Durig Fixed Income Bond Review
This week, we look for a second time at an oil producer whose assets are exclusively located in California. California Resources Corporation (CRC) is an independent oil and gas exploration and production company who was formerly part of Occidental Petroleum. The company recently surprised investment analysts with its outstanding results for Q1. Here are a few of the highlights:
Excellent interest coverage of nearly 3x.
Free cash flow of $100 million.
Debt reduction of $147 million in Q1.
CRC signed two additional joint venture agreements, which will add production with no additional costs to CRC.
CRC continues to have solid banking relationships, with the company being recently reaffirmed for its bank borrowing base, unchanged at $2.3 billion.
CRC has done a masterful job reducing debt since its spin off from Occidental in 2014. With its joint ventures to infuse capital for new drilling projects, the company has learned how to better leverage its substantial asset base. The company’s 2021 bonds, couponed at 5.5% and discounted to around 81, offer a yield to maturity of nearly 14% and an opportunity to increase fixed income portfolio returns. With the location of its assets in one of the most lucrative oil and gas markets in the country, we are looking to overweight CRC’s 2021 bonds in our FX2 high yield global income portfolios.
Excellent Q1 Results
California Resources Corporation (CRC) recently posted its financial results for the first quarter 2017. The company surprised analysts by beating earnings per share (EPS) by $0.24. In addition, the company had several other big wins with its quarterly results:
Revenue exceeded analysts estimates by over $100 million.
Cash flow from operations came in at $133 million, up from $115 million a year ago.
CRC also registered free cash flow of $100 million.
Adjusted EBITDAX for Q1 was $200 million as compared to $124 million for Q1 2016, an increase of 61%.
Adjusted EBITDAX margin in Q1 2017 was 39%, up from 31% in Q1 2016.
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.
The Elk Hills Field is CRC’s world-class onshore asset located 20 miles west of Bakersfield in Kern County. The field, covering 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 2016, CRC produced 52,000 BOE per day (37 percent of CRC’s total production) on average from its 3,000 wells at Elk Hills. 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.
The company’s other activities are located in the Sacramento Basin, Ventura Basin and the Los Angeles Basin.
Continued Debt Reductions
CRC has steadily and systematically reduced its debt load over the past few years. In our last review, we highlighted the company’s purchase of $102 million face value of its bonds in the open market at a significant discount. The company has continued in its efforts to shore up its balance sheet with several additional actions since that time. In August of 2016, the company initialized an offer to purchase outstanding notes for cash. Bondholders responded overwhelmingly, easily surpassing the $500 million minimum exchange level set by CRC. The end result was a massive net reduction in debt of $625 million, or 11% of outstanding debt.
Following the success of that tender offer, CRC continued to deleverage in its most recent quarter, reducing debt by an additional $147 million from year-end 2016. What is even more impressive for the company, is that since mid-2015, total debt has gone from $6.8 billion to its current level of 5.0 billion, a reduction of 26%. The following graphic, from CRC’s Q1 earnings presentation visually shows the company’s debt reductions.
Joint Ventures = No Cost Production Increases
In addition to CRC’s outstanding first quarter results and its continued progress on deleveraging it balance sheet, the company signed two additional joint venture agreements in the first quarter. Joint ventures (JV) are a brilliant way to add additional production with minimal additional cost to the company who owns the assets (CRC). The first JV, with Benefit Street Partners, calls for BSP to invest up to $250 million for development opportunities within CRC’s assets in California. BSP will make an initial $50 million investment, and will make subsequent investments in tranches up to $50 million each over a two-year investment window. BSP funds 100% of drilling capital and receives a portion of cash flows on wells drilled with the JV capital. Following the payout, all interests revert back to CRC.
The second joint venture, with Macquarie Infrastructure and Real Assets (MIRA) will add $160 million in capital for development of CRC’s oil and gas properties, with a focus on the San Joaquin Basin. MIRA also may increase its investment to $300 million. Again, MIRA funds 100% of the drilling costs. In exchange, MIRA will receive 90% working interest initially, and after a threshold return is reached, CRC’s working interest will increase from 10% to 75%. The bottom line for CRC is that the company can increase its production of oil and gas with minimal internal capital to achieve it.
Interest coverage is of paramount importance for bondholders. In its latest quarterly results, CRC had operating income of $111 million. If you also add back non-cash depreciation expense of $140 million, this boosts this figure to $251 million. With interest expense of $84 million in Q1, this calculates to interest coverage of nearly 3x.
Risks to bondholders are tied to California Resources Corporation’s ability to continue to deleverage its balance sheet and increase its revenues. The company has done a fantastic job of reducing the amount of debt on the balance sheet, especially given the fact that the company was spun off of Occidental Petroleum directly before the start of the precipitous fall in oil prices in 2014. Its success in signing joint ventures is a brilliant way to add production at minimal cost to the company, and also attests to the value of its assets. Considering these factors, we find the excellent 14% yield on these 52-month bonds outweigh the risks we have 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 begun to recover since their historic lows in the first half of 2016, however, there is no consensus as to whether they will remain at current levels, continue rising, or fall back to previous lows.
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 confounded its critics with its stellar first quarter results. It has continued to deleverage its balance sheet. Management is predicting the company will finally reverse its two-year production decreases by mid-year due in part to its successful joint venture agreements, which have infused much needed capital spending into its drilling program. The company has solid interest coverage and registered excellent free cash flow in Q1. The company’s 2021 bonds are currently selling at a nice discount, with an excellent yield-to-maturity of about 14%. This competitive yield-to-maturity makes these notes an excellent addition to our fixed income portfolio FX2.
Issuer: California Resources Corporation
Bond Coupon: 5.5%
Rating: Ca / D
Yield to Maturity: ~13.84%
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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At Durig Capital, we provide investors with a specialized, transparent fiduciary service at a very low cost. To obtain higher yields and keep costs as low as possible, we typically bundle smaller retail orders into larger institutional sized orders with many global trading firms and bond platforms. Our professional service enables access to a greater spectrum of bonds, higher yields, and lower price points. Most of our client accounts are custodied in their own name at TD Ameritrade Institutional, a large discount service provider that is SPIC insured.
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Disclosure: Durig Capital and certain clients may have positions in California Resources Corporation September 2021 bonds.
Disclosure: We believe that accounts under our discretionary management have significantly outperformed those that require clients to make their own investment decisions.
To learn more about this bond call our fixed income specialist at 971-327-8847
Always putting your interests first,