Bellatrix Exploration (BXE-T) - Orange Capital's 14.3% Stake A Positive Catalyst
Bellatrix Exploration is another in a long list of Canadian energy stocks that have been taken out to the woodshed and spanked hard during the recent sector-wide sell off. Despite the big 8%+ move yesterday (Wednesday), the stock is still down 52% YTD and a whopping 65% since its May high of $10. But that's the past, and this is now. Question is: does BXE represent good value for long-term oriented investors? Let's take a look.
Bellatrix is a production growth oriented O&G company (mostly gas) operating in Western Canada's Sedimentary Basin. The following slide gives a good general summary of the corporation:
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Source: November Presentation
Note the drastic change in market cap (red highlights added by the author) just since September 30th, and certainly since the highs back in May. This extreme sell-off in Canadian energy companies has not gone unnoticed - takeover winds are swirling. Tuesday Global News reported that Calgary based Talisman (TLM-T) confirmed it has agreed to a takeover by Repsol (OTCQX: REPYY) in a transaction valued at $8.3 billion. Talisman, which had been trading under $4 closed Wednesday at $7.62 per share. Even so, many shareholders believe Talisman was too quick to make a deal and sold out to cheaply (see: Talisman Energy Deal Not Productive For Shareholders).
Orange Capital Increases Its Stake to 14.3%Bellatrix's sell off has also generated some outside interest - notably activist investor group Orange Capital. On December 12, 2014 Orange amended its 13D filing to reveal it increased its stake in BXE to 27,452,063 common shares, or 14.3% of the total number of common shares outstanding, for a total consideration of $183 million (~$6.66/share).
In return for the addition of two Orange supported Board members, one of which is Orange Capital co-founder Daniel Lewis, the activist investor group has agreed to abide by certain standstill provisions until November 30, 2015.
This development is a positive catalyst for Bellatrix. While the company has proven its ability to grow production at a very fast clip, it frequently outgrows transport and processing infrastructure. As a result, Bellatrix is not considered one of the lowest cost producers, but it is in top half of the peer group. In addition, this year Bellatrix strayed from its tried and proven JV agreements to accelerate development drilling and instead went to the equity markets with a botched secondary offering that was not well received. In May, when BXE was trading around $10.20/share, Bellatrix announced plans to issue 25,650,000 common shares for $250 million ($9.75/share). Shortly after that news hit the market, the company issued a press release announcing it had re-sized (lowered) the issuance to 15,800,000 shares at $9.50/share for gross proceeds of $180,000,000. This too was not welcome news as it proved demand for the shares was much lower than expected. The stock immediately dropped ~5% commensurate with the new $9.50 stock offering. It's gone straight down ever since to a recent low of $3/share.
There are many reasons for the weakness in the stock. Let's start with the effect of the share dilution by taking a look at the Q3 EPS report:
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The problem with BXE is clearly outlined above. While YTD total revenue and FFO were up nicely (117% and 100% respectively) on the back of strong production growth, Q3 per share net income was actually down 2 cents, and up only 37% YTD. Meantime, net debt has more than doubled.
Per share metrics were down primarily due to near 60% increase in the fully-diluted common share count:
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Had the share count not ballooned, per share net income in Q3 would have been closer to ~$0.35/share instead of the $0.23/share of EPS the company posted. YTD, net income would have been closer to $0.84/share versus $0.59/share. However, you might say, the proceeds from the secondary helped grow production. But looking at the net debt numbers, I am not sure that is the case. Note that despite proceeds from the secondary, net debt has still ballooned - more than doubling yoy to $470 million.
Recent AcquisitionBellatrix appears to be a case of management growing production at any costs. As a result, per share metrics to share holders have not keep pace with production growth and the debt load has skyrocketed. Meantime, on December 1st the company announced an additional $118 million spend for a strategic acquisition of 5.7 net sections of land at Alder Flats. The deal includes 2,200 boe/d of Mannville production (80% natural gas, 20% liquids).
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The purchase does appear to be a nice bolt-on fit to BXE's current acreage, and the deal's metrics (see above), including an expected doubling of yearly avg production to 4,500 boe/d for a relatively small $16 million spend, are fairly appealing. However, in light of the Q3 performance, current debt levels, and the extreme underperformance of the shares - the timing of the deal is questionable to say the least. The market agreed with that opinion, and the stock dropped another 25% after the announcement.
My doubts of the deal go back to what the company itself has been touting as a primary reason to invest in Bellatrix: close to 400,000 acres of prime O&G undeveloped property and 20 consecutive quarters of a 100% drilling success rate with attractive returns. If that's the case, why the need at this point in time - when shareholder value has been so degraded - for the addition of another 5.7 net sections of land for $118 million?
