Description

Post-bankruptcy equity, formerly Memorial Production Partners LP, now a C-Corp.  Cue eye roll. In addition, it’s small and illiquid. One of many upstream MLP victims of the energy meltdown, most of these dogs housed mature, high-cost, largely conventional assets.  Amplify has those qualities, but the balance sheet has been cleaned up, and it’s mispriced. Assuming $2.70 natural gas, I estimate that the PV-10 of Amplify’s proven reserves crosses its enterprise value at $43 oil.  The company is reasonably leveraged to WTI and carries low operational risk.

Thesis

Investors gain oil exposure well below market.  Based on year-end 2017 Standardized Measure ($51.34 WTI, $2.98 Henry Hub), Amplify trades at 86% of PDP and 55% of 1P reserve value.  Several leveraged oil producers (DNR, CRC, etc.) with similar percentages of developed reserves have become popular oil proxies / trading vehicles.  While larger, liquid and less gassy, the year-end 2017 Standardized Measure for these companies does not cover their debt stacks. There are good reasons for AMPY to carry a discount valuation to these stocks, but not this much of a discount. Company stats:

1) Total Proved Reserves = 165mm BOE

2) 44% Oil, 15% NGL, 41% Gas

3) 64% Proved Developed Producing, 71% Proved Developed

4) Four areas of operation - one that I would categorize as spend-and-grow, two that work quite well in a $60 WTI environment and are in “maintenance mode,” and one that is of small consequence

The company is owned and controlled by hedge funds (distressed debt holders), with Board representation.  All options are on the table, and I have zero insight beyond what’s been publicly announced (all assets are for sale).  Absent asset sales, I believe the plan is sensible: spend enough on D&C to keep production flat to slightly up and use the excess free cash to deleverage on the way to a blow-down / liquidation of the assets.  The sum of the free cash and potential assets sales should be greatly in excess of the current enterprise value.

Given the relatively low upside but high predictability of the assets here, I won’t go into much detail on the operational forecast beyond this:  I expect AMPY to continue to truck along producing around 30k BOE/d, split roughly 50/50 liquids versus gas. Notably, production has increased 4% sequentially each of the last two quarters, after bottoming in second quarter of 2017. At $60 WTI and $2.70 Henry Hub, I expect pre-hedge free cash flow of $42mm in 2018, and another $26mm from hedges, on a $72mm CapEx budget.  Recurring FCF yield to the equity is 17%, not including this year’s kicker from the hedges. The company provides detailed guidance and has an outstanding IR function in place, making forecast modeling simple and easy.

That said, I look at this predominantly on a Standardized Measure basis, and AMPY is abnormally discounted to the current spot price.  The below table lays out the methodology: calculating the delta in Standardized Measure value change between 2016 and 2017, you can ascertain a benchmark pricing “flow-through” percentage to reserve value, i.e., 33% of the wellhead price increase in 2017 flowed-through to the increase in the PDP value per BOE.

When dealing with multiple operating areas, I find that dynamic PV-10s can be difficult to calculate accurately given the typical lack of detail that is offered.  Some may look down on this method, but I have found that simplified, historical torque to changing prices has been a good predictor of reserve PV-10 under new pricing scenarios - usually a better estimator than a detailed model with bad assumptions or too many unknowns. This is obviously not scientific and it is barely arithmetic, but I don’t care for two reasons:  1) AMPY trades so far below fair value that it doesn’t begin to matter until there is quite a move up; and 2)  I have thoroughly cross-checked my calculations with past company data (10-Ks and past presentations, most notably the BK emergence deck), and they are close.  Finally, I have attempted to isolate the oil-only areas of operation (Rockies, California) with past data, and I am satisfied with my understanding of these assets.

Operating Areas

1) East Texas / Louisiana (49% of proven reserves, 75% Gas):  the bulk of the CapEx budget resides here, as the company will continue to drill the predictable Cotton Valley formation - this has been the company’s bread and butter for some time now.  In time, I would expect some exploratory drilling in their higher upside Haynesville acreage. With over 200 identified locations, this should offer modest, but continued reserve replacement.

2) Rockies (28% of proven reserves, 100% Liquids):  EOR operation (CO2), characterized by low decline rates (6-7% tops) and high LOE.  This area works very well at current prices, but as pricing moves down to $50 WTI, the economics decay quickly.  RLI is 27 years.

3) California (19% of proven reserves, 100% Oil): Offshore production known as the Beta properties, this is a really nice asset (my favorite).  LOE are lower than the Rockies, the decline rate is similar, and there is real opportunity to increase production here.  A minimal level of workover capital grew production 5% in 2017, and the cash flow is prodigious at $60 WTI. RLI is 19 years.

4) South Texas (4% of reserves, 60% Liquids):  consists of a 5% working interest in the Eagle Ford, limited drilling activity planned here for 2018.

Conclusion

At year-end pricing, if you believe the Standardized Measure, AMPY is a 56 cent dollar.  At $60 / $2.70, it’s a 140% return proposition - this one appears particularly attractive from a risk/reward standpoint. These assets were originally put into an MLP for their predictability, so the drilling risk is minimal. The absolute development capital requirement is low relative to future production (over 70% Proved Developed).  The guys that control 70%+ of this thing all want an exit, and I view $10 per share as being paid to hold that call option.

There are lots of E&Ps out there that are cheap, and there are others that look cheap but are not.  It’s likely they all trade up if the back-end of the curve ever moves up and out of backwardation, or if the front-end stays where it is now for long enough.  But with AMPY, the margin of safety with a good shot at upside is too compelling to ignore.

Catalyst

Asset Sales