Thursday, February 22, 2024

Earnings Notes III (Q4 2023)

Chesapeake Energy Corporation (CHK)
Investors liked Chesapeake's earnings announcement this week, sending shares up about 10%. The key was that the company promised to cut capital expenditures and let production fall! They said that they will cut capex by 20% and expect production to be 22% lower in 2024 than 2023. That's a difference of 770 million cubic feet which is about 0.65% of U.S. production; not insubstantial. Chesapeake's announcement was also enough to lift the futures curve for natural gas.

The market capitalization (after the release) is now $11 billion. The company has $1 billion of net debt so the enterprise value is $12 billion. During the fourth quarter of 2023, cash from operations was $470 million and capital expenditures were $379 million for free cash flow of only $91 million, a FCF yield on the enterprise value (annualized) of a mere 3.3%.

Chesapeake is not earning its cost of capital at these natural gas prices, but with so little debt, you have a call option on natural gas that is not in immediate danger of expiring. Management points out in the investor presentation that there is going to be 12 bcf/d of LNG export capacity coming online by 2028. They think that the realized netback per MCF will be $4-6, far above the current $2.87 average realized price in the third quarter. With a cash production cost of over $1/mcf, there is subsantial leverage to higher natural gas price if LNG export drives a higher commodity price. (At $5/mcf, earnings more than double.)

Still, there are other ways to get exposure to natural gas that do not require so much capital and operating expenditure. Dorchester Minerals (DMLP) is getting about one-third of production (in BOE terms) from natural gas, which is being practically given away for $2/mcf. And we will look at Blackstone Minerals and Kimball Royalty Partners below.

Marathon Petroleum Corporation (MRO)
This Marathon is the E&P company, not the refiner (MPC). Another capex cut! Management said in the earnings release that investors should "expect 5% to 10% fewer net wells to sales in 2024 to deliver flat year-on-year total oil production as the Company optimizes well mix to maximize corporate returns and FCF generation." Very nice.

Also up about 8% after earnings, so the current market capitalization is $14 billion. They didn't publish a balance sheet with the Q4 release, but the enterprise value should be about $20 billion. During the fourth quarter of 2023, cash from operations was $1.1 billion and capital expenditures were $360 million for free cash flow of $681 million, a FCF yield on the enterprise value (annualized) of 13.6%. Shareholder returns during the fourth quarter (mostly repurchases) were $417 million, which is a shareholder yield of 12% (annualized). Their guidance for 2024 is $1.9 billion of free cash flow, assuming $75/bbl WTI and $2.50/MMBtu Henry Hub natural gas. That would be a 9.5% yield on the enterprise value.

Suncor Energy Inc. (SU)
The current market capitalization of SU (at a $33.50 share price) is $43.5 billion, and with $10 billion of net debt, the enterprise value is $54.5 billion. Cash from operations for the fourth quarter was $3.2 billion and the company spent $1.1 billion on capital expenditures. The resulting free cash flow for the quarter was $2.1 billion, which is a 15% yield (annualized) on the enterprise value. In the fourth quarter, Suncor returned $1.15 billion via repurchases, dividends, and debt repayment for an annualized shareholder yield of 10%. The fully diluted share count was down 3.5% y/y at the end of the year.

Upstream production was up 6% year over year to 808,100 barrels per day in the fourth quarter. Refinery utilization was 98% versus 94% the prior year quarter. Upstream capital expenditures were up 17% year-over-year, for a "production shortfall" of 11%. Oil sands "base" capex was up only 5% and production was up 10%, for a negative production shortfall. This is what we want to see from our slow decline oil sands with front loaded cost!

The oil sands segment generated funds from operations for the fourth quarter of $1.9 billion, with a production volume of 757 thousand barrels per day and an average crude price realization of $61/bbl. The refining and marketing segment generated funds from operations of $592 million, processing 456 thousand barrels per day and making a gross margin (LIFO) of $34.35 per barrel.

Texas Pacific Land Corporation (TPL)
The market capitalization of TPL (at $1,563 per share) is now $12 billion. The company has built up quite a cash pile during the shareholder activism dispute, so the current assets net of liabilities are $749 million and the enterprise value is $11.25 billion.

