This week, we take our second look at an oil exploration and production company who has made the decision to focus its efforts in the lucrative Merge play in Oklahoma. This decision has already begun to yield results as evidenced by its most recent quarterly results:
Jones Energy beat Wall Street’s expectation in Q2, posting earnings per share of $0.12, which shattered Wall Street’s prediction by $0.29.
Due to its excellent first half year production and cost savings efforts, Jones has lowered its expected capital expenditure (capex) from $275 million to $250 million.
Even as it has lowered its capex, it also increased its 2017 midpoint production guidance.
In addition to its excellent Q2 results, the company continues to work at deleveraging its balance sheet, recently completing the sale of a non-core Arkoma Basin asset and using the proceeds to pay down its revolver. Jones Energy has found a sweet –spot in The Merge area of Oklahoma and is using it for maximum advantage. The company’s 2022 bonds, couponed at 6.75% with a current yield-to-maturity of nearly 16% make a great bond for addition to our Fixed-Income2 managed income portfolio. The most recent performance of our managed FX2 portfolio is shown below.
Jones Energy – Q2 Results
Jones Energy recently released financial and operational results for the three months ending June 30, 2017. From these results, the company appears to be capitalizing on its decision to focus on its recently acquired assets in the Merge play in Oklahoma. Jones’ average daily production during Q2 of 23.8 Mboe/d (thousand barrels of oil equivalent per day) was 12% above its guidance midpoint. In addition to this, the company’s total revenues and operating revenues both registered increases over Q2 2016. Total revenues for Q2 2017 were $66.5 million as compared to $60.6 million a year ago, a 9.7% increase. Operating revenues increased by an astounding 67%, coming in at $48.6 million as compared to $29.1 million in Q2 2016.
About the Issuer
Jones Energy is an independent oil and gas company engaged in the exploration, development, production and acquisition of oil and natural gas properties in the mid-continent United States, spanning areas of Texas and Oklahoma. Jones Energy CEO, Jonny Jones, founded its predecessor company in 1988 in continuation of his family’s long history in the oil and gas business, dating back to the 1920’s. The company has grown rapidly by leveraging its focus on low cost drilling and completion methods and horizontal drilling expertise to develop its inventory and execute several strategic acquisitions. Jones Energy has accumulated extensive knowledge and experience in developing the Anadarko and Arkoma basins, having concentrated its operations in the Anadarko basin for over 25 years and applying its knowledge to the Arkoma basin since 2011. Its operations are focused on distinct areas in the Texas Panhandle and Oklahoma, primarily in the Western and Eastern Anadarko Basins.
Jones is recognized as one of the lowest cost drilling and completion operators in the Cleveland and Arkoma Woodford shale formations and believes that its low-cost drilling expertise will apply directly to its new drilling in the Merge area, which is located approximately 150 miles to the east of its Cleveland play.
Arkoma Asset Sale
As discussed in our previous review, Jones Energy anticipated selected asset sales in order to generate cash toward deleveraging as well as to increase its focus in the Merge drilling area. In Q2, the company completed the sale of its Arkoma assets for $65 million. These funds were used to pay down debt on the company’s revolver. Moving forward, Jones indicated on its most recent earnings call that it plans to continue to market non-core assets with a focus on continuing to improve its balance sheet.
Doing More With Less…..
Due to the company’s outstanding production metrics in Q2, it has made adjustments to both its 2017 capital expenditure (capex) budget as well as adjusted its midpoint of its 2017 production guidance. Both of these adjustments are net of the recently completed Arkoma asset sale. Jones Energy lowered its 2017 capex budget from $275 million to $250 million. According to Jonny Jones, Chairman and CEO of Jones Energy, “we now believe that we can achieve our 2017 goals with less capex than initially budgeted.” As for the company’s 2017 Guidance, it now projects an average daily production of 20,700 to 22,000 barrels oil equivalent (Boe) per day, which is an increase in guidance net of the divested Arkoma Basin assets.
….While Decreasing Costs
In addition to the outstanding drilling results Jones Energy achieved in Q2, it also brought down costs as well. For the three months ending June 30, 2017, the company brought down both its lease operating expenses and its general and administrative (G&A) expenses. Lease operating expenses were reduced, albeit slightly, going from $4.46 per barrel a year ago to $4.35 in Q2 2017, a reduction of 2.5%. In addition, G&A expenses decreased by 16.8% year-over-year, going from $4.80 to $3.99 per barrel.
Interest Coverage and Liquidity
Interest coverage is of primary importance to bondholders as it indicates a company’s ability to cover the cost of its debt. At first glance, Jones Energy does not appear to have sufficient operating income to cover its interest expense. But a closer inspection and calculation of operating income without the non-cash Depletion, Depreciation and Amortization charge (DD&A) charge gives Q2 operating income of $20.8million. With an interest expense of $12.7 million, this gives an interest coverage of 1.6x, more than adequate to cover bondholder interest. In addition, the company had total liquidity at the end of Q2 of $250 million comprised of $244 million available on the company’s credit revolver and $6 million cash. We provide many energy company reviews and bench-marked returns allowing you to see how Jones Energy compares to others in the universe of resource bonds.
Since Jones Energy is in a younger more volatile business model and investment merits might and will change, we will post updates here.
The risks for bondholders is Jones Energy ability to translate its new focus in the The Merge area into solid production that will enable the company to continue to deleverage its balance sheet and grow the company into a main producer in the The Merge area. The company has definitely made its mark in its newly chosen area of focus judging on its excellent production numbers. They continue to pay down debt through the sale of non-core assets. Finally, the company recently lowered its capex for 2017, but increased its 2017 guidance midpoint. Based on these items, the company’s 2022 bonds, with a current yield to maturity of about 16%, appears to outweigh the risks identified.
Jones Energy generates its revenues from the sale of oil and natural gas. While both oil and natural gas have experienced significant price volatility in the last few years, both appear to be making a recovery. The OPEC deal has, for the most part, favorably affected oil prices and natural gas prices appear to be stabilizing as well. Both of these developments bode well for Jones Energy to increase its future revenues if prices continue to rise.
In general, bond prices rise when interest rates fall and vice versa. This effect tends to be more pronounced for lower couponed, longer-term debt instruments. Any fixed income security sold or redeemed prior to maturity may be subject to a gain or loss. Higher yielding bonds typically have lower credit ratings, if any, and therefore involve higher degrees of risk and may not be suitable for all investors. Investment risk can change quickly, to receive updates on portfolio changes regarding Jones Energy Holdings, click here.
Summary and Conclusion
Jones Energy has continued to make progress on its goal of making The Merge its flagship asset. In the process, it has sold non-core assets, paid down debt with the proceeds and has now lowered its capex while simultaneously raising the midpoint of its 2017 guidance. Management has made a wise decision to focus in the The Merge and it is beginning to pay dividends. For those investors still looking for opportunities to benefit from oil’s recovery, these 55-month bonds with a current yield-to-maturity of about 16% are an ideal addition to a diversified income portfolio and will make an excellent addition to our FX2 managed income portfolio.
Issuer: Jones Energy Holdings LLC
Bond Coupon: 6.750%
Rating: Caa2 / NR
Yield to Maturity: ~15.86%
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Disclosure: Durig Capital and certain clients may have positions in Jones Energy 2022 bonds.
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