Nathan is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Equal Energy (NYSE: EQU) came through a transformational period during the second half of 2012. The company took some giant steps and sold a lot of its assets, primarily the Canadian ones, lightening its bank debt in order to focus its activities on the liquids-rich Hunton formation in Oklahoma. Some shareholder activism worked and the majority of shareholders made the management team initiate a strategic review in order for the company to become an income growth machine and attract more investors. However, there are still issues that need to be addressed.
Equal is currently a producer of 7,800 boepd (48% oil and liquids) with an enterprise value (EV) of approximately $130 million and proved reserves of 30 MMboe (44% liquids) after the latest dispositions. This gives a valuation of $17,000/boepd and $4.33/boe of proved reserves. Both metrics are well below the average metrics of peers with a balanced production between oil/liquids and natural gas. With net debt at $23 million and estimated Funds from operations (FFO) at $33 million, the D/CF ratio is also as low as 0.7x. So what's not to like here?
Digging into the peers
The peers have not been selected accidentally. They are US and Canadian producers with a balanced production between oil/liquids and natural gas. Penn Virginia (NYSE: PVA) holds acreage in Oklahoma, Mississippi, Texas and Pennsylvania. Its production is 17,000 boepd (51% oil and liquids) with 129 MMBoe proved reserves and an EV at almost $900 million, out of which $670 million is long-term debt mainly held through notes due after 2015. So Penn Virginia trades for $52,000/boepd and $7/boe of proved reserves. With estimated annualized FFO for 2012 at $270 million, the D/CF ratio also stands at 2.5x.
Magnum Hunter Resources (NYSE: MHR)produces 18,500 boepd (58% oil and liquids) with 67.7 MMBoe Proved reserves and an EV at $1.5 billion currently. Thus, Magnum trades for $81,000/boepd and $22.2/boe of proved reserves. With FFO (annualized) for 2012 at $90 million, the company sports a D/CF ratio at 8.8x, which is too high.
Crew Energy (TSX: CR)is a Canadian producer of 28,000 boepd (52% oil and liquids) with an EV at $1 billion currently. As the proved reserves are 75.7 MMboe (Dec 2011), it trades for $36,000/boepd and $13.2/boe of proved reserves. With estimated FFO (annualized) for 2012 at $180 million, the company has a D/CF ratio of 2.1x.
Canadian Artek Exploration(TSX: RTK)has a production of 4,000 boepd (45% oil and liquids) currently and an EV is $218 million. According to the company, the net debt is $45 million. As the proved reserves are 12.9 MMboe (report as of Dec 2011), it trades for $54,500/boepd and $16.9/boe of proved reserves. Production grew significantly in Q4 2012 propelling the FFO, which are estimated to be $5 million in Q4 2012 and $20 million (annualized), and bringing the D/CF ratio at 2.3x.
The math shows that the peers have an average valuation of $55,800/boepd and $14.83/boe of proved reserves despite the fact that all the aforementioned companies are more leveraged (higher D/CF ratios) than Equal Energy. There are of course other considerations such as the amount of acreage each company has, the quality of the acreage and the ability to finance future development. However, Equal has a huge valuation gap versus its peers that makes it look like a good buying opportunity.
Digging into the Oklahoma deals
To check whether Equal is truly a buying opportunity currently, let's take a look at the deals in Equal's neighborhood:
1) In Jan 2012, Apache Corporation paid $2.85 billion to acquire the privately held Cordillera Energy Partners that was holding acreage in the energy-rich Anadarko basin, a shale formation in western Oklahoma and the Texas panhandle. Cordillera had a production of 18,000 boepd (53% oil and liquids) and 71.5 MMboe proved reserves.
2) In April 2011 Equal Energy acquired Petroflow's interest in the Oklahoma Hunton play for $93.5 million establishing Equal as a dominant player in the Hunton liquids-rich natural gas play in Oklahoma. Petroflow was producing 3,100 boepd (42% oil and liquids) and had proved reserves of 8.7 MMboe. Based on a purchase price of $93.5 million, the transaction metrics were $28,290 per flowing barrel and $10.08 per boe of proved reserves.
3) Back in 2010, PetroHawk sold its interest in the Hunton Lime Unit Field for $155 million. PetroHawk was producing 2,000 boepd (60% oil and liquids) and had proved reserves of 3.8 MMboe. The transaction metrics were $77,500 per flowing barrel and $40.78 per boe of proved reserves.
It is easy to do the math here to find that the average transaction metrics in this liquids-rich area is $87,930 per flowing barrel and $30,29 per boe of proved reserves.
Land and insiders' ownership
My concerns with Equal are its relatively small acreage of 8,700 net acres and the low insider ownership. Is this land enough to provide the required room for sustainable growth? Maybe yes, because the decline rate of the Hunton formation wells is low on an annual basis (less than 20%). So why don't the insiders load up at the current low price? What is their concern? Don't they trust the land?
It is clear that the market has not recognized Equal's value yet despite the completion of its major restructuring plan. One reason is the weakness in natural gas and liquids prices, but in my opinion the main reason is the current CEO who has not proved that he can unlock Equal Energy's fair value. The company has been lacking growth yoy and a concrete strategy hurting its stock performance, which has been very poor thus far. However, I believe Equal is a buying opportunity at current levels for a long term investor looking forward to either a management change or a buyout. For a short term investor though, more pain may be coming.