In the fourth quarter of 2023 (8-K), production volumes for TPL were 26,300 BOE per day, which was up 23% from the prior year. Oil volumes were up the same amount. This was the highest quarterly royalty production level in TPL history. Royalty revenue was up 2% thanks to the higher volumes, even though the price of oil was $78.46 versus $83.16 the prior year. Water sales, water royalties, and easement income were up 37% year-over-year, although the water service business has operating expenses, which were up.

Total expenses were $29 million (excluding depreciation) versus $25 million the prior year. Thankfully legal fees were only $3 million this quarter and not the gigantic $17 million we saw one quarter earlier this year during the heat of the shareholder activist battle.

Interesting to note that the expenses (again excluding depreciation) are a hefty 17% of total revenue. That's partly because TPL has established a "water services" business which is lower margin than collecting royalty revenue.

Operating income was $134 million for the quarter, and if you add back $3.9 million of depreciation, depletion, and amortization, you get a "cash flow-like number" of $138 million, which would be an annualized yield of 4.9% on the current enterprise value. (It was up 8.9% year-over-year.) For the full year, the company spent $100 million on dividends and $43 million on share repurchases. 

The share count shrank by only 0.33%; management let net current assets grow by $225 million during the year, to $818 million. That cash could have been used to shrink the share count an additional ~2% if it had been deployed at times when the share price was weak.

Black Stone Minerals LP (BSM)
Black Stone Minerals is another publicly traded minerals partnership. They had an IPO in 2015 although predecessor entities have been around much longer. They are bigger than Dorchester, with a market capitalization of $3.2 billion. Current assets net of all liabilities are $144 million and there is also $300 million of convertible preferred, making the enterprise value $3.4 billion. (The convertible preferred gets a quite expensive ten year yield plus 5.5% distribution rate, which is currently 9.8%.)

For the fourth quarter, BSM reported distributable cash flow of $119 million on total revenue of $191 million, which represents a yield of 15% on the market capitalization. Oil production was 1 million barrels and natural gas production was 16.5 bcf; production was therefore almost three quarters in terms of energetic equivalent BOEs. (But oil was a much greater percentage in terms of revenue.)

Something different about Black Stone compared with Dorchester is that they hedge their production. They have 570,000 barrels swapped for each quarter of 2024 at $71.45/bbl and 210,000 barrels swapped for each quarter of 2025 at $70.50 per barrel. That's about half of 2024 and a quarter of 2025 production hedged. For natural gas they have around 10 billion bcf swapped for each quarter of 2024 at $3.56 per bcf and 1 billion bcf for each quarter of 2025 at $3.65 per bcf. That's 60% of this year and a small proportion of next year.

Heading into 2023, they had swapped natural gas at $5/mcf, which obviously has supported the trailing distributions. Also noteworthy is that one of the big drillers on their Haynesville acreage (Aethon) is taking a "time out" on its drilling commitments due to low gas prices. So both volumes and prices will be lower in 2024, plus the preferred stock yield reset from 7% to 9.8% in November 2023, which will reduce income to common by a further $8.4 million per year.

Why hedge? Unlike Sitio, Black Stone does not have significant leverage. It sounds like they are bullish on natural gas over the longer term, once more LNG export capacity opens. Anyway, this is one to keep in mind if we were to get bullish on natural gas. A $5 natural gas price might give them an extra $125-150 million of earnings every year, which would be a decent boost to the current cash flow yield. (Of course, that would be assuming that management didn't bungle it with a hedging trade.)

Kimbell Royalty Partners LP (KRP)
One last publicly traded mineral partnership. Something interesting is that KRP is a limited partnership that has elected to be taxed as a corporation, so there is no K-1. There is a good bit of nepotism in the C suite to be aware of. Robert Ravnaas is the Chairman and CEO; David Ravnaas is the President and CFO, and there is also a Rand Ravnaas as VP of Business Development. KRP had its IPO in 2017 and has grown from acquisitions in 2018, 2019, 2022, and 2023.

