This week, Durig Capital looks at an oil and natural gas producer who had an outstanding first quarter and has almost equal production between oil, natural gas and natural gas liquids (NGLs). Sanchez Energy recently posted its results for Q1 (three months ending March 31, 2018). The results are nothing short of impressive:
- Total revenues increased by 88%
- Oil, natural gas and NGL production all registered year-over-year increases between 33% and 75%.
- Net cash from operations was $84.5 million versus a loss of $13.7 million in Q1 2017.
- Outstanding interest coverage over 3x.
While commodity price increases did contribute to the company’s Q1 increases, the production increases were a key factor in the company’s excellent increases in revenues. The company also currently has over $550 million in cash. Sanchez Energy’s 2021 bonds, couponed at 7.75% are currently trading at a discount, giving them a yield-to-maturity of over 14%. Given Sanchez’ excellent increases in production and revenues, their 2021 bonds make an ideal addition to Durig Capital’s Fixed Income 2 (FX2) Managed Income Portfolio, the most recent performance of which is displayed below.
Outstanding First Quarter Results
Sanchez Energy recently released its results for the three months ended March 31, 2018. The company had a fantastic quarter, with increases in production and revenues. Total revenues for the quarter were $251.2 million, up from $133.8 million a year earlier, an increase of 88%. This increase in revenues can be attributed to both increases in production as well as increases in the average sales price Sanchez received for its sales of oil, natural gas and NGL’s (natural gas liquids).
Sanchez had significant increases in production of oil, natural gas and NGL’s in Q1. Oil production increased 63%, natural gas liquids production increased 75%, and natural gas production increased 33%. Along with these production increases, Sanchez also had higher average sales prices for all three commodities (taking into account hedging / derivatives). For oil, the average sales price in Q1 2018 was $53.32 per barrel, a 13% increase over Q1 2017. Similarly, the average sales price for natural gas was up 5% year-over-year, and NGL’s were up 4%.
Perhaps one of the more impressive statistics from the company’s Q1 results was Net Cash Provided by Operating Activities. Sanchez generated net cash from operations of $84.5 million as compared to a loss of $13.7 million a year earlier – a significant turnaround.
Sanchez has been gaining ground on production, and not just in the first quarter. For 2017, the company’s production for the full year was approximately 25.7 MMBoe, or 70,320 Boe/d, which represents a year-over-year growth rate of approximately 31 percent.
About the Issuer
Based in Houston Texas, Sanchez Energy Corporation is an independent exploration and production company focused on the acquisition and development of U.S. onshore unconventional oil and natural gas resources, with a current focus on the horizontal development of significant resource potential in the Eagle Ford Shale in South Texas. Sanchez
also holds an undeveloped acreage position in the Tuscaloosa Marine Shale (TMS) in Mississippi and Louisiana, which offers future development opportunities. As of March 31, 2018, the company has assembled approximately 487,000 gross leasehold acres (285,000 net acres) in the Eagle Ford Shale. For the year 2018, Sanchez plans to invest substantially all of its capital budget in the Eagle Ford Shale. The company continually evaluates opportunities to grow its acreage and producing assets through acquisitions. Successful acquisition of such assets will depend on the opportunities and the financing alternatives available at the time the company considers such opportunities.
Oil, Gas and Natural Gas Liquids
Many exploration and production companies (E&P) are mainly focused on oil production. This focus on the production and sale of one commodity comes with its own set of risks, the most obvious being of “having all your eggs in one basket” – in other words, if oil prices fall, it has an immediate and direct impact on the company’s revenues. This was the case in 2015 and 2016 as oil prices dropped precipitously, and many E&P companies went bankrupt or were acquired by larger producers. However, Sanchez is somewhat unique in that its production is nearly equally split between oil, natural gas and natural gas liquids. For example, in Q4 2017 the company’s production mix consisted of approximately 34 percent oil, 34 percent natural gas liquids, and 32 percent natural gas. This diversification gives Sanchez somewhat of a buffer when the price of one commodity decreases.
