This week, Durig Capital takes a look at a unique oil and gas producer. Reviewed several times in the past, most recently in May of 2019 following the company’s release of their Q1 Results, California Resources Corporation (NYSE:CRC) produces oil, natural gas and natural gas liquids (NGL) strictly within the state of California. And, it sells all of it oil production in the state of California, which, as a state, represents the 5th largest economy in the world. The company recently signed its third major joint venture agreement, which will allow the company to add production and revenue with no initial capital cost to CRC. In addition to this great news, CRC also posted some excellent results from its second quarter.
- Revenues were up 19% over Q2 2018
- Adjusted EBITDAX for the first six months increased by 12%
- Year-to-date oil production was up 3% over 2018 despite the company’s recent 50% divestiture of one of its major assets
Potentially damaging state legislation from earlier this year has been delayed, perhaps indefinitely, which is a huge sigh of relief for CRC and other companies tied to oil and gas in California (see the discussion under the Risks section below). In addition, the company remains laser focused on debt reduction, having repurchased $260 million in face value of its second lien notes over the last year. The company’s 2021 bonds are currently priced significantly below par, giving them an outstanding yield to maturity of about 33.5%. In light of the company’s continued excellent performance, these short-term maturity (24 month) bonds are ideal for additional weighting in Durig Capital’s Fixed Income 2 (FX2) High Yield Managed Income Portfolio, the aggregated performance of which is shown below.
California Resources Corporation Second Quarter 2019 Results
The big recent news from CRC is its new joint venture with Colony Capital (NYSE:CLNY). This deal was finalized after the close of the second quarter (ended June 30), but is a major piece of CRC’s plan to grow production and revenues with a significantly smaller capital outlay. In addition to this news (see below for more details), the company posted some definite wins in its second quarter and year-to-date results.
- Total revenues for the second quarter increased by 19%, from $549 million a year ago to $653 million.
- For the first six months of 2019, CRC registered adjusted EBITDAX of $556 million as compared to $495 million in 2018, an increase of 12%.
- Total production in the first six months was up approximately 2% and oil production was up 3%. This increase came in spite of the company’s May divestiture of a 50% interest in its Lost Hills operations.
Todd Stevens, CRC’s President and CEO commented on the company’s most recent joint venture:
“These joint ventures allow CRC to de-risk our resource base, bring production and cash flow forward to enhance our credit position, and provide flexibility in our capital program to respond to fluctuations in commodity prices.”
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.
New Joint Venture
CRC has masterfully used joint ventures in the past (and is still using them) to develop its inventory of low-decline assets within its large real estate holdings in California. In July, the company signed another joint venture agreement with Colony Capital Inc., worth up to $500 million. Initially, Colony will fund $320 million for the development of CRC’s flagship Elk Hills field, which is located in the San Joaquin Basin. The initial amount is to be invested over three years, where Colony will fund 100 percent of the development costs, earning a 90% working interest. Upon achievement of an agreed upon return, CRC’s working interest will increase from 10% to 82.5 percent. Joint ventures are a great way for CRC to continue developing its world-class assets without the capital expenditures normally required, while still realizing increases in production and revenues. Here is a snapshot of CRC’s joint ventures.
(Source: CRC Q2 2019 Investor Presentation)
Recent Oil News
There have been some recent developments in the world of oil and gas. Just this past week, some encouraging news on the oil front emerged from the Middle East. Saudi Arabia’s new energy minister, Prince Abdulaziz bin Salman, has signaled a continued commitment to curbing oil production. The markets received this news as positive, with West Texas Intermediate Crude for October delivery rose by 2.4% to $57.85 and November Brent Crude, the global benchmark, increased 1.7% to $62.59. Both benchmarks registered their highest finish since July 31, 2019. The OPEC nations do appear to be in agreement with Saudi Arabia about continuing to curb production. OPEC officially meets again on December 5th where they are sure to revisit the issue of production cuts. California Resources receives Brent Crude pricing on its oil. Increased pricing on oil will help support the company’s goal to improve its balance sheet.
