Description

Abraxas Petroleum Corp Equity Long

Current WTI Price: $57.30

Current AXAS Price: $1.28

Thesis

We believe that Abraxas Petroleum Corp (AXAS) is a compelling long at current levels. AXAS has high-quality acreage trading at an extremely low valuation with a strategic alternative process as a catalyst to unlock value. Management appears to agree as it was recently buying stock prior to the announcement of the strategic alternative process. We see greater than 100% upside at current levels.

Company Overview

Abraxas is a small capitalization, multi-basin E&P operator. Abraxas owns acreage in the Delaware Basin, Williston Basin, and Eagle Ford. Production during Q3 2018 was 10,070 boe/d and had a high oil cut of 65%. In addition, Abraxas owns other assets which had a net book value of $20.8mm as of October 31, 2018.

Capital Structure & Downside Protection

Given how poor E&P companies have been as investments, we think it is important to start with the capital structure and downside.

AXAS has a simple capital structure:

• RBL: $146mm / $200mm (L+1.5%-2.5%)
• Real estate lien note: $3.4mm (4.9%)
• Market capitalization: $215mm
• Total enterprise value: $366mm

LTM Adjusted EBITDA ex. hedges is ~$100mm. Net leverage of 1.5x is manageable and liquidity of $54mm is sufficient for a company of this size. This insulates AXAS from a sustained commodity downturn. By our math, AXAS would survive a $20 oil price decline to the $30s for at least two years at its 2019 drilling pace. We believe such a sustained downturn is unlikely due to the supply side’s expected response. E&P companies are pulling back on capital expenditures in today’s ~$57 pricing environment, let alone $20 lower.

The LTM valuation of ~3.7x is undemanding as well. Unlike many E&P’s that require a significant outspend to justify its valuation, AXAS is cheap on trailing numbers and has a sizable production base that can fund future operations without the need for external financing.

2019 Guidance and Valuation

AXAS is guiding to 12% y/y production growth based on the midpoint. AXAS’s strong well returns translate into strong corporate returns due to its high-quality acreage, cheap debt, and low G&A. At the current strip, we estimate that AXAS will produce ~$15mm of free cash flow, a 7% levered FCF yield. On an EV/EBITDA multiple, AXAS will be trading at 3.1x 2019E adjusted EBITDA ex. hedges of $118mm, significantly below Permian peers. Double-digit production growth while generating free cash flow is extremely rare at such a low EBITDA multiple.

AXAS’s stock would need to appreciate 31% if one assumed a constant 3.6x EBITDA multiple. Assuming a 5.0x EBITDA multiple, AXAS would have a TEV of $590mm and trade at $2.60, implying greater than 100% upside. This EV would be in line with the PV-10 of $558mm disclosed in the January 2019 Presentation at $57.50 WTI.

Sum of the Parts Valuation/Asset Level Deep Dive

Delaware Basin

AXAS owns 11,000 net mineral acres in the Southern Delaware Basin in Ward County. Offset operators include Felix, JAG, HK, CPE, XOM/XTO, and OAS (Forge). Using any of these operators as comps would result in significant value for AXAS’s Delaware Basin acreage. It is worth mentioning that AXAS is next to offset operators JAG and HK’s best acreage. For example, JAG has three project areas, Cochise, Whiskey River, and Big Tex. AXAS offsets the better two, Cochise and Whiskey River. In HK’s case, AXAS offsets Monument Draw, which is significantly better than West Quito Draw (gas anomaly) and Hackberry Draw. Furthermore, AXAS’s acreage is even more favorable because Monument Draw has an H2S problem, HK has a liquidity issue, and HK (had) a G&A issue.

The Delaware Basin acreage is 95% operated by AXAS and predominately held by production. The acreage has an effective net royalty interest of 80% vs. 75% for most peers. Theoretically, AXAS could monetize the difference to a royalty company. AXAS has identified 542 net potential locations in the 3rd Bone Spring Shale & Sand, Wolfcamp A1, A2, B, and C. This represents a substantial 60 rig years of inventory. AXAS plans on drilling 7 gross wells in the Delaware Basin during 2019.

On November 19, 2018, Cimarex announced it was acquiring Southern Delaware Basin operator Resolute Energy for $1.6 billion. The spot WTI price then is fairly similar to today. This yields a per acre value of $54k assuming $30k/flowing barrel, $5k per Alpine High acre, and G&A at an 8.0x multiple split 50-50 between seller and acquirer:

Applying this to AXAS’s 11,000 net acres would imply $600mm of value for AXAS’s Delaware Basin acreage. While this is more of a theoretical value because AXAS will not be able to develop the asset as quickly as XEC or REN and pull forward the NPV, it is instructive. The value of the ~3 mboe/d Delaware Basin production stream adds an additional $90mm of value at a similar per flowing barrel metric.

Williston Basin

AXAS owns 4,000 net acres in the core of the Williston Basin in McKenzie County. However, since this acreage is so economic, it has been largely drilled by AXAS. There are only 39 remaining locations, with some refrack candidates as well. The acreage has an effective net royalty interest of 82.5% vs. 75% for most peers. Similar to the Delaware acreage, this excess interest could be monetized to a royalty company.

The best comparable is the failed VEAC acquisition of QEP’s Bakken assets. The deal was announced when WTI was trading at $62. Shortly thereafter, WTI collapsed to the low $40s. Due to that and a wide Clearbrook differential ($10+), the SPAC approval process was doomed.

WTI has rebounded and is just 7% lower today than November 7, 2018. Furthermore, the Clearbrook differential has returned to a more normal level, so we think a $30k/flowing barrel (13% discount to QEP) is a fair marker to use. This implies ~$210mm of value for AXAS’s Williston Basin asset (mainly production).

Eagle Ford

AXAS owns 9,000+ net acres in Atascosa County. It is north of the volatile oil window. There was a sale process being run for the asset. Unsurprisingly, it didn’t close during 2018 due to the oil volatility at the end of the year. We assign $10mm of value to the entire position based on $1k/acre.

Other Assets

AXAS owns and operates the Ravin #1 drilling rig. Ravin #1 is currently drilling in the Williston Basin, but it is well suited for future operations in the Delaware Basin. We value the other assets at net book value.

Sum of the Parts

Putting it all together, we calculate a NAV of $4.15. We capitalize 2019E G&A at an 8.0x EBITDA multiple, which is significantly above the corporate EBITDA multiple. This implies >200% upside to the current share price.

Note: At current strip prices, the value of AXAS’s hedges is negligible. They show up as a liability on the Q3 balance sheet due to higher oil prices at that point in time.

Capital Allocation/Strategic Process

When the stock price collapsed to current levels, management stopped acquiring Delaware Basin acreage given the look through valuation of its owned acreage and expressed a desire to buy back stock. While it was not possible given the RBL terms, the CEO acquired stock 174,652 shares at $1.14 for his 401-K.

Furthermore, the company is significantly long acreage in the Delaware Basin. By selling the Bakken asset and investing the proceeds in the Delaware Basin, AXAS would be able to bring forward the 60 rig years of inventory.

Risks

While communicated to the market, Q4 2018 results could disappoint expectations due to weak differentials. The differential blew out in both the Delaware Basin and Williston Basin. It has tightened significantly since then.

AXAS underperforms more levered peers with marginal well economics in a strong oil market

Catalyst

Execution

Strategic Process Conclusion

M&A – Someone, like Oasis, could decide to buy the entire company instead of just the Bakken asset being marketed.