A quick look at the balance sheet for Sanchez from its Q1 results reveals a very high level of cash on hand – just over $550 million as of March 31, 2018. Earlier this year, Sanchez issued $500 million in bonds, maturing 2023. The proceeds from these notes will be used to fund some of the company’s operations and capital expenditure budget over the next few years. On Sanchez Energy’s most recent earnings call, Howard Thill, Sanchez CFO spoke about the company’s plans for this large cash balance. Thill stated, “Based on current market prices and our production and cost assumptions, we believe our cash flows and cash-on-hand at March 31 will fund our anticipated operating needs, net debt service obligations, and capital expenditures over a multi-year planning horizon.”
Asset Divestiture to Improve Balance Sheet
Another topic on the company’s most recent earnings call was the possibility for continued asset sales in order to reduce debt. In 2017, Sanchez was able to raise over $316 million from divesting some of its non-core assets. Antonio Sanchez, CEO indicated that proceeds from any asset sales at this point “ would likely go towards a reduction in our debt levels”. He reiterated this point again a bit later in the call stating “we’re highly likely to apply those proceeds to reduction in debt.”
Interest Coverage and Liquidity
Interest coverage is of paramount importance to bondholders as it indicates a company’s ability to service its existing debt. For its most recent quarter (three months ending March 31, 2018) Sanchez Energy had operating income of $138.2 million (without the non-cash charge of depreciation, depletion, amortization and accretion). Q1 interest expense was $43.9 million. This calculates an outstanding interest coverage ratio of over 3x.
As discussed earlier, Sanchez currently has ample cash. In addition, the company also has availability on its credit revolver of approximately $162 million.
The risk for bondholders is Sanchez Energy’s ability to continue growing not only production, but revenues as well. Sanchez had an outstanding quarter in Q1 in terms of revenue and production growth. Certainly the revenue growth is tied to the increase in commodity prices over this time last year. But the company’s production has increased significantly over last year as well – 63% in oil, 75% in NGLs and 33% in natural gas. These two factors contributed to the company’s breakout in Q1. Sanchez has a massive amount of cash that it can use at its discretion to help fund its capital expenditures, as well as use to pay operational expenses if needed. Sanchez has given production guidance ranges for 2018, 2019 and 2020 predicting a steady increase in production over the next few years with capital spend equal to 2018 levels. If Sanchez can hold to these figures, and if commodity prices remain somewhat constant, then the company looks to be in an ideal position. In light of these considerations, the more than 14% yield to maturity on these 2021 bonds appears to outweigh the risks identified.
Recently, there have been questions raised about the continued viability of increasing production from the large shale plays in the United States – the Permian, the Bakken as well the Eagle Ford where Sanchez operates. The questions surround the high decline rate of shale wells, and the ability of technology to continue to improve extraction techniques in more mature shale plays. For instance, despite technology improvements, the Bakken is already showing signs of wear, with well-productivity improvements having flat-lined or decreased over most of the play. If signs of this slowdown begin to show in the the Eagle Ford, this would likely have an effect on Sanchez production and revenues.
Summary and Conclusion
Sanchez Energy’s Q1 performance was nothing short of outstanding as compared to one year ago. While the improvement in commodity pricing definitely helped, the company’s productions increases were nothing short of impressive. With the company’s large current cash balance, they are in a prime position to invest for growth. For bondholders, the large cash balance along with outstanding 3x interest coverage is a great reason to include these 2021 bonds in a diversified income portfolio. For this reason, Durig Capital has identified these bonds as an ideal addition to its FX2 Managed Income Portfolio.
Issuer: Sanchez Energy
Ratings: Caa1 / B-
Yield to Maturity: ~14.37%
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About Durig Capital
Durig Capital provides investors with a specialized, transparent fiduciary service at a very low cost. Our FX2 (Discretionary Management) Portfolio over time has greatly outperformed our FX1 (Non-discretionary) Portfolio, giving significantly higher (at times double) the returns of FX1. Our professional service enables access to a broad spectrum of bond, high yields, and lower price points that are often found in less efficient markets, but not evidenced in many bond services.
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Disclosure: Durig Capital and certain clients may hold positions in Sanchez Energy’s June 2021 bonds.
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