Laredo Petroleum (LPI) looks capable of generating a modest amount of positive cash flow over the next couple of years at current strip prices. Laredo’s oil production is expected to fall considerably during 2020, but then rebound after Q4 2020 as it completes its oil heavy Howard County DUCs.

Laredo’s stock appears to require sustained mid-$50s oil to have significant true upside. Laredo’s unsecured bonds are still trading at a noticeable discount to par, and look to be a solid value though, given Laredo’s low projected amount of credit facility debt. Laredo’s next bond maturity isn’t until January 2025, so it may be able to pay out four years of interest payments and still provide a substantial recovery for noteholders if oil recovers slowly, but doesn’t reach the mid-$50s level. At mid-$50s oil, Laredo may be able to deal effectively with the 2025 bonds.

2020 Production

Laredo has cut its 2020 capex budget to $265 million, and now expects total 2020 production to average around 81,250 BOEPD and 2020 oil production to average around 26,300 barrels per day. This is roughly flat total production growth and a decrease of -8% in oil production compared to 2019.

Source: Laredo Petroleum

However, the expected Q4 2019 to Q4 2020 decline in production is much greater due to Laredo’s front loaded capex plans. Twenty-eight of the 33 planned completions in 2020 came in Q1 2020.

Laredo expects its Q4 2020 total production to be down -12% versus Q4 2019, while its oil production is expected to be down -22% over the same period of time.

Source: Laredo Petroleum

2020 Outlook

At $39 WTI oil in 2020 (around current strip), Laredo may deliver $661 million in revenues. This includes $232 million in positive 2021 hedge value. Laredo is affected by low NGL prices as it only received $4.68 per barrel for its NGLs in Q1 2020 and it anticipates receiving $1 to $2 per barrel for its NGLs in Q2 2020. NGL futures are improving for later in 2020, but Laredo’s average NGL price will still likely be low for the whole year.

Barrels/Mcf $ Per Barrel/Mcf (Realized) $ Million
Oil 9,599,500 $36.00 $346
NGLs 9,426,673 $5.00 $47
Natural Gas 63,780,470 $0.80 $51
2020 Hedge Value $232
Net Midstream Service $5
Net Oil Purchases -$20
Total Revenue $661
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Laredo’s total cash expenditures are estimated at $611 million for 2020. This includes $51 million that it is paying for additional 2021 hedges.

$ Million
Lease Operating Expense $85
Production and Ad Valorem Taxes $30
Marketing and Transportation $50
Cash G&A $45
Interest $85
2021 Hedge Cost $51
Capital Expenditures $265
Total Expenses $611

Thus, Laredo is expected to end up with around $50 million in positive cash flow in 2020. This would have been over $100 million without the payment for additional 2021 hedges. However, this positive cash flow is only achieved with a combination of strong 2020 hedges and significant production declines in the second half of the year.

2021 Outlook

It appears that Laredo may be able to maintain total production (at Q4 2020 levels) in 2021 and increase oil production while generating a bit of positive cash flow. I estimate that it could maintain total production at 73,500 BOEPD and significantly increase its oil production to around 25,000 barrels per day in 2021 with a $250 million capital expenditure budget.

This would be accomplished primarily through drawing down most of the 40 Howard County DUCs that it expects to have at the end of 2020. Laredo mentioned that it expected to be able to maintain Q4 2020 production levels in 2021 by completing as few as 30 Howard County DUCs. However, I believe that would require it to front-load the wells into the first part of 2021, so I am assuming a higher capex budget than the cost of completing 30 Howard County DUCs in order to achieve a more balanced rate of completions during the year. The Howard County wells are forecasted to have 80% oil production during their first year, contributing to Laredo’s increased oil production while its total production remains flat.

At around $43 WTI oil in 2021, Laredo may end up with around $560 million in revenues after hedges. This also assumes some rebound in NGL prices and natural gas prices compared to 2020. NGL prices would still be below 2019 levels in this scenario, but natural gas prices would be higher with the WAHA basis differential narrowing significantly.

