Rex Energy Makes a Big Splash into Liquids

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

In investing circles you’ll hear a lot of discussion surrounding companies that have things like durable competitive advantages or recurring revenue.  We tend to like companies that live within their means and that are growing in a measured and projectable manner.  Those companies that deviate from this path and instead lever up to go all in rarely end well. 

That’s why it’s not hard to be somewhat surprised to see Rex Energy (NASDAQ: REXX) announce a massive 2013 capital budget of $230 million to $250 million. That represents a big increase to their 2012 budget of $180 million which for some perspective represents the company investing about 27% of their $900 million enterprise value to growth projects next year.  About 95% of this proposed drilling budget is focused on liquids making this a really big splash for such a small company.

This leaves investors with two big questions.  First, how do they plan on paying for this?  Second and probably more importantly is it worth it?

To answer the first question, simply they’ll be levering up, but not in the traditional sense.  In conjunction with the release of their capital plans Rex announced a proposed $250 million senior notes offer.  The offering will be used to pay off their revolving credit facility as well as to knock out their second lien term loan facility.

At last count they had $225 million outstanding on these two facilities and once they are paid off anything left over will be used for general corporate purposes.  Bottom line though, with less than $4 million in cash at the end of the third quarter they won’t be funding this ambitious growth with cash on hand.  Instead a bulk of it will be funding through tapping back into their credit line which currently has $290 million in borrowing capacity. 

Does it make sense then for Rex to lever up and go all out on their drilling program?  First, it is important to see what those funds should deliver and how they’ll be spent.  With the proposed budget the company is guiding for production of 90.5 to 94.5 MMcfe/d in 2013.  That’s a 34% to 40% year-over-year growth in production.  It’s also spread fairly evenly between their core Appalachian basin positions which includes the Upper Devonian, Marcellus and Utica plays as well as their Illinois Basin position.

Just $10 million of the budget is going to their non-operated Marcellus which is part of a JV with WPX Energy (NYSE: WPX).  That will be enough to fund the seven wells (2.8 net) that the two plan to fracture, complete and place into service next year.  While Rex still holds a 40% working interest it’s clearly evident that this area is being relegated to the back burner as they turn their focus almost solely on liquids.  Even WPX is seemingly playing down the Marcellus for their other core operating areas. 

For Rex, the rest of the budget will be spent on drilling a total of 47 wells (40.4 net) in 2013.  By the end of the year they plan to have all but 18 (13.5 net) of these wells placed into service along with another 11 wells currently being completed.  That will enable the company to grow liquids production by 70% and plan to end the year with 30% of their production volume being that of liquids. 

Unless we see a complete collapse in liquids the strategy makes some sense for Rex.  Given the continued sluggish natural gas prices Rex and their peers need liquids in order to grow.  Rex’s 2013 capital budget is a big step in that direction. 

The concern however would be that Rex would find themselves in a liquidity situation similar to the one that Chesapeake (NYSE: CHK) found themselves in during the depths of the financial crisis.  Chesapeake was forced to turn to both asset sales and other creative forms of financing to right their financial ship after betting big on natural gas.  Now they and the rest of the industry are betting just as big on liquids and it remains to be seen if that bet will face the same fate. 

I have to admit I’m of two minds when it comes to Rex.  They really have a great position in the Marcellus and what appears to be a solid Utica position as well.  They are well hedged for the next year or so and appear to have a lot of future upside.  However, outsized bets like this are very binary in nature to say the least. 

Shares remain very volatile having bounced between $10 and $14 over the past couple of months.  Given that volatility and their supercharged growth plans I’d prefer to buy shares closer to $10 each and even then only via writing puts. Still, they remain a very interesting company to watch.

latimerburned has no positions in the stocks mentioned above. The Motley Fool 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. 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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