This week, Durig Capital looks again at an oil and gas producer focused in the Gulf of Mexico. W&T Offshore has been reviewed on several occasions by Durig Capital – in November 2016, April 2017 and most recently in August 2017. W&T continues to post solid quarterly results as evidenced by its fourth quarter (Q4) and full year 2017 results.
- Operating income for Q4 increased 55.6% year-over-year.
- For the full year 2017, cash flow from operating activities was $159.4 million