QEP Resources (QEP) is an interesting prospect for long-term oil and gas E&P (exploration and production) investors. In recent months, the market has not treated the business well, especially as oil and gas prices have gyrated up and down. Add in that the company does have some leverage, and it’s understandable why some shareholders and market participants might be a bit concerned. However, when you take the data into consideration, the company does appear to be more attractive than many other players out there.
Some recent updates
Since publishing its latest quarterly results, the management team at QEP has had some updates for shareholders. Most recently was August 31st when management announced the redemption of its remaining 6.875% Senior Notes due in 2021. These are its nearest-maturity notes and at present, the amount outstanding is just $275.3 million. The exact price being paid for these notes has not been stated, but the indenture for them makes clear that any redemption must be at the greater of 100% of principal or the sum of the present value of all remaining scheduled payments of principal and interest, discounted to the redemption date (semi-annually) at the treasury rate plus 0.50%. In either pricing outcome, the company must also pay any accrued interest payments up to the date of redemption, to their holders.
As of the end of its latest quarter, QEP had cash on hand of just $3.4 million. That said, this leads us to another update announced last month: the receipt of a tax credit entitled to the business. This amount, inclusive of $5.1 million worth of accrued interest, works out to $170.7 million. This, combined with what cash flow QEP has generated, will help it to redeem these notes. This isn’t just a one-off event, by the way. During the second quarter this year, the company bought back $57 million worth of Senior Notes. Management said this was done at a discount, but while this is true, that discount was modest at best. The firm’s cash flow statement shows $55 million for the notes repaid, plus $0.5 million worth of issuance costs for around $1.5 million reductions in net debt.
Putting health in context
In some respects, 2020 has proven to be a decent year for QEP, while in others, it has proven to be a pain. For instance, production in the latest quarter was up 5.8% compared to the same quarter last year. Year-to-date (through the second quarter), it’s up 3.7% compared to 2019. This trend should not be expected to continue though. Earlier this year, management had guided for capex to range between $545 million and $595 million with a mid-point of $570 million. That was reduced in the company’s second quarter guidance to between $340 million and $380 million with a mid-point of $360 million.
As capex was reduced, so too were expectations. At the mid-point, initial guidance for 2020 was set at 32.6 million boe (barrels of oil equivalent). This represents a gain of 1.2% over the 32.21 million boe seen in 2019. Now, the expectation is for output to total 28.85 million boe this year. That implies a year-over-year decline of 10.4%. Falling capex is unlikely to have been the only contributor to this revision because management did state in their second quarter earnings release that they did curtail uneconomic production as a result of extreme pricing volatility earlier this year.
Despite this impaired production outlook, the financial results posted by QEP so far this year have been encouraging. According to management, EBITDA in the first half of the year totaled $331.2 million. This is up from $286.3 million the same time last year. If we annualize this figure, investors should be looking at EBITDA of $662.4 million for 2020, while if we see second-half EBITDA outpace first-half by the amount it did in 2019, then this year’s should total $767.7 million. With net debt of $1.70 billion, this implies a net leverage ratio for the firm of between 2.22 and 2.57. Most investors prefer net leverage ratios of 2 or lower right now, but this is close enough that QEP should not be considered burdened by its debt. Management should, however, focus intently on reducing leverage if it wants to win the appeal of a broader base of prospective shareholders.
There are other ways to judge the company’s results. While second quarter operating cash flow of $72.5 million was below the $117.4 million seen the same quarter last year, first-half operating cash flow of $224.4 million outpaces last year’s $195.7 million. If the second half looks like the first half, free cash flow should be at least $88.8 million for 2020. This is at odds, it’s worth saying, compared to the $150 million being forecasted by management, but in my opinion, their measure of free cash flow includes things it should not include. For instance, in the latest quarter, the company reported free cash flow of $95.3 million. This is up from -$32 million a year earlier. A more appropriate measure of free cash flow, as it’s meant to be, reveals a second-quarter figure of $35.9 million compared to -$52.5 million seen in 2019. For the first half of the year, the figure totaled $9.3 million, up from -$141.4 million on a real basis seen in 2019’s first half.
Based on the data provided, it seems to me like QEP continues to chug along. No, the company has not been appreciated by shareholders, as illustrated by the trajectory its shares have been on, but so long as energy prices don’t fall much from here, it seems to be a solid prospect to consider, even if leverage is toward the high end of what’s accepted at the moment.
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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.