This week, Durig Capital looks at an oil producer who has built its company using non-traditional production techniques. Denbury Resources (NYSE:DNR) has been successfully using enhanced oil recovery (EOR) techniques to build its name in the world of tertiary oil production. The company had a fantastic 2018 as well as a solid first quarter. 

• 2018 revenues increased 30% over 2017, and outstanding debt decreased by $243 million in 2018.
• For 2018, net income was $323 million, nearly double the the $163 million from 2017.
• For Q1 2019, Denbury registered free cash flow of $26.6 million as compared to a loss of $6.4 million a year earlier.
• Denbury’s low decline assets held production stable at 59,208 BOE /day.

With the recent appreciation in oil prices, Denbury has raised its expected level of free cash flow for 2019 from its original range of $50 million to $100 million to $150 million. This will afford the company many more options to strengthen its balance sheet. Its 2021 bonds are significantly discounted at this time resulting in an outstanding yield-to-maturity of over 18%. Based on its excellent performance in 2018 and its first quarter this year, Durig Capital is considering these bonds for additional weighting in

its Fixed Income 2 (FX2) High Yield Managed Income Portfolio, the aggregated performance of which is shown below.

Denbury’s Q1 2019 Results

As oil prices have continued to recover from their unexpected dip in late 2018, Denbury’s first quarter had some definite wins. Increased oil prices as of late have definitely painted a brighter picture for the company for the rest of 2019, most noticeably in management’s adjustment of its estimated free cash flow generation for the year. Instead of its original estimate of $50 million to $100 million of free cash flow, it is now estimated that Denbury will generate free cash flow well above $150 million this year. In addition to this fantastic news, first quarter had other wins as well. 

• Production from Denbury’s Bell Creek field was up 5% from fourth quarter 2018 and 15% as compared to first quarter 2018.
• Free cash flow for the quarter was $26.6 million as compared to a loss of $6.4 million in the first quarter of 2018.
• Net cash provided by operating activities for the first quarter totaled $64.4 million.
• Denbury’s low decline assets delivered 59,208 BOE / day (barrels of oil equivalent), essentially flat when compared with fourth quarter 2018 and first quarter 2018.
• Denbury reaffirmed its bank credit facility at $615 million. No amounts were outstanding as of March 31, 2019.

Chris Kendall, Denbury’s President and CEO commented on the company’s continued strong performance. “As I consider the rest of 2019, I am looking forward to sharing more of what this great Company can deliver. We will maintain our priority of strengthening our balance sheet; the results of our high-return capital investments will continue to shine; we will continue to drive our highly impactful Cedar Creek Anticline enhanced oil recovery project toward first oil; and we will have results from exciting new exploitation tests. I see all of this combining to pave the way to a strong and sustainable future for Denbury.”

About the Issuer

Headquartered in Plano, Texas, Denbury Resources Inc. is an independent oil and natural gas company 

with 262.2 MMBOE of estimated proved oil and natural gas reserves as of December 31, 2018, of which 97% is oil. Denbury’s operations are focused in two key operating areas: the Gulf Coast and Rocky Mountain regions. The company’s goal is to increase the value of its properties through a combination of exploitation, drilling and proven engineering extraction practices, with the most significant emphasis relating to CO₂ enhanced oil recovery operations. As of December 31, 2018, Denbury Resources had 847 employees.

Debt Levels Continue to Decrease

Denbury continues to remain very focused on improving its balance sheet through debt reduction. In the company’s most recent earnings call, Mark Allen, Denbury’s CFO, commented on the company’s progress in this area. The company’s “trailing 12 month’s debt to EBITDAX ratio has improved to 4.3x, a full turn better than the comparable metric a year ago.” He went on the emphasize that Denbury expects this ratio to continue to trend down through the balance of 2019 to end the year between 3.5x and 4x.

(Source: Denbury Resources Presentation –JP Morgan 2019 Energy Conference)

Recent Debt Exchange

Denbury recently offered holders of its notes maturing in 2021, 2022, 2023 and 2024 an opportunity to exchange these notes for either new 7.75% senior secured second lien notes due 2024, or convertible senior notes due 2024. Here is a summary of the early participation results for the offering.

(Source: Denbury Resources Presentation –JP Morgan 2019 Energy Conference)

Moody’s Investor Service issued a ratings update on the exchange. James Wilkins, Moody’s Vice President commented on the exchange, “We view Denbury’s debt exchange transaction, which extended the average debt maturity without increasing interest expense and used cash to reduce debt, as a modest credit positive.”

What is CO2 Enhanced Oil Recovery

Denbury has capitalized on a niche production technique that focuses on tertiary oil recovery from established oil fields. Oil producers in the U.S. have largely recovered much of the easy-to-produce oil from the major oil fields in the country. Many producers have experimented with various enhanced oil recovery (EOR) techniques that offer the possibility to recover 30 to 60 percent of the reservoir’s original oil. One of these techniques that has been proven to be very effective is gas injection. This technique involves injecting gas such as natural gas, nitrogen or carbon dioxide (CO₂) that will expand within the reservoir and push additional oil into a wellbore. Nearly 60% of the U.S. EOR production is accomplished using this technique. Denbury has successfully used this technique in its tertiary oil recovery operations.

