PDC Energy (PDCE) is one of the financially stronger producers in the industry. As such, this management can simply wait for more favorable industry conditions. That appears to be exactly what this management is going to do.

The second quarter could throw a lot of company ratios way off in the industry. But that quarter is likely to be treated as an anomaly. Some competitors will be sufficiently hedged to get through the quarter without major changes to key debt ratios while others may need to get a covenant variance as a result of the second quarter.

PDC Energy probably will not need that kind of help.

Source: PDC Energy Presentation At JPMorgan Energy Conference June 2020.

The key debt ratio shown above is conservative by most industry standards. That means that this company is unlikely to fall out of compliance with any covenant ratio when the second quarter is reported.

The merger with SRC Energy (SRCI) did add to the debt so that the current leverage ratio is about 1.9. But that is still pretty low by industry standards. Management will stop drilling to wait out the current period of low prices and will also shut in some older high cost wells. Those kinds of actions are made possible by the conservative leverage ratio shown above.


Interestingly, the DJ Basin tends to have a high percentage of natural gas production as shown below:

Source: PDC Energy Second Quarter 2020 Earnings Press Release

The natural gas production is significant enough that these shares could rally with the anticipated strengthening of natural gas prices.

Source: PDC Energy Second Quarter 2020 Earnings Press Release

What has always made the DJ Basin so profitable has been the extremely low operating costs. This basin typically has production costs that are typical of a dry gas producer. Therefore, the natural gas liquids and the oil production add considerable profitability to operations in this basin. The margin ends up being relatively high. The payback period for a well drilled in the basin tends to be under a year when pricing is normal.

The first quarter saw an impairment charge more than offset the gains in the hedging contracts to report a loss to shareholders. But the “cash costs” of production practically “guarantee” decent cash flow even under the currently extreme circumstances. That is especially true given the hedging program.

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In the second quarter, lease operating expenses declined due to a lack of activity. That low level of second-quarter lease operating expenses is unlikely to be repeated anytime soon. Unrealized hedging losses began to offset the first-quarter hedging gains in the second quarter as commodity prices began to recover during the quarter.

Thanks to the merger, cash flow from operating activities did increase to more than $260 million in the first quarter. The second-quarter cash flow dropped to roughly $100 million. However, the lack of activity ensured free cash flow.

Production will decline since management is drilling but not completing wells at the current time. Offsetting some of that decline is the realization that wells do produce at a higher rate after they are shut in. That is followed by the usual rapid decline back to expected production levels.

But that first-quarter cash flow annualized will easily support the debt of approximately $1.9 billion at the end of the first quarter. Since the second quarter will most likely be an outlier, there is really no reason to consider it in debt servicing. More importantly, there is likely to be free cash flow for a while as management appears to plan a maintenance budget for the next fiscal year.

Like many companies with low costs, this producer is usually a fast grower once we get past the coronavirus demand destruction.

Source: PDC Energy First Quarter 2020 Earnings Press Release

The enterprise value shown above is about 3 times the annualized first-quarter cash flow. That is a very low price to pay for a growth company. The price is especially low because commodity prices are very weak right now. Once commodity prices begin to rally and drilling resumes, this stock could be trading much higher.

The company does have a relatively small presence in the Permian. This company is in a position to take advantage of distressed sales in either basin. Generally, this company makes significant acquisitions using stock. That probably will not change in the current environment as management likes to keep the debt ratio very low.

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Debt Due Profile

The conservative debt ratio at the end of 2019 should allow for adequate access to borrowing if the company needs to borrow.

Source: PDC Energy First Quarter 2020 Earnings Press Release

The convertible notes due will easily fit on the revolving credit line. The hedging appears to sufficient for the current fiscal year to ensure generous cash flow. Obviously cash flow would drop significantly next year if commodity prices remain weak. But industry activity has decreased so much that pricing is unlikely to remain weak even though there is a fair amount of demand destruction from the coronavirus challenges.

There appears to be plenty of time for the coronavirus challenges to head to the rearview mirror before this company needs to refinance any debt.


In the meantime, investors should expect this management to just patiently wait out the current period of weak pricing. For better or worse, the economy is beginning to open up again. Even though the coronavirus challenges may be the biggest set of challenges that the economy has faced in some time, it should be obvious that this economy will get past this challenge.

Once that happens, investors should expect the relatively fast growth pace of the past to resume. The combination of the average pricing combined with the relatively low production costs ensure a very decent margin and probably a continuation of fast payback periods in the future.

PDC Energy also tends to grow by acquisition. In the past, such growth led to some size advantages that accrued to shareholders through better stock pricing. Right now the stock price appears to be at bargain levels. How that influences future acquisitions remains to be seen. But bargain priced stock can be used to acquire bargain priced properties or even companies and still be accretive to shareholders.

This management has handled the growth and cost control of the company very well. Furthermore, those with a long memory may remember that the management of SRC Energy was the same management that sold Kodiak Oil & Gas to Whiting Petroleum (WLL). The fact that the management of SRC Energy was willing to sell to PDC Energy in exchange for stock is a vote of confidence in the PDC Energy management from some very experienced people. That opinion could change of course if the SRC managers should decide to sell their stock.

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In the meantime, this company sells for a little more than annualized cash flow from operating activities. In more normal times, an enterprise value to annual cash flow from operating activities of 6 to 8 would be a far more normal range. If rapid growth resumes, that ratio could go as high as 10. Therefore, this company is a bargain at current prices.

The current management is very likely to sell this company (for the right price) at a certain point in the future. Some investors may want to consider buying at the current price and then waiting for management to sell the company. Others may want to trade the stock. The relatively experienced management provides some degree of safety not usually seen in companies of this size.

I analyze oil and gas companies like PDC Energy and related companies in my service, Oil & Gas Value Research, where I look for undervalued names in the oil and gas space. I break down everything you need to know about these companies — the balance sheet, competitive position and development prospects. This article is an example of what I do. But for Oil & Gas Value Research members, they get it first and they get analysis on some companies that is not published on the free site. Interested? Sign up here for a free two-week trial.

Disclosure: I am/we are long PDCE. 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.

Additional disclosure: Disclaimer: I am not an investment advisor, and this article is not meant to be a recommendation of the purchase or sale of stock. Investors are advised to review all company documents and press releases to see if the company fits their own investment qualifications.

Via SeekingAlpha.com