Activism - The Good, The Bad, or The Needed?Although other shareholders apparently disagree (see An Activist Investor Targets Bellatrix - Are You Kidding Me?), I welcome Orange Capital's investment and Bellatrix and inclusion on the Board of Directors. Orange's stake of 14.3% is larger than management's (~9%), but more importantly they are not being paid salaries. Orange is not going to care about production growth for growth's sake - they are aligned with ordinary shareholders and care about one thing: stock price appreciation. Normally activist investors look for a minimum of a 50-100% return on their investment. Considering Orange is into BXE at an average price of $6.66/share, we should expect Orange to do whatever possible to get BXE back to $10/share, which is where the stock was before all the sloppy moves by the current management.
Some Good News(click to enlarge) 
To be fair, the current management has shown a proven ability to grow production and reserves at an impressive rate (see above). Recent quarterly production was 37,838 boe/day of which 69% was gas and 31% liquids. From the Q3 release, we can also see that YTD realized prices have been strong:
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YTD, total production growth on a boe/d basis is up 72%. Liquids production has essentially doubled yoy. A YTD average risk adjusted realized price of $40.83/boe is up 12% yoy. Nothing wrong with those numbers. But again, this impressive production growth has been diluted by a huge increase in the common share count in addition to a doubling in debt.
While per boe netbacks are nicely higher yoy, some production growth stress is beginning to show, specifically in transport costs, which are up ~50% YTD to $1.25/boe. This is in stark contrast to the low-cost Canadian gas producer Peyto Exploration (PEY-T). Peyto has a transportation cost of $0.12/mcfe (~$0.72/boe). The price differential is primarily a result of the fact that Peyto owns and operates virtually all of its transport (and processing) infrastructure while BXE does not. However, this can be an area that BXE can improve on going forward. With Q3 production of 37,838 boe/d, that 50 cent differential in per boe transport cost equates to a missed opportunity of ~$1.7 million in profit per quarter. That number just grows as production increases.
Commodity Price PressureAlso to be fair, Bellatrix's stock price has likely taken a shellacking due to general commodity price weakness across the board, and this includes Canadian AECO gas prices:
As can be seen in the chart, after a nice pop in January and February due to the harsh 2013 winter the AECO gas price has generally drifted lower throughout the year and is now down 9% yoy. This move is despite the fact that November Canadian nat gas storage levels are still more than 100 Bcf below average for this time of year.
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We all know what has happened to the price of WTI so there is no need to cover that here, other than to say ~30% of BXE's production is liquids.
Hedging ProgramAccording to the Q3 EPS release, the company has a hedging program as outlined below:
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However, unless my eyes deceive me - this is the same exact hedging report shown in the company's Q2 EPS report and indeed at the beginning of the year. In other words, it's a Jan 1 to Dec 31 summary, but does not give the investor any clue as to what hedges have been previously exercised, and which ones are still active. Since the company doesn't provide access to quarterly management discussions on its webcasts webpage, I have no additional source of information on the hedging program. Obviously this is a very important issue at this time, but ordinary investors are left to fly blind. All that said, I would assume management considered that prices could weaken in Q4 and save some dry powder to mitigate the impact on earnings.
Upside PotentialThe stock of Bellatrix Exploration has likely bottomed and there are signs lately that it is ready to make a move to the upside.
In the latest acquisition press release, BXE announced that in light of recent commodity price pressure, the company has reduced its 2015 cap-ex guidance by $50 million to $400 million. At the same time, Bellatrix announced an increase in the full year 2015 average production guidance range by 1,000 boe/d to ~49-50,000 boe/d.
The midrange of the 2015 guidance (49,500 boe/d) would be ~30% higher than the expected average 2014 production rate of 38,500 boe/d.
Federal Reserve Chairman Janet Yellen said yesterday that recent low energy prices will prove to have a transitory impact on inflation. By association this implies that low oil prices will also prove to be transitory. At least that is my interpretation and history proves that to be the case. So we have to go back to the original investment thesis in Bellatrix:
Year end 2013 proved reserves of 124 million boe, 36% liquids.Year-end 2013 NPV10 = $1.4 billion.Significant production growth via drill-bit implies another year of excellent reserves growth.20 consecutive quarters of a 100% drilling success rate.Currently, BXE has a market cap of $797 million and debt at the end-of-Q3 of $470 million for a total EV=$1.27 billion. That is a $130 million discount to the 2013 year-end NPV10 value. On a per share basis, that works out to $0.64/share. Trading of BXE on the company's home market (the TSX) is currently trading at $4.16. The discount suggests a 15% short-term pop to $4.80 (on the TSX) or $4.14 (on the NYSE).
