NGL, uncovered. Assume a realization of $50.

  • 11,175 MMCF of natural gas, 1,296 sold at $2.56, 4,250 at $3.06, 7,200 at $2.49 (fully hedged, ~1,500 MMCF not produced against hedges). Calls made at $8 and I cleared gas not produced for $8 million.

Turnover (M)

Oil

$125.1

NGL

$19.5

Gas

$34.3

Calls sold

$35.0

Total income

$213.9

OpEx

$71.0

DD&A

$32.8

GEORGIA

$15.5

Interest

$18.4

Taxes

$15.0

Net revenue

$61.2

standardized EPS

$0.43

(Source – Company Tips, Spot Price)

Given that the Street estimates second-quarter revenue at $240 million and EPS of $0.47, that doesn’t seem set for a major earnings beatdown — unless WTI provides the high end of the forecast. as they did in the first quarter. There will also be significant bets and takes marking their hedging book in the market, so GAAP to the above estimates may look different.

Evaluation

Based on the guidance above, WTI should trade around 4x PE if a Q2-22 annualized. They also have about $500 million in net debt and nearly half a billion in asset retirement obligations that will eventually need to be addressed, implying a ~$2 billion in enterprise value. The company made $220 million in FY21 adjusted EBITDA and $91 million FCF, suggesting it’s trading at 10x and 20x multiples in a more normalized environment, but also ignoring its production growing. annualized Q1-22 EBITDA and FCF were $359m and $188mgenerating less demanding 6x and 11x multiples for what should be their lowest production and achievement quarter of the year.

Note – I am not adjusting the EV for the millions of in-the-money natural gas calls.

Reservations

WTI Reserves

WTI Reserves (WTI Investor Presentation)

In support of the above assessment, at a weighted average lagged price of oil at $77.42 and gas at $4.66, WTI still has proved reserves well above their current VE at a rate 10% discount. Management materials explain how they have historically been able to produce reserve levels above SEC guidelines due to the nature of the sandstone formations in the gulf:

Growth of WTI reserves

Growth of WTI reserves (WTI Investor Presentation)

Management

One of the unique characteristics of WTI is their concentration of ownership, as Founder, Chairman and CEO Tracy Krohn holds 48 million shares (~34%) and exercises significant control over the company through this interest. This type of insider ownership is not something you often see in energy, which has allowed WTI to pursue growth initiatives at a time when most public E&P is focused on returns. of capital, reflecting their belief in what will best increase shareholder value.

Insider ownership

Insider ownership (WTI Investor Presentation)

Interestingly, from the 2008 energy crash through 2014, WTI has paid out over $350 million in dividends, demonstrating its ability to take care of shareholders through a cycle.

Upward bonus

A previous article has comments highlighting a possible unique advantage over WTI. The WTI well is expected to begin drilling in Q4 22, “Holy Grail” is a new well from Callon Energy’s 2008 effort which was sidelined by the energy crash. Expectations were for 22,500 boe per day of two wells in the field, which will probably end up looking optimistic, but still demonstrates that there could be significant growth in bringing this well online. This, with recent acquisitions and the deployment of hedges, demonstrates that WTI is a rare energy growth story and a very attractive way to play on expectations of higher and sustained energy prices.

WTI has also developed joint ventures with deep-pocketed investors, including current efforts with HarbourVest (OTCPK:HVPQF) and Baker Hughes (BKR), and a recently announced agreement with Korea National Oil. These agreements allow WTI to access capital without significant financial exposure, with opportunities to increase their returns through execution.

Since WTI has natural gas calls of 30 million, 25 million and 23 million for the remainder of 2022, 2023 and 2024, if the price of natural gas were to reach $16, these calls would equal the full capitalization the company’s $1 billion stock market, given their ~$3.50 strike. This excludes the profitability of the company’s current operations with gas hedges in place, partially unhedged oil and NGL production, and future acquisition growth.

It’s generally best to avoid taking a firm stance on where commodity prices are headed, but there are cases that suggest gasoline at $20 and above is more likely than a return to $3. in the short term, because Shale production in the United States does not progress as expected. If this prediction comes true, WTI should be one of the best performing stocks in the market.

Risks

  • WTI is focused on growth through acquisitions and new exploration, so poor execution on either front could lead to value destruction.

  • WTI has an ATM of $100 million to use if needed in connection with an acquisition or refinancing (possible 10% dilution to $8 share price). This risk would be more acute if there were not significant insider participation.

  • No return on capital programs are currently running, unlike most public E&Ps.

  • WTI strongly hinted during their last earnings call that they were approaching a refinancing of their 9.75% Notes Due 2023. I expect the outcome of a refinance to be strongly positive, but the execution risk remains until it is completed.

Conclusion

The The history of W&T Offshore is quite simple – grow the business, increase production, maintain exposure to rising energy prices. WTI hedges offer some downside protection if prices crash, but buying WTI is primarily a bet on continued energy strength.