On the flip side, tensions have continued to build in the trade war with China. As a result, beginning September 1, 2019, China began levying a 5% tariff on U.S. oil imports in response to the ongoing trade war with the United States. The ultimate effects remain to be seen, but most predict that this will decrease the amount of oil the U.S. exports to China. As the supply of oil produced by the U.S. has been increasing, finding another market / buyer the size of China may be challenging for the U.S., especially amid rumors of a global slowdown.
Interest Coverage and Liquidity
Interest coverage is important for bondholders as it is an indication of an issuer’s ability to service its existing level of debt. For its most recent quarter, CRC had operating income (without the effect of non-cash depreciation expense) of $243 million and interest expense of $98 million for an interest coverage ratio of 2.5x. Liquidity is important for companies as it helps to cover operating expenses when cash flow fluctuates from quarter to quarter. As of June 30, 2019, CRC had total liquidity of $336 million made up of $27 million in cash and $309 million available from its revolving credit facility.
The risk for bondholders is whether CRC can continue to grow and maintain production and revenues in the face of possible oil volatility from global events, as well as whether the company can continue to de-leverage and improve its balance sheet. The company has made a wise decision to continue to invest in joint ventures as this is a fantastic way to increase production without the high capital cost. In terms of debt reduction, company management repeated its commitment to debt reduction several times on its most recent earnings call. The company also showed its progress over the last year in reducing the outstanding amount of its second lien notes.
(Source: CRC Q2 2019 Investor Presentation)
Earlier this year, California’s legislature was considering a bill that would have affected oil drilling across the state. AB 345 was proposed during the 2019 session and called for a 2,500 foot setback between residences and any new oil industry operations. But even with a bevy of supporters, AB 345 was pulled from the docket in mid-May. However, AB 345 is a two-year bill, meaning it can still be reconsidered as early as January 2020. And even though the language of the bill is meant to apply to future oil drilling, opponents of the bill see it as a back door to ban all drilling in the state. While CRC, and companies like it, breathe a sigh of relief, they will still need to be vigilant in monitoring upcoming and proposed legislation.
CRC’s revenues are derived from the sale of oil and, to a lesser extent, natural gas, so price fluctuations of these commodities is also a risk. Oil prices, which react to both market forces as well as national and international politics, have been recovering since the unexpected decline in late 2018. However, predicting the movement of commodity prices is difficult at best. A drop in prices could affect CRC’s ability to increase its production through increased capital spending.
Generally, there is reduced risk for investors who invest in Durig Capital’s Fixed Income 2 (FX2) High Yield Managed Income Portfolio due to its diversification across many bonds and industries, as compared to the purchase of individual bonds. Also, historically the FX2 Portfolio has significantly outperformed when compared to portfolios where investors have chosen bonds individually. Durig Capital currently holds this bond in its FX2 Portfolio.
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 is continuing to make the most of its outstanding asset base by securing additional joint ventures. The company is able to realize the higher Brent crude price for its oil sales within California which has contributed to its ability to continue to decrease its debt load. Production has grown even as the company divested some of its assets. CRC’s 2021 bond is currently trading at a deep discount, giving these relatively short 24-month bonds a whopping yield-to-maturity of about 33.5%. Investors seeking additional return will want to consider investing in this unique E&P oil and gas company. Durig Capital already holds a position in these bonds and given CRC’s continued performance, these bonds make an ideal candidate for additional weighting in Durig Capital’s Fixed Income 2 (FX2) High Yield Managed Income Portfolio.
Durig Capital has several high yield portfolios available, click below to learn more.
TD Ameritrade Advisors
We have now started offering our highly successful Fixed Income 2 (FX2) Portfolio, our Dividend Aristocrats 40 Portfolio, and our Income Aristocrats Portfolio to clients of other Registered Investment Advisors through segregated accounts at TD Ameritrade Institutional. Please ask us to learn how this might work for you and your current advisor.
Issuer: California Resources Corporation
Bond Coupon: 5.50%
Rating: Caa3 / CCC-
Price: ~ 62.5
Yield to Maturity: ~ 33.5%
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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 CRC’s September 2021 bonds.
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Randy Durig, Durig Capital, Inc.
A Registered Investment Advisor