Kimbell has a market capitalization of $1.5 billion. They have $269 million of net debt and $325 million of convertible preferred stock outstanding, for an enterprise value of $2.06 billion. Production in Q4 was 24k boe/d, coming mostly (55%) from the Permian and the Haynesville. Their recent investor presentation gives more guidance than other partnerships. They estimate that at $2 natural gas and $80 oil, their distribution (at a 75% payout ratio) would be $1.61, which would be a 10.4% yield on the current price.

Kimbell also hedges - they swapped about 140k bbl of oil and 1.3 bcf of natural gas for each quarter for the next two years (2024-2025) at prices ranging from $82-67/bbl for the oil and $3.52-$4.32/mcf for the natural gas. That is about a quarter of their oil and gas production levels.

As we mentioned in the past about Sitio, we are not big fans of borrowing (expensive capital) to buy mineral properties and then hedging the commodity price. It seems like the outcome that mainly delivers is scale. We can see how that would be important to insiders, though, since they get paid as a function of scale. The CEO of KRP was paid $5.2 million in 2023 and his son was paid $4.7 million. The CEO owns $17 million of common units and his son owns $11.7 million. 

Our humble opinion is that Dorchester has the simplest, cleanest model with the fewest moving parts, least promotional management, and longest track record.

Sprouts Farmers Market (SFM)
We wrote about Sprouts back in October 2023. At that point, the market capitalization was $4.3 billion and the enterprise value was $5.8 billion. Shares have been on a tear and the market capitalization is now $5.5 billion (+28%).

What we like about Sprouts is two things. First, the Sprouts stores are extremely well run and well merchandised, putting pressure on (and taking customers from) the tired old grocers that are owned by Kroger and Albertsons. Second, the business generates free cash flow even while expanding, which the company has been using to cannibalize its own shares. During 2023, Sprouts grew the share count by 21 net (5%) to 407 stores while shrinking the share count by 5.3%.  

For the full year 2023, Sprouts did $6.8 billion of sales (up 6.8% versus 2022) and generated $465 million of cash from operations (7% OCF conversion), spending $238 million on capital expenditures and an acquisition (compared with $265 million of depreciation and amortization), while paying off $125 million of debt, and repurchasing $203 million of stock.

As we said, the market capitalization is $5.5 billion and the enterprise value is $7 billion. That gives a FCF/EV yield of 3.2%. Reported net income per share (diluted) is $2.50 for the year, which gives a P/E ratio of 21.5x, and which was up 4.6% y/y. Management guidance is to open 35 new stores in 2024, with total revenue growth in the mid single digits.


KJP said...

Black Stone Minerals has $300 million in high yield preferred outstanding that wasn't picked up in your EV. They are also very big on maintaining the distribution, rather than varying it with O&G prices. I believe that is one of the reasons they hedge and will continue to do so.

Unless there is a very significant rebound in gas prices, 2023 is likely to be the high water mark for cash flow and distributions for awhile. First, 2023 benefited from hedges at prices above $5/MCF. Second, one of the big drillers on their Haynesville acreage (Aethon) is taking a "time out" on its drilling commitments due to low gas prices. That will hit volumes in 2025.

Also, the preferred recently reset higher. It's now yielding close to 10%. They chose not to redeem any portion it this year, but if they do when the next window opens up, there may be less capital available for distribution to common units.

CP said...

OK, I fixed that.

CP said...

Any reason you follow BSM so closely?

CP said...

If I had to choose long or short:


Short: CHK

KJP said...

I initially picked BSM as my O&G royalty play about five years ago due to its huge, diversified acreage. At the time, I did not fully understand all of the differences between it and other royalty companies. It would not be my first choice today, due to its very heavy gas exposure, hedging, and relatively high G&A. But due to tax considerations (dividend recapture), I've stuck with it and continue to read all the quarterly disclosures and CC transcripts and update a fairly simple but historically pretty accurate model for its earnings. On the bright side, following it closely gave me the confidence to buy more when it was very cheap in 2020. I'm not particularly excited about it right now because I think a distribution cut is coming, and I'd rather wait to see if that is correct and to see (and potentially benefit from) the market reaction.