California Resources (NYSE: CRC)
Events: Idea Write-Up
December 7, 2014
- Recent PPS: $6.46
- Shares Out: 387 million
- Market Cap: $2.5 billion
- Enterprise Value: $8.8 billion
- 2015E EPS: $.73 @ $70 WTI
- FVPS: $11
- Quintessential spin-off opportunity created by uneconomic selling
- Market cap dwarfed by former corporate parent (OXY) – $2.5B versus >$60B
- Prospective investor base (small cap, growthy independent E&P) vastly different than OXY’s stable large-cap, yield-oriented base
- Leverage profile riskier than OXY at 3 times EBITDA (@ $70 WTI)
- Potential quadruple-dip IRR opportunity
- Single-Dip: Uneconomic spin-off selling (above)
- Double-Dip: 30%+ oil price decline exacerbates spin-off selling pressure
- Triple-Dip: If likely upcoming tax loss selling leads to CRC declining to between $4 and $5
- Quadruple-Dip: Energy sector is extremely oversold on an absolute and relative basis versus the broad market, and positive fund flows in the face of recent declines indicate selling pressure could soon subside. Short- to medium-term buying pressure (potentially heavy) likely emerges on 1/1/15 as tax loss selling vanishes, creating a unicorn opportunity to “time” an investment that already has significant IRR potential.
- Unique asset with economies of scale
- CRC has operated in California since the 1950’s, allowing it to operate at a significant cost and technological advantage (i.e. well data across a vast expanse of territory). This advantaged position has afforded CRC the ability grow production while simultaneously generating strong FCF, a rare feat amongst the notoriously FCF-lite mid-sized independent E&P companies.
- With management unshackled from its corporate parent, CRC has an open-field opportunity to leverage its advantaged position and profitably grow production over the next five to ten years.
- Undervalued at $70 WTI
- At $70 WTI, $4 gas and with approximately 61 million BOE of production, CRC will generate a “clean” $.73 of earnings per share and EBITDA of $2.1 billion.
- With medium-term production growth of 5% to 10% and strong FCF generation, I believe CRC warrants an average multiple of around 15 times mid-cycle earnings. As a sanity check, at 15 times earnings CRC would trade for 5 times EBITDA…
- At 15 times $.73, CRC is worth approximately $11 per share.
- M&A potential
- Over the long term I believe the likelihood of an accretive M&A transaction is very high. CRC could either be acquired by the next largest California producer, Cheveron (NYSE: CVX), or perhaps acquire CVX’s Californian assets in a tax-efficient merger.
- While I do not intend to hold this position – if I choose to invest – for the long term, the potential for M&A could be a catalyst for the stock to catch a bid over the near-term if the market begins pricing in the possibility (think Lands’ End, which has done extremely well since the spin despite limited profitability and growth prospects).
- Long-term oil bear market
- It is far too complex of a discussion to delve into here, but I believe the broad-based downward move in commodities since 2011 is likely indicative of the end of the secular bull market in commodities that began in the early 2000’s. In my opinion, it is unlikely oil will escape this downward pull, and any rally in E&P-related equities should be treated as a bear market rally.
- As such, the CRC situation is extremely short-term in nature – 4 months at most, as I believe any rally by the Energy sector, regardless of explosiveness, will soon fail.
- Look for more downside in CRC over the final weeks of December 2014, perhaps to between $4 and $5 per share.
- Begin accumulating CRC at the earlier of $5.11 (7 times $.73 EPS) or the final week of December, up to $7.30 (10X).
- Begin selling CRC at the earlier of $15.30 or March 1, 2015.
- $15.30 is the mid-point of 15 times $.73 EPS and 15 times $1.31 EPS at $80 WTI
- Two months is a back-of-the-napkin estimate of how long a snap-back rally would last