Going forward, we need to estimate what the 2014 year-end reserves report might reveal, as well as the valuation of those reserves. We need to consider two factors:
A lower commodity price forecast for the 2014 reserves report.An increase in year-end reserves due to the 2014 drilling campaign and the recent acquisition.On the first bullet, we will take a look at the 2013 reserves report. We see the BT proved reserves NPPV10 estimate of $1.4 billion was achieved by the consultants (Sproule) using the following price forecast:
How things have changed: WTI is currently trading at $54.83, or roughly half the forecast - as are the other oil indexes, while AECO is hanging in there. For the 2014 year-end reserves report, the SEC-mandated crude oil price (for example) will be $94.99/Bbl, not as low as some would expect. This is because the value is found by averaging of the price on the first day of each month of 2014 and early in the year prices were high. As a result, $95 will be only a 6% shave on the forecasted oil price shown for 2014.
It is also important to realize that the majority of BXE's 2013 proved reserves (64%) are dry gas. As pointed out earlier, AECO is currently trading down 9% yoy, but as recently as last month were up yoy and AECO has spent most of this year higher than in 2013. So we'll call that a push.
Year-end 2014 Proved Reserves EstimateFor the second bullet above (yoy proved reserves growth), and in consideration of the 2014 drilling program and production growth, BXE should easily match (or likely exceed) last year's reserves growth which was in the ~35% range. That equates to an organic proved reserves estimate of ~167 million boe. If we add in the 10.75 million boe of proved reserves due to the most recent acquisition (discussed earlier), we come up with a 2014 year-end proved reserves estimate of ~177 million boe.
A very conservative estimate of the BT NPV10 value on 177 million boe would be to make a straight read-across from 2013, and then reduce it by 10% to take into account the reduction in SEC oil prices (6%) and even though the majority of BXE's reserves are gas.
BT NPV10 = (177/124)($1.4 billion)(0.9) = $1.8 billion.
On that basis, and if we subtract the current $470 million debt load, we get a suggested market cap of $1.33 billion versus today's $797 million. In other words, a very conservative 2014 year-end reserves BT NPV10 estimate says the stock is undervalued by a whopping 67%.
And remember, this is just a proved reserves value. A bigger value would be obtained when one considers the massive potential of BXE's ~400,000 acres - the vast majority of which is undeveloped. The above estimate also neglects infrastructure investments in the company's natural gas processing plants. Clearly, the 67% upside based on proven reserves growth (only) is a very conservative way to value the company. If you combine the large acreage position with 20 consecutive quarters of a 100% success with the drill-bit, that's a pretty good combination. In particular, only Penn West (NYSE: PWE) has more net sections in the Cardium play than does Bellatrix - which owns 338 net sections. With Cardium wells costing only $3.75 million (and that figure is likely to go down in a lower cost drilling environment), these wells are very profitable even at $3 gas and $60 oil, with an IRR approachng 100% (see red highlights below):
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These are some of the reasons that likely explain why Orange Capital took such a big stake in the company.
Downside RiskThe short-term risk for BXE is that near-term commodity pricing remains weak and the energy sector stays out of favor. Yet from a price perspective, BXE has been so heavily sold I believe the downside here is fairly limited as the bottom appears to have been put in at $3. This sell-off was likely due to the "energy panic" in addition to capitulation and year-end tax-loss selling. It is possible the stock could fall back and re-test the $3 level if panic comes back into the market. However, I think the worst is over and if we look at the recent bounce in the shares over the last few days, they indicate should a Christmas rally in the shares is likely.
Summary & ConclusionBellatrix has had a wild ride 2014 which has seen many big developments: extended JVs, a secondary offering, financing agreements, acquisitions and divestitures, and finally - an activist investor (Orange Capital) stepping in which now controls 14.3% of the shares and two seats on the Board of Directors. Orange's position was established for an average price of $6.66, so they are down big at this point. In the short-term, BXE looks to be over-sold, to have bottomed, and due for a pop. On a 2013 NPV10 basis, that pop could easily be 15%. In the mid-term, a very conservative BT NPV10 estimate on 2014 proved reserves shows the company is easily 67% undervalued. Longer-term, I would expect Orange Capital to work for a decent return on its investment by leveraging BXE's enormous acreage position - especially in the Cardium play. At the end of the day, the investment thesis in Bellatrix remains what it has always been: ~400,000 prime acres in Western Canada's Sedimentary Basin, 20 consecutive quarters of a 100% drilling success rate (i.e. a reproducible drilling program), excellent production growth, and growing FFO and profits. If Orange Capital can rein in management from diluting shares and keep BXE focused not on growing production, but growing production and profits on a per share basis, not only will Orange Capital likely double or triple its investment, but so too will all the other ordinary shareholders who can go out today and buy shares at a signifcant discount to the average share price of Orange's big stake. BXE is a STRONG BUY.
| Prev Close 3.50 | High $3.90 | | Open $3.76 | Low $3.53 | | Volume 284.7k | 52 Wk High $10.7 | | Mkt Cap $ 695.28M | 52 Wk Low $2.97 | | Avg Vol 522.0k | P/E 5.43 | | 1Y Target Est $ 7.19 | EPS $0.67 | | Beta 1.87 | Div & Yield N/A |
Source: Yahoo Finance ("NYSE" shares).
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