Will Weaknesses Prevent This Energy Underdog from Running Higher?

Matthew is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

(This article is part 3 in a series drilling down into Rex Energy through a SWOT analysis)

No company is without fault, and Rex Energy (NASDAQ: REXX) certainly has their share of it.  The real question is if their weaknesses are enough to cripple the company.  In this continuation of a SWOT analysis of Rex Energy, I’ll take a deeper look at some of the company’s weaknesses to see if any are a deal breaker for investors. 

Volatile Small Cap

What makes Rex an underdog in the energy world is their rather small size.  With a market cap of less than $700 million Rex is very small by public company standards.  Consider this: the top dog in energy, Exxon Mobil (NYSE: XOM) is worth $418.3 billion and made $41.1 billion of net income last year.  This meant that Exxon made more money every week than Rex’s whole equity market cap.  Now, Exxon’s not likely to double any time soon, and that’s where the opportunity lies with Rex.  However, small companies are more volatile, have less favorable access to capital, and are more affected by adversities like dry holes and environmental issues.

Their volatility could affect their ability to raise capital.  Since going public shares have both soared and swooned, and it could have an impact on both the amount of capital they can raise and the affect it has on diluting current shareholders.  The following chart shows just how volatile the company has been since going public:

<img src="http://media.ycharts.com/charts/b546610c78bb92c80418c41e9760bdae.png" />

REXX data by YCharts

Back in January, Rex announced that they’d be raising capital, causing shares to fall 7.6% in after hours trading with those newly issued shares pricing even lower.  In that offering they raised around $70 million in capital for $9.25 a share.  Two years earlier they raised slightly more capital at an offering price of $12.25 a share.   As you can see, volatility and Rex go hand-in-hand, which can impact their ability to raise capital on favorable terms.       

Future Liquidity

Given their small size, Rex has longer term liquidity concerns.  I listed their current balance sheet as a strength, so you might wonder what gives.  They do indeed have more than enough to cover the balance of their 2012 capital budget, and while they’ve yet to release a 2013 capital budget, it will likely be in the range of the $180 million that will be spent in 2012.  With $220 in liquidity to start next year, that means that looking to 2014 they’ll either need to raise capital or slow down their growth.

Until the company can fully fund its growth plans with internally generated capital they’ll be at the mercy of the capital markets.  We’ve seen how unmerciful those markets can be on more than one occasion.  Look no further than Chesapeake Energy (NYSE: CHK) and the bind they got themselves into when an overactive drilling program met with an over-leveraged balance sheet at a time when natural gas prices plummeted.  Rex is a lot smaller and has fewer assets that they could possibly sell if they needed to plug a hole in their balance sheet.  This is definitely something to watch.  

Concentration of Assets

Rex’s production is currently limited to just the Appalachian and Illinois Basins. They do have acreage in the DJ Basin that they are trying to sell, but it’s now considered discontinued operations.  Rex’s focused operations could be a weakness if it turns out that the Utica isn’t all it’s cracked up to be. Their much larger Appalachian peers like Range Resources (NYSE: RRC) operates in four basins, while Chesapeake spreads their operations across eight shale gas and unconventional liquids plays. 

While there is nothing wrong with having focused efforts, and Chesapeake is a prime example of how being unfocused can be a disadvantage, being too concentrated does have its pitfalls.  These could range from weather-related issues to local environmental problems, on up to state legislation.  For example, New York placed a moratorium on fracking, and while it’s unlikely that Ohio would ever follow suit those types of risks remain and have a greater impact when a company lacks diversity.

Inability to Sell DJ Basin Acreage

Back in December of last year the board of directors approved the plan to sell the DJ Basin acres. They have now been on the block for the past year and there still are no takers.  The company pieced together this position over time, having added 26,900 gross acres in June of 2010 for $18.7 million.  In an effort to refocus their efforts they put the assets on the market, but have been forced to write them down for $12.6 million so far this year, and there was also a $400,000 charge for leased acreage that’s now expired.  Questions remain if they’ll be able to find a buyer before they must endure additional write downs. 

CEO Turnover

In October of 2011 Rex named co-founder and CFO Thomas Stabley as its CEO.  In June of that year it was announced that then CEO Dan Churay was leaving the company, after being appointed just the previous November.  This was after the previous CEO Benjamin Hulburt left the company to pursue other interests that October.  While the turnover isn’t reason enough to be concerned about deeper issues within the company, it simply is something to watch. 

Anytime there was a need for an interim CEO the company turned to Chairman Lance Shaner, so there is stability with him.  Further, company officers and directors own 18% of the outstanding shares, which demonstrates their alignment with shareholders.  

Bottom Line

I don’t view any one of Rex’s weaknesses as enough to hinder the company going forward. However, if I were to point to one that would concern me the most it would be their future liquidity.  Another perfect storm where the capital markets are shut off and commodity prices plummet could send investors running for cover.  A lot has to do with how the company allocates capital over the next couple of years.  Spending more than you make can only last for so long.

That being said, they have no near term liquidity concerns and a lot could go right over the next year and a half to make this all a moot point.  They could monetize their DJ Basin acres at very favorable prices, and when they do need to raise capital it could very well be on favorable terms.  The company has some real game changing opportunities ahead that I think overshadow these weaknesses. 

latimerburned has no positions in the stocks mentioned above. The Motley Fool owns shares of ExxonMobil and has the following options: long JAN 2013 $16.00 calls on Chesapeake Energy, short JAN 2014 $15.00 puts on Chesapeake Energy, long JAN 2014 $20.00 calls on Chesapeake Energy, and long JAN 2014 $30.00 calls on Chesapeake Energy. Motley Fool newsletter services recommend Range Resources. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.

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