Description

A post-bankruptcy equity, I have wanted to post Berry Petroleum for a long while but have not due to lack of trading liquidity and company information.  They recently filed a confidential S-1 with the SEC and some blocks are starting to shake out. At the risk of this being annoying and non-actionable, I am doing it now because it is possible more stock will become available.  In addition, I would expect the IPO or some kind of direct offering to be relatively imminent. I am biased and might like this story more than the market will, but either way I think it’s mispriced.

One caveat:  Berry is a private company and the financials are confidential.  I am not sure of the company’s policy on getting access to them, whether you need to be a shareholder or not.  I am a small shareholder and have full access. Importantly, they did a $400mm bond offering in February - that prospectus, or the similar information statement made available to shareholders, is a must for anyone willing to look at this one.

Thesis

Berry was part of the LINN bankruptcy, having been acquired by them in 2013 - it is now back to being a separate entity.  Management has been busy streamlining the company, having sold their Hugoton assets, acquired the 84% of the South Belridge Hill property they did not own, and cutting costs.  I believe Berry will generate north 10% production growth, as measured by 2018/2017 exit levels. At $11.60 per share and assuming $72 Brent, I have Berry shares trading at roughly 4.6x unhedged 2018 EBITDA (tacking hedge losses onto net debt).  To me, this is a 5x+ EBITDA asset base.

The best public comparable, California Resources (CRC), is on a tear despite a clear inability to grow production; in fact its production is still declining from its peak in 2015.  While CRC is traded like a leveraged proxy for oil sentiment, they have made some effective corporate moves (JVs, cleaned-up the debt stack, and made what I think was a nice tack-on acquisition).  But their operational story is not as interesting as Berry’s in my opinion, and it gets 5-6x 2018 EBITDA depending on assumptions used.

Company

Nearly two-thirds of the company’s reserves (142 mmboe, 71% oil) are located in California, the majority in the San Joaquin basin.  It’s a shallow, low decline, heavy oil resource - a conventional play with decades of history. Most of the rest of the production and reserves are in the Uinta and Piceance, where only 15% of the current capital budget is expected to be deployed.  The company has 786 net locations booked in PUDs and nearly double that in additional locations that mgmt believes offer similar economics. The drilling inventory here is prodigious, and the all-in corporate decline is 11-12%.  I think this thing can grow modestly for a very long time under a capex budget that will simultaneously result in meaningful free cash flow at current Brent pricing.

Projections

Assumptions:  $72 Brent in 2018 and 2019.  Very substantial hedge losses in 2018/19 on their WTI short are reflected in the cash flow section.  Production is somewhat of a rough estimate - the bond prospectus laid out their 2018 guidance range, I am on the higher end of it based on the 4Q’17 results (released subsequent to the bond deal).  My understanding of the capital efficiencies here lead me to this number. I feel I am being more conservative with regard to 2019. Another quarter will be very illuminating (1Q’18 not yet released), as the 4Q’17 was the first full period containing both the Hill acquisition and the Hugoton disposition.

Capital Structure / Target

Berry’s net debt as of year-end was $345mm, all drawn on the RBL.  They did a $400mm senior unsecured note at 7% in early February. Common shares are 33mm outstanding, preferred shares outstanding are roughly 38mm (disclosure:  I have a position in both classes). The preferred shares were created in a rights offering that raised $335mm just prior to emergence, and they are entitled to a 6% annual dividend (PIK and/or cash).

The preferred stock will have to be exchanged into common before the IPO, I believe.  I am told the preferred is quoted at up to a $2 premium to the common, so 38mm preferred shares x $13.60 = $517mm / $11.60 = 44.6mm common shares that will need to be issued.  So I’m using an adjusted share count of 78mm common shares outstanding. For me, the combination of unbooked but low risk inventory and low decline nature of the CA assets make this worthy of 6x this year’s EBITDA.

As a cross-check, the bond prospectus has a PV-10 page that marks 1P reserves at $1.069B using $53.40 for Brent and $3.01 for gas.  That goes to $1.311B with Brent at roughly $58, gas at $2.91. I have attempted to reverse engineer these calculations without full reserve report information, and my methodology imputes my price target = PV-10 at Brent $67 and gas at $2.75.

Catalyst

IPO or an outright sale of the company