This week, Durig Capital looks for a third time at an oil and gas producer serving one the biggest energy markets in the nation. California Resources Corporation (CRC) was reviewed in both June 2016 and May 2017. This California exploration and production company has continued to make strides in improving its balance sheet as well as enter into new, advantageous joint ventures. In addition, CRC recently closed on a deal where it acquired the remainder of the Elk Hills field, one of the most productive fields in the United States. The company’s first quarter results are also encouraging.
- Registered 25% year-over-year increase in adjusted EBITDAX.
- Generated cash flow from operations of $200 million, a 50% increase over Q1 2017.
- Q1 Production was above guidance midpoint range.
- Excellent interest coverage of 2.5x.
CRC was able to pay down an additional $95 million of principal on its second lien notes in early April. The company recently entered into a $750 million joint venture with Development Capital Resources / Ares Management that has added significant incremental capital with which the company has been able to further deleverage and put proceeds toward the Elk Hills acquisition. CRC’s 2021 bonds, couponed at 5.50%, are currently selling at a discount, giving them a competitive yield-to-maturity of over 10.5%. Considering CRC’s recent developments, these 2021 bonds are ideal for additional weighting in Durig Capital’s Fixed Income 2 (FX2) Managed Income Portfolio, the most recent performance of which is shown below.
Latest CRC Developments
Durig Capital has reviewed California Resources Corporation on two different occasions, June 2016 and May 2017. Since the May 2017 review, CRC has continued to reduce debt, leverage its joint ventures and has completed two transactions in early 2018 that will help the company to turn the tide on the decreasing production from the past few years.
The company also recently released its quarterly results for the three months ending March 31, 2018. Some of the highlights of these results include:
- Generated adjusted EBITDAX of $250 million, an increase of 25% over Q1 2017, and an 8% sequential improvement over Q4 2017 Adjusted EBITDAX.
- Cash flow from operations for Q1 totaled $200 million compared to $133 million in Q1 2017, an increase of 50%.
- Adjusted EBITDAX margin increased from 39% to 41%. (If calculated under prior rules, Q1 2018 margin would have been 44%. New accounting rules now require transportation costs to be included as a cost item).
- Registered production of 123,000 BOE per day, which is above midpoint of guidance range.
Commodity prices have definitively recovered from the lows a few years ago. CRC’s realized prices for oil in Q1 was $62.77 / barrel (versus $50.24 a year ago) and NGLs were at $43.13 / barrel (versus $34.33 last year). Natural gas has continued to experience volatility around the $2.70 to $3.00 / mcf (CRC’s Q1 realized price was $2.81 / mcf).
About the Issuer
California Resources Corporation (CRC) is an oil and natural gas exploration and production company focused on high-growth, high-return conventional and unconventional assets exclusively in California. Formed in 2014 as a spin-off from Occidental Petroleum, CRC explores for, produces, gathers, processes and markets crude oil, natural gas and natural gas liquids.
CRC is the largest oil and natural gas producer in California on a gross-operated basis. The company has one of the largest privately-held mineral acreage positions in the state, consisting of approximately 2.3 million net acres spanning the state’s four major oil and gas basins, including the lucrative San Joaquin Basin. According to the California Department of Conservation’s Division of Oil, Gas, and Geothermal Resources, approximately 75 percent of California’s daily oil production for 2015 was produced in the San Joaquin Basin, which includes the oil and gas rich Elk Hills Field.
Continuing Debt Reductions and Joint Ventures
CRC has continued to make progress on improving its balance sheet by its continued strategy of debt reduction. In February, the company paid $297 million of the outstanding balance on its 2014 revolving credit facility. Then in April, the company repurchased a total of $95 million in principal amount of the company’s second lien notes for $79 million in cash. Overall, CRC has done a fantastic job of reducing debt since the height of its debt in Q2 2015, reducing total debt by nearly $1.9 billion.
(Source: CRC Q1 2018 Presentation)
In terms of joint ventures, CRC recently announced a $750 million joint venture with Development Capital Resources (DCR) funded by Ares Management. The joint venture will operate certain CRC existing midstream infrastructure assets in the Elk Hills area in support of CRC’s operations in that region. CRC retains a significant ownership interest in the joint venture. The $750 million was instrumental in helping CRC pay down its outstanding credit facility earlier this year.
Elk Hills Acquisition
In early April, California Resources Corporation closed on the purchase from Chevron of the remaining working and mineral interests in the Elk Hills field. The field, covering approximately 75 square miles, was discovered in 1911 and has produced over 2 billion barrels of oil equivalent (BOE), making it one of the most productive fields in the United States. During 2017, CRC produced 48,000 BOE per day (37% of CRC’s total production). Elk Hills is also the largest natural gas and natural gas liquids (NGL) field in California, generating over half of the state’s natural gas production. As a result of this transaction, CRC now owns 100% working interest and 100% net revenue interest. The company estimates that these interests would have generated approximately $100 million of annual operating cash flow in 2017 assuming current commodity pricing.
CRC expects to realize $5 million of annualized operational savings within the first six months after the close of the transaction and an additional $15 million within the next 18 months as the company streamlines production processes.
Interest Coverage and Liquidity
Interest coverage is of paramount importance for bondholders as it indicates a company’s ability to service its existing debt. In its latest quarterly results, CRC had operating income of $108 million. If you also add back non-cash depreciation expense of $119 million, this boosts this figure to $227 million. With interest expense of $92 million in Q1, this calculates to interest coverage of 2.5x.
The risk for bondholders is whether CRC can continue to improve production and its balance sheet. Through its acquisition of the remainder of the Elk Hills field, production should improve this year as the company has predicted flat production (no year over year change) for Q2 without the effects of the additional production from the additional interest in Elk Hills. The company has also made shrewd moves that have allowed it to continue to pay down its debt each year. Also, another positive sign is that the company recently had its borrowing base under its 2014 credit agreement reaffirmed at $2.3 billion. Considering these factors, the over 10.5% yield-to-maturity on these 2021 bonds appears to outweigh the risks identified.
Certainly, commodity risk is present. CRC’s revenues are derived from the sale of oil and, to a lesser extent, natural gas. Oil prices have recovered since their historic lows in the first half of 2016 and NGLs and natural gas also appear to be on the upswing. However, predicting the movement of commodity prices is difficult at best. A drop in prices could affect CRC’s expansion plans for increased capital spending this year.
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
California Resources Corporation continues to perform, now coming to a crossroads where the company’s production should begin to see meaningful increases, especially from its Elk Hills field. Deleveraging continues as CRC continues to pay down debt. Margins are improving and the company’s most recent joint venture with DCR / Ares Management has added significant incremental capital that CRC has used to pay down debt, as well as help fund the purchase of Elk Hills. With CRC providing energy to one of the biggest markets in the nation, the company’s products are certainly in demand. Interest coverage is also solid. With so many positives, and the 2021 bonds still selling at a discount, the competitive ~10.54% yield-to-maturity makes these notes an excellent candidate for additional weighting in Durig Capital’s Fixed Income 2 (FX2) Managed Income Portfolio.
Issuer: California Resources Corporation
Bond Coupon: 5.5%
Rating: Caa3 / CCC-
Yield to Maturity: ~10.54%
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Disclosure: Durig Capital and certain clients may hold positions in CRC’s September 2021 bonds.
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