California Resources (NYSE: CRC)
Generals: FV & Thesis Update
January 27, 2015
(Bulk of the post written January 25, so pricing & data few days old)
- Recent PPS: $4.06
- Shares Out: 387 million
- Market Cap: $1.57 billion
- Enterprise Value: $7.87 billion
- Updated FVPS: $13.46 (from $11 on 12/7/14)
- Original event-driven analysis off base, though…
- Comfortable moving from “events” category to “generals” due to wide margin of safety
- Oil has overshot to downside sooner than expected; as such…
- Any rally in oil and related equities likely to frustratingly long for oil bears
- CRC worth $13.46 at mid-pt terminal EV/EBITDA of 6X using…
- Current strip pricing thru 2017, and $80 & $4.50 oil & gas long-term
As outlined in the 12/7/14 write-up, the event-driven investment thesis for CRC was:
- Attractive entry point created by uneconomic spin-off selling
- Potential four-fold IRR opportunity created by: spin-off selling, oil price decline, potential tax-loss selling into year-end, over-sold Energy sector likely to rally in the near-term
- Unique asset with economies of scale
- Undervalued at $70 oil and $4 gas
- Long-term M&A potential
- Long-term oil bear market makes the CRC investment short-term in nature
At initiation I viewed CRC as an event-driven investment for two reasons. First, the spin-off “event” created uneconomic selling pressure as a result of CRC’s small relative size to OXY, which likely led to greater undervaluation than otherwise would have been in place had CRC declined in line with the sector since mid-2014. Second, the large-scale decline in the price of oil in combination with potential YE tax-loss selling created a coiled spring for a near-term rally in oil-related equities. My thought with Brent Crude in the low $60s – at the lower end of the marginal cost range – was further oil price downside was limited and thus conducive to a rally in oil-related equities.
My belief was that the spin-off dynamics created a best-of-all-worlds situation in CRC, where 1) in the event of continued Energy sector selling pressure CRC would decline less than the sector; 2) in the event the Energy sector flat-lines, CRC would rally; and 3) if the sector rallied as I anticipated, then CRC would dramatically outperform on the upside.
Clearly my “event” analysis in this situation was extremely lacking. I was wrong on all fronts. But while a true trader would say that a “trade” should never turn into an “investment”, I am not a true trader…I am perfectly willing to shift investments between categories depending upon the circumstances, as long as the MOS/IRR is sufficiently attractive. CRC’s fundamental business value has declined slightly since early December 2014 based on a hybrid “strip” DCF analysis using long-run marginal cost for the out years; but importantly, the updated FV estimate provides a huge margin of safety over the original purchase price (~$5.30)…in addition to the recent quote of just over $4.
Part of the original thesis was that oil has entered a LT bear market and that any rally in oil and related equities should be sold. As such, I viewed CRC as a very short term situation. My view on this has changed with oil’s plunge climbing to almost 60%, the third-worst decline since 1986 according to Ned Davis Research. It is no surprise to see oil trading below $50; the surprise is how soon the $50 level was breached. As such, I believe a sustainable medium-term bottom is in for oil, and that any rally in oil and oil-related equities will be frustratingly long-lived for oil market bears.
Based on trading volume since the spin in early December 2014, I estimate that spin-off related selling exhausted itself by YE 2014 at the latest. As such, the sellers driving CRC down over 26% YTD are likely either those who purchased the shares from OXY shareholders, or short sellers. Given CRC’s considerable debt load and high sensitivity to oil, my guess is the latter, as the June 2015 Brent Crude contract is down over 13% YTD and near-term Brent currently sits below $50. With CRC (CalRes) 2024 debt trading around $80, I believe the debt market is looking beyond the current oil price weakness. Think about it – CRC does not exist at $50 perpetual oil, yet with NT oil trading below $50, those who will not receive their principle for almost 10 years have marked the debt down to a mere 20% discount to face value. That tells me the risk of bankruptcy is extremely low, and that the capital markets have simply raised CRC’s cost of capital to account for NT operational headwinds.
In summary, the updated investment thesis for CRC is as follows:
- Categorization updated to “generally undervalued”, as no discernible near/medium-term catalyst currently in place
- Updated fair value $13.46 – “Strip” pricing thru YE17; $80 oil/$4.50 gas 2018 and beyond; FV range of $9.53 at 5X to $17.39 at 7X
- Opportunity created by 50%+ decline in Brent Crude oil price since mid-2014, spin-off selling and likely recent short-sale pressure on debt sustainability concerns
- Unique asset with economies of scale; Enhanced Oil Recovery focus drives long-lived production and high margins; underinvestment under OXY management creates outsized growth opportunity once oil prices stabilize
- Long-term M&A potential – CRC is the largest Californian producer at over 29% of the State’s production; with interwoven acreage positions, an accretive M&A transaction with CRC as the consolidator or consolidated is highly likely over the long-term
FAIR VALUE UPDATE
According to a December 2014 Raymond James initiation report, CRC’s 2015 projected operations are as follows:
- Production: 62.05MM BOE; 6.57 & 14.24 of which comprised of NGL & Gas
- OPEX: $1,590 million, excluding exploration expense
- Interest Expense: $306 million
Of note, due to pre-spin investment by OXY, 2015 production growth is preset. CRC management believes it can maintain 2015 production with CAPEX of $1B – for conservatism, I estimate maintenance CAPEX to be approximately $1.2B. Assuming a 6% decline rate, it would cost CRC ~$322 per declining BOE to keep production flat.
At the current strip, if CRC has no tax liability and lives within its cash flow, production will bottom at just over 60MM BOE in 2017, before rising to 64.46MM BOE terminally if oil & gas average $80 & $4.50 beginning in 2018. Projected OPEX is the greater of $25.62 per BOE and 2015E OPEX of $1,590.
At the current strip, leverage peaks at 6.1 times 2015E EBITDA of $1,036, before falling to 3.23 times by FYE 2017.
CRC is worth between $9.53 and $17.39 today at a terminal EV/EBITDA multiple of between 5X and 7X.
Alternatively, CRC is worth $12.32 today at a 15X terminal PE.
PORTFOLIO MANAGEMENT CONCLUSION
Unfortunately the initial position size has largely precluded me from averaging down aggressively as I typically like to do (I really thought the bottom was in due to the uneconomic spin-off selling pressure). I say largely because part of the reason is that I like my current portfolio configuration and want to minimize extraneous PM activity. I thought I would perhaps get a shot at CRC below $3, as the stock was really taking it on the chin over the course of this month, but recent price action suggests that may not be realistic. Regardless, the first shot I will have to add to the position is post-TRGP/ATLS merger consummation (likely March) when $9.12 of cash per ATLS share is distributed. My hope is that CRC declines into March so that I can average down on the position. Average down or not, I am more than comfortable with the position long-term (of course there is short-term discomfort – at times extreme – when the price of oil acts like it is going to $0; but stepping back and analyzing the oil market and CRC from a long-term perspective gives me comfort).