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Morningstar | Halcon Uncertainty Still Extreme Because of Leverage and Liquidity Concerns

We have raised our fair value estimate for Halcon Resources to $5 per share from $4 after incorporating the firm's second-quarter financial and operating results. That signals more than 10% upside at the current level. However, we caution that because of its high leverage, our valuation is very sensitive to commodity prices and other inputs, and there is a wide range of potential outcomes.

A lot hinges on whether it can sell a portion of its oilfield-services business in the second half of 2018 as planned. The firm has invested about $150 million in this segment to date and believes it can sell for at least 2-3 times that amount. That could boost its liquidity and lower its leverage during a potentially difficult period. Halcon is exposed to Midland pricing for crude, which is currently heavily discounted to the West Texas Intermediate benchmark because of pipeline congestion (which is a near-term concern and should be alleviated during the second half of next year). Because of this pricing weakness, the firm's operating cash flows are unlikely to fund its operations for the next 12-18 months, and outspending could easily top $200 million. Right now, it has around $300 million in available liquidity ($200 million via its revolving credit facility).

Therefore, there is a plausible bull scenario in which the services sell-down generates a comfortable bridge to free cash flow neutrality and enables Halcon to add a fourth rig during 2019. Since the firm is growing production from a low base, this could have a strong impact on next year's output and earnings, and the positive impact on its equity value would be magnified by its high leverage. Conversely, with no sale, Halcon could be forced to cut back its operations next year, especially if the pipeline logjam drags on longer than expected. In this scenario, earnings would dip well below our current estimates while net debt is increasing, driving its leverage even higher.

As a reminder, second-quarter volumes came in at 12.8 thousand barrels of oil equivalent per day, or mboe/d, which was 16% higher sequentially but below the bottom end of guidance. While the firm did recently drop to three rigs from four due to Midland Basin pricing weakness (announced previously), this did not take place until July and had no impact on the second quarter. Instead, the disappointment was attributed to downtime triggered by power reliability issues and inclement weather. With normal operations, management estimates that second-quarter volumes would have been 13.3 mboe/d, which is below the midpoint but within the range of prior guidance. Current production has risen to 13.8 mboe/d, and full-year guidance was lowered to 14-16 mboe/d (from 15-20 mboe/d, reflecting the operating issues in the second quarter as well as the impact of reducing the rig count).