This week’s bond review takes us to the Texas panhandle / Western Oklahoma where an oil and gas producer has hit the jackpot in a recently developed shale play. Jones Energy (NYSE:JONE) has been operating in this area since its beginnings in the 1920’s, but its most recent acquisition of acreage in the Merge play in Oklahoma is making news. The company also has an established drilling program and solid production in its Cleveland assets located in the Western Anadarko Basin which straddles the Texas / Oklahoma state line.
Jones Energy’s Cleveland assets were primarily responsible for the company’s 59% year-over-year increase in operating revenues in Q1.
Initial well drilling and completions in the Merge play has shown outstanding results, with Q2 production estimates 10% above guidance.
In addition to the company’s lucrative Merge assets, it has solid 1.7x interest coverage and has been aggressively reducing debt to improve its balance sheet. Jones has issued April 2022 notes, couponed at 6.75% with a current yield-to-maturity of about 14%. For investors looking for opportunities in the oil and gas sector, these notes would make a fantastic addition to an already diversified portfolio. We have identified these 56-month bonds as an excellent addition to our Fixed Income 2 (FX2) Global High-Yield income portfolio. The most recent performance of our managed FX2 portfolio is shown below.
Q1 Results – Solid Performance from Western Anadarko / Cleveland Formation
Jones Energy has focused drilling and producing oil and gas from the Western Anadarko region in Oklahoma. This proved advantageous in its most recent quarterly results as the company’s production exceeded the top end of guidance, even despite a crippling ice storm in January. The company’s average daily net production for the first quarter was 18.0 Mboe /d (thousand barrels of oil equivalent per day), 1.4 Mboe/d above midpoint of guidance. In addition, 60% of the wells brought online in the Cleveland formation in 2017 are performing above expectations.
Most impressive, total operating revenues for the quarter totaled $41.2 million, as compared to $25.9 million in the first quarter of 2016, representing a 59% increase.
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 continental 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.
Moving to the “Merge”
In August 2016, Jones Energy acquired 18,000 acres between the SCOOP and STACK plays in Oklahoma. This area has been dubbed “the Merge” as it is where these two prolific oil and gas plays merge with one another. Earlier this year, the company added an additional 3,140 net acres to its initial acquired position in the Merge.
This move has already begun to show benefits for Jones Energy. As the following graphic shows, the company has made astounding progress in the Merge area since its initial entry in August of last year.
In the span of 10 months, Jones has grown production from less than 200 BOE per day to over 3,350 BOE per day. In addition, the company’s net unrisked resource potential has grown by 175 million barrels of oil equivalent (BOE). It is also worth mentioning that Jones recently provided a mid-year update on its production showcasing outstanding numbers largely credited to its Merge acreage. For the second quarter, Jones Energy expects production of approximately 23.8 MBoe/d, or 2.17 MMBoe, which is approximately 10% above the top end of prior guidance of 20.7 – 21.7 MBoe/d for the quarter. The Company believes it remains on pace to achieve its full year 2017 production guidance of 20,700 to 23,000 Boe/d.
The company just added a second drilling rig to the Merge acreage, and plans to add a third rig by the end of the year. Of its $275 million capital expenditure budget for 2017, Jones plans to spend $110 million on Merge well drilling and completions, with 26 wells planned in that area for 2017.
As indicated by Bob Brooks, Jones Energy CFO, in its Q1 earnings call, the company has taken several steps to manage and improve its balance sheet. First, it redeployed cash from Jones Energy Inc. to Jones Energy Holdings in the amount of $17.5 million and used these proceeds to pay down the company’s revolver.
Next, the company monetized a portion of its hedges in Q1, to the tune of approximately $21 million and also used these proceeds to pay down debt. Lastly, the company is selling non-core assets; earlier in the year it sold its operations in the Arkoma Basin for $70 million. In addition, the company intends to sell several smaller assets which it believes will net approximately $75 million, which in turn would also be used to reduce debt.
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 Q1 operating income of $22.15 million. With an interest expense of $12.89 million, this gives an interest coverage of 1.7x, more than adequate to cover bondholder interest. In addition, the company had total liquidity at the end of Q1 of $279 million comprised of $270 million available on the company’s credit revolver and $9 million cash.
The risks for bondholders is Jones Energy ultimate success in its new focus area in the Merge. Early indications are extremely positive for the company to meet its 2017 guidance (20,700 to 23,000 BOE per day), whose midpoint represents approximately a 14% increase in production compared to 2016. Production numbers from the wells coming online in the Merge area are exceeding estimates in many cases and the company continues to have solid production from its established Cleveland assets. In addition to increasing production, the company is aggressively looking to reduce debt and improve its balance sheet. Considering all of these factors, the nearly 14% yield to maturity on the company’s 2022 notes 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.
Summary and Conclusion
Jones Energy has consistently and strategically drilled and produced oil and gas from the Texas panhandle / Western Oklahoma area since its beginnings in the 1920’s. With its recent entry into the lucrative Merge play in Oklahoma, the company appears to be on the cusp of solid, well-fought gains in its production and, in turn, its revenues and profits. There looks to still be opportunities for income investors in the oil and gas sector and Jones Energy appears to be one of them. The company’s 56-month bonds, couponed at 6.750% with a current yield-to-maturity of about 14+% would make a solid addition to a diversified income portfolio and as such, we have marked these for addition to our FX2 managed income portfolio.
Issuer: Jones Energy Holdings Llc
Bond Coupon: 6.750%
Rating: Caa2 / NR
Yield to Maturity: ~13.88%
To learn more about this bond, call our fixed income specialist at: (971) 327-8847
Always putting your interests first,
Registered Investment Advisor
DIR (971) 732-5119
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Disclosure: Durig Capital and certain clients may have positions in Jones Energy 2022 bonds.
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