EUR 850.00 For Business Accounts Only

Morningstar | Halcon Asset Value Eclipses Market Price, Despite Near-Term Constraints

Halcon Resources delivered production of 17.2 mboe/d in the fourth quarter, which was 6% higher sequentially but below the low end of guidance due to sour gas takeaway constraints in the Monument Draw area (which negatively impacted oil volumes as well as NGLs and natural gas). The constraint is likely to affect first quarter results, too, as it will not be alleviated until Halcon’s sour gas treatment plant is completed later this month. As a result, the firm’s financial results were also weaker than expected, with adjusted EBITDA and adjusted earnings per share coming in at $25 million and negative $0.09, respectively (consensus estimates were $31 million and negative $0.07).

Looking to 2019, the firm plans to operate two rigs across its asset base, driving production to 24 mboe/d by the end of the year (40% higher than its current output). It also expects meaningful cost reductions, partly stemming from the increase in scale. That may not show in the next quarter or two due to overhang from the sour gas constraint, but once the plant comes online firmwide cash costs should average $16/boe. That’s still higher than what most Permian firms are reporting but much better than the $30 average Halcon posted in 2018. The updated activity level and aggregate cost savings are consistent with our previous forecasts, leaving our fair value estimate unchanged at $3 per share.

This gives us confidence that the firm can eventually align itself competitively with peers and achieve free cash flows by 2022. It will be forced to outspend in the interim, but it does have adequate liquidity and is unlikely to run into trouble unless crude prices fall well short of the current strip. Organically growing by efficiently developing the firm’s acreage is one of the methods of unlocking value that the interim CEO has proposed.

The alternative is through M&A (interpreted to mean a sale of the entire company). Due to economies of scale, established Permian operators would be able to extract much more value from the portfolio than Halcon can. For instance, adding Halcon’s debt and assets to our Diamondback Energy model would generate $1.6 billion total value (equivalent to $6 per Halcon share). Diamondback is an unlikely suitor, as it still digesting the recent purchase of Energen Corporation, but other Permian companies could be interested, especially as the market price for Halcon is currently well below this valuation at around $1.50 per share. We would anticipate a takeover premium of about 30%, making this a steal for the purchaser.

We believe the market has oversold the stock due to 1) a poor balance sheet, 2) short-term issues like the sour gas constraint, and 3) fears about the management vacuum following the recent departure of several key executives (including the CEO). We assign an extreme uncertainty rating to reflect the high leverage. Still, the balance sheet should improve at a rapid clip, given how fast the company is growing. And in any case the value of Halcon is driven by the value of the land it has leased for development, which hasn’t changed in our view. Our valuations for Halcon either as a standalone business ($3/share) or incorporated in a larger Permian firm (up to $6/share) both imply a strong premium to the current price.