Halcon Case:"In Math We Trust" or "In Speculation We Like"?

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

My Foolish Africa Oil

During my Foolish inauguration, my first article discussed Africa Oil Corporation (TSXV: AOI) and how irrational the market was with Africa's valuation. The stock was hovering at $10.50 one month ago. Although I pointed out how overvalued that company was, I didn't short it, as I never short stocks. If you would have read my Nov 23 article, then shorted Africa Oil, you would have started making money effective Nov 24. The stock hovers currently below $7. This is a huge 40% drop in just 25 days. Not bad for the shorts, huh? Did you guys drink a beer for me?

"In Math We Trust"

Halcon Resources (NYSE: HK) is currently priced perfectly. The company has three core areas after a spending and acquisition spree during the last 10 months.  After the acquisition of the Williston Basin assets, the company has debt of $2B on its balance sheet and produced 27,000 boepd (77% oil and liquids) in Q4 2012. After the latest financing, it has 367M shares outstanding and an Enterprise Value (EV) of $4.8B.

As of December, Halcon has 115MBoe (79% oil) proved reserves. This being said, it trades for $174K/boepd and $41/boe of proved reserves. 

After the Williston Basin acquisition, I estimate the funds from operations (FFO) to be $40M in Q4 2012. So it trades with a whopping 30x the FFO (annualized) and a staggering DCF ratio of 12.5x on an annualized basis. None of the metrics above looks a bargain to me.

"In Speculation We Like"

The speculation that Halcon's acreage is top notch quality is the primary reason which is behind the company's current sky high valuation. However, the company's acreage both in Utica/Point Pleasant and in Tuscaloosa is unproven land and there is zero production there as of today. The first results from Utica come out in March 2013 and Tuscaloosa Marine Shale's results are expected in Feb 2013. 

Halcon has not released any results from its core Woodbine/Eagle Ford play either although there are currently 15 horizontal wells producing. Why doesn't the company want to make investors happy assuming its drilling results are amazing?

Some other Eagle Ford wells have averaged 545 Boe/d (93% oil) during the first 30 days of production, but no decline rate has been given although these wells have been flowing since August. Isn't it disturbing that the company knew of this rate of decline when its Q3 report was released in November, but did not disclose it publicly?

In terms of its Bakken wells, the company notes: "Four of the wells have been online for less than 30 days and the other five wells have an average 30 day rate of 347 Boe/d (91% oil)." Sincerely, does this IP-30 impress you?  

It is clear that the company's Eagle Ford and Bakken acreage is not a goat pasture, but it is also clear that this acreage is far from having whopping IP-30 rates. Why is Halcon valued like it owns Saudi Arabia's Ghawar oilfield that is producing 6.25% of global production with IP-30 of 5,000 bopd and a negligible decline rate?

On an ending note, the company's wells in Midway formation of Texas have an initial gross production rate of approximately 595 boepd. From an initial gross rate perspective, this number obviously cannot justify the current overly rich valuation either.

Some folks may say: "Halcon is so pricey because it has the wells with the highest IP rates (both gross and 30 days) in North America". Well, please check the sweet spot of Beaverhill Lake in Canada where Second Wave Petroleum sits (TSX: SCS) and you will see that Second Wave's wells have initial IP of 3,000-5,000 boepd and an average IP-30 of 500 boepd. 

Kodiak Oil and Gas (NYSE: KOG) also sits on the sweet spot of Bakken in North Dakota. Kodiak's wells have 24-hour IP rates between 2,000-4,000 boepd and IP-90 rates between 500-1000 boepd on average. Sorry, HK longs.

What about Halcon's spot? Is it sweet, bitter, or sweet and sour? Nobody knows it.

The peers

Let's check two of the most richly priced oil players of North America. The US-based Kodiak Oil and Gas with an exit 2012 production of 27,000 boepd (86% oil and liquids) and EV=$3.3B trades for $122K/boepd and 11.5x the FFO annualized. Based on the Q4 2012 production, the DCF ratio is 3.3x (annualized).   

The most acquisitive Canadian oil player, Crescent Point Energy (TSX: CPG), has an exit production of 109,000 boepd (90% oil and liquids) for 2012 and EV=$15.5B currently after the new shares from the latest financing. It trades for $142K/boepd and 9.5x the FFO annualizedBased on the Q4 2012 productionthe DCF ratio is only 0.9x (annualized).

Foolish Round up

Halcon noted in its Q3 2012 report that "Production for the third quarter was adversely impacted by Hurricane Isaac". I will add that several unexpected "hurricanes" could hit Halcon in 2013 as the operating anomalies and below expectations drilling results are normal for the energy players. So I would like the company to deliver first. Until it delivers, I am very hesitant in dipping my buying toes into Halcon. I believe that Halcon has bitten more than it can swallow and it will need to take many "digestive enzymes" (i.e. asset sales) in 2013. Should I buy shares of the health and wellness retail giant GNC instead? GNC Holdings sells a ton of digestive enzymes every day!

 


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