Barrels/Mcf $ Per Barrel/Mcf (Realized) $ Million
Oil 9,125,000 $40.00 $365
NGLs 8,320,175 $8.50 $71
Natural Gas 56,293,950 $1.40 $79
2020 Hedge Value $60
Net Midstream Service $5
Total Revenue $580
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With $250 million in capital expenditures, Laredo’s total cash expenditures for 2021 are estimated at $557 million.

$ Million
Lease Operating Expense $81
Production and Ad Valorem Taxes $35
Marketing and Transportation $46
Cash G&A $40
Interest $105
Capital Expenditures $250
Total Expenses $557

Thus, Laredo is projected to end up with $23 million in positive cash flow in 2021 if it attempts to maintain 73,500 BOEPD in average production (along with a significant increase in oil production).

Laredo’s Howard County wells are now expected to provide okay returns at $40+ oil (and higher IRRs for finishing the DUCs), so I can see it completing the DUCs in 2021 if oil remains in the $40s.

Source: Laredo Petroleum

Debt And Valuation

Laredo started 2020 with $375 million in credit facility debt, while its working capital deficit (excluding derivatives) was pretty minimal. Laredo’s forecasted positive cash flow in the 2020 and 2021 scenarios mentioned above, as well as its note offerings in early 2020 should reduce its credit facility debt to approximately $135 million by the end of 2021. This includes the effect of its non-budgeted $22.5 million Howard County acquisition in February 2020.

Thus, Laredo may end 2021 with approximately $1.135 billion in total net debt. At that level of debt and 2021 production levels, Laredo’s leverage would be 3.4x at $45 WTI oil, 2.9x at $50 WTI oil and 2.7x at $55 WTI oil. This assumes no hedges.

WTI $45 $50 $55
Leverage 3.4x 2.9x 2.7x

Laredo’s historical valuation has been around 3.0x to 3.5x EBITDAX, so at $45 to $50 WTI oil, its common stock has pretty minimal value. At $55 WTI oil, Laredo’s common stock may be worth around $21. While Laredo’s stock isn’t hopelessly out of the money in the long run, it does require sustained oil in the $50s to have upside without being overvalued.

Notes On Bond Valuations

Laredo’s unsecured bonds (currently trading in the mid-60s) appear to have solid potential though. Laredo’s credit facility debt is expected to be reduced substantially by the end of 2020, leaving it with plenty of liquidity. It also appears able to maintain total production (and increase oil production) from Q4 2020 levels at current strip of $43 WTI oil for 2021 without cash burn. This is with the benefit of DUCs though.

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Source: Laredo Petroleum

After its hedges run out in 2021, Laredo’s breakeven point should rise to around $45 to $50 WTI oil.

Laredo looks capable of keeping its credit facility debt at relatively low levels. Laredo’s next bond maturity is in January 2025, so it may be able to get its credit facility extended to at least 2024.

This means that in a scenario with at least slowly improving oil prices, Laredo’s unsecured bonds could receive four years’ worth of interest payments. As well, at $45 WTI oil, Laredo’s unsecured bonds would be worth around 85 cents on the dollar assuming a 3.0x multiple.

Conclusion

Laredo Petroleum’s hedges should help it generate a modest amount of positive cash flow in 2020 and 2021. Its production (particularly its oil production) is expected to decline considerably from Q4 2019 to Q4 2020. However, it looks likely that Laredo’s total production can stabilize and its oil production can increase after that point with the help of its Howard County wells.

Laredo’s common stock likely requires a sustained period of mid-$50s oil to have significant long-term upside from current levels. A prolonged period of mid-$50s oil may allow Laredo to deal with its 2025 notes as well.

In case of lower oil prices, Laredo’s unsecured bonds can probably get four years’ worth of interest payments as well potentially a significant (85% with $45 oil) recovery in restructuring if it comes to that. This also depends on natural gas and NGL prices, and I have assumed longer-term realized prices of around $1.20 and $10 (22% of WTI) respectively in my calculations.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.



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