High stakes for Whiting Petroleum

The US-based energy company is one of the most leveraged plays on the oil price.

While the majority of our international shares recommendations are trading nicely above their initiation price, at $US35 Whiting is substantially below its ‘price at call’ of $US83.80. Also, its original target price is a bit unrealistic at $US131 in a world of $US50 per barrel of oil.

The culprit in Whiting’s price decline is – needless to say – the substantial fall in the oil price. On July 16, 2014, when we recommended the stock, oil was trading at $US96 and Whiting traded as high as $US93 on the back of its well received and transformational Kodiak acquisition.

Since then, the oil price has fallen over 50 per cent, trading as low as US$46.51, and is currently in the low $US50s. As you would expect, Whiting – and all its exploration and production (E&P) peers – have seen a precipitous decline in their share prices.

If you don’t believe the oil price will recover to the mid $US60s sometime this year and hit $US70 sometime in 2016, combined with improved sentiment towards leveraged E&Ps, then you don’t want to own Whiting – no matter how extensive its acreage or how good of an operator it is.

However, if a sharp reduction in energy production  (especially in the US) reduces supply, and an expanding US and improving global economy works down excess inventory and improves the demand side, oil prices could quite easily top $US60 later this year and move higher into 2016.

If that’s the case, you’ll make money with Whiting. At almost 90 per cent oil in its asset base and with higher than average debt levels, the leverage is exceptional.

Consider the following:

Whiting remains the largest holder of shale plays in the Bakken formation with over 855,000 acres and some 3400 drilling locations through its Kodiak acquisition.

The company is “positioning” itself for $US55 crude over the medium term; it intends to grow production 10 per cent this year while reducing costs and selling non-core assets (probably a few surplus gas processing plants and its CO2 EOR asset in North Ward Estes).

Whiting (via a debt and equity offering) has significant liquidity to maintain loan covenants and fund its exploration programs, although it dilutes equity holders by 25 per cent. The company raised $US1 billion in the combined deal. Capital expenditure in 2015 will be $US2 billion.

Whiting has flagged a return to 20 per cent production growth in the 2016 to 2017 timeframe.

Share price catalysts for 2015

There are a several events which could bolster Whiting Petroleum’s share price during 2015:

  • Whiting reports lower completed well costs in its Bakken and Redtail plays, affirming its expressed intention to lower operating costs and quantifying the ongoing success of its cemented liner plug & perforation extraction technology as well as its coiled tubing fracking approach.
  • The company reports more positive results in its 32 per well spacing strategy at Redtail.
  • The company continues to meet production milestones.

What is interesting is that these are exactly the same investment points I made in July, 2014 (see Our first offshore stock pick). The only thing that’s changed is the oil price and, of course, Whiting’s stock price.

So this is the same company with the same assets and the same strategy to grow the business.

There is one more factor at work in Whiting’s favour and that is the renewed appetite for the oil majors to “buy” assets and production growth rather than find them. The $91bn Royal Dutch Shell acquisition of BG Group just announced is a case in point. I wouldn’t recommend a stock solely on the basis of a potential takeout but given the quality of Whiting’s properties it remains a possibility and it would likely be above our target price profiled below.

Target price and valuation

Our original price target of $US131 was based on a crude price environment of $US80-90 per barrel – where it had been trading for over five years – and that Whiting achieved a peer enterprise valuation to earnings before interest, tax, depreciation and amortisation (EV/EBITDA) multiple of 8.5 times.

Without the subsequent dilution from the debt and equity offering, a target price of $US71 (now based on a US$70 oil price) would have been appropriate.

Whiting’s peer group trades at 9 times 2016 EV/DACF* (debt adjusted cash flow). I expect if my oil price assumptions are correct and Whiting meets (or beats) the various milestones listed above that Whiting could achieve the same multiple given its superior asset base and operational efficiency. 9 times 2016 EV/DACF for Whiting equals a $US50 target price, or roughly 42 per cent upside from current levels.

For your information, Wall Street is still supportive of the stock. 24 analysts rate it a “buy”, 13 call it a “hold”, and there is 1 “sell”. Their average target price is $US43.

Risks

The risks to Whiting Petroleum’s valuation are the oil price, oilfield service cost inflation, exploration failures, and infrastructure constraints – risks common to all E&P companies.


*DACF is a financial ratio commonly used in the analysis of oil companies, representing the after-tax operating cash flow, excluding financial expenses after taxes. It equals the cash flow from operations financing costs (after tax) exploration expenses (before tax) /- working capital adjustment). Source: Investopedia

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