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Morningstar | Recent Oil Declines Weigh on Denbury's Valuation; Trimming Fair Value Estimate to $3 Per Share

The terminal price forecasts in our model, based on the long-run marginal cost of U.S. shale producers, collectively the global swing producer in our framework, are unchanged (we model $55/bbl WTI and $60/bbl Brent). But the recent declines in global and U.S. crude prices still weigh on our valuation because our methodology incorporates strip prices over the next three years and highly leveraged Denbury is particularly sensitive to crude price inputs. Our new fair value estimate is $3 per share.

Otherwise, our thesis has not changed since our third-quarter update. As a reminder, the firm delivered production of 59 thousand barrels of oil equivalent per day in the period, which was 5% lower sequentially and 2% lower year over year. The decline was partially due to the sale of the 550 boe/d Lockhart Crossing field, but seasonal temperatures affecting injection efficiency across the Gulf Coast as well as downtime at Oyster Bayou and Cedar Creek also had an impact on volumes. Management described these issues as "expected" on the conference call, though we note that at the midpoint, full-year guidance was lowered by about 2% (even after adjusting for the divestiture). On the plus side, realized pricing was exceptionally strong, with an average selling price of $71 for oil ($2 above WTI). This reflects the advantage of having substantial operations on the Gulf Coast, eliminating basis risk. As a result, the firm's financial results were still in line with Street estimates, with adjusted EBITDA and adjusted earnings per share coming in at $148 million and $0.13, respectively (consensus forecasts were $148 million and $0.11).

The firm's production profile will change substantially in 2019, when it completes the previously announced acquisition of Penn Virginia. The deal was valued at $1.7 billion at the time of the announcement, based on a $400 million cash payment coupled with the assumption of $480 million in debt (190 million Denbury shares will be issued to cover the remainder, leaving current shareholders with a 71% stake in the combined business). Though we have previously expressed concern over Denbury's leverage, we note that adding a free cash positive business in a part-stock deal makes sense as the combined business can deleverage more quickly than Denbury could by itself (net debt/EBITDA could dip below 2 times by year-end 2019).

We also believe the transaction makes sense strategically, as it paves the way for Denbury to apply its extensive enhanced oil recovery, or EOR, expertise in Texas' Eagle Ford Shale, a maturing resource play with geological attributes that make it receptive to EOR rejuvenation. The acquired assets compliment the portfolio nicely due to the location in Denbury's backyard near the Gulf Coast (maintaining exposure to premium coastal pricing), and the high oil weighting, which should keep average unit revenue high and help justify the higher unit costs associated with EOR production. The deal also adds 500 traditional (non-EOR) well locations in Gonzales and Lavaca counties, giving the firm a more capital-efficient short-cycle growth opportunity.