(Source: Denbury Resources Presentation –JP Morgan 2019 Energy Conference)

When enhanced oil recovery (EOR) is used to produce oil from established oil fields, there is typically less risk for the operator (Denbury), since it is drilling in an area that has already shown steady, primary oil production. In addition, Denbury’s assets have a significantly slower decline rate than shale oil wells which translates to less capital for exploration. Denbury has established itself on this niche production technique which will continue to be valued as oil demand grows in both the U.S. and globally.

Interest Coverage and Liquidity

Interest coverage gives bond investors a snapshot into a company’s ability to service existing debt levels. For its most recent quarter, Denbury Resources had operating income (without the effects of non-cash depreciation, depletion and amortization) of $20.9 million, and interest expense of $17.4 million for an interest coverage of 1.2x. In terms of liquidity, most of the company’s current liquidity lies in its unused $615 million bank credit facility. As of March 31, 2019, Denbury also had cash of $5.7 million.

Risks

The risk for bondholders is whether Denbury can continue to build free cash flow and profitability while also continuing to address its upcoming debt maturities. The positives are the company’s low decline assets, the recent rally in oil prices as well as the successful recent debt exchange. Add to this the continued increasing production from the Bell Creek field. The challenge for Denbury will be to continue to decrease its leverage ratio as it looks toward its 2021 maturities. However, given the fact that Denbury has shed over $1.1 billion in debt since 2014, the company is no stranger to de-leveraging. At present, the company’s 2021 bonds are trading at a significant discount which, for investors, translates to an outstanding yield-to-maturity of more than 18%. Based on Denbury’s improving position, it does appear this excellent yield outweighs the risks identified. 

As nearly all of Denbury’s revenues come from the sale of oil, the company is significantly exposed to fluctuations in the price of oil on a daily basis. If the price of oil were to decrease significantly, it could affect the company’s ability to generate enough cash flow for daily operations as well as to pay bondholder interest.

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

Denbury has weathered the volatility of oil prices over the past five years. Now, the company looks to be on more solid ground, with an improving free cash flow outlook for the rest of 2019, Bell Creek production continuing to improve, a recent successful bond exchange and still looking forward to tertiary production from its crown asset, Cedar Creek Anticline. Denbury truly has made a name for itself in enhanced oil recovery (EOR) producers. The company’s 2021 bonds, couponed at 6.375% and trading at a significant discount, have a yield-to-maturity of over 18%. In light of these developments, these 2021 bonds, already a holding in Durig’s portfolio, make an outstanding candidate for additional weighting in the Durig Capital Fixed Income 2 (FX2) High Yield Managed Income Portfolio, shown above.

Issuer:  Denbury Resources, Inc.
Ticker: (NYSE:DNR)
Coupon: 6.375%
Maturity: 8/15/2021
Ratings: Caa2 / D
Pays: Semiannually
Price:  ~ 80.0
Yield to Maturity: ~18.25%

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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.  Most of our client accounts are custodied in their own name at TD Ameritrade Institutional, a large discount service provider that is SPIC insured, or at Interactive Brokers. We have now started offering our highly successful FX2 service to clients of other Registered Investment Advisors through segregated accounts at TD Ameritrade. Please ask us to learn how this might work for you and your current advisor. 

Disclosure: Durig Capital and certain clients may hold positions in Denbury Resources’s August 2021 bonds.

Disclaimer: Please note that all yield and price indications are shown from the time of our research.  Our reports are never an offer to buy or sell any security. We are not a broker/dealer, and reports are intended for distribution to our clients. The high yield strategies presented in this review by Durig Capital may not be suitable for all investors.  This is not investment advice from Durig Capital, nor a specific recommendation to buy or sell securities. If you have any questions or concerns about its suitability for your personal investment, you should seek specific investment advice from a registered professional before making an investment decision.

We track thousands of bond issues and their underlying fundamentals for months, sometimes years, before finding any that achieve or surpass the targeted criteria we have found to be successful.  Our main priority is to provide the best opportunities for our clients.  Our bond reviews are first distributed to our clients, then published on our website and our free email newsletter, and lastly on the Internet and distributed to thousands of prospective clients and competitive firms. Bond selections may not be published if they have very limited availability or liquidity, or viewed as not being in the best interests of our clients. When high yielding bonds with improving fundamentals are acquired at lower costs, Durig Capital believes that investors will appreciate earning higher incomes with our superior high income, low cost, fiduciary services. 

To learn more about this bond call our fixed income specialist at (971) 327-8847

Always putting your interests first,

Randy Durig
Registered Investment Advisor
DIR  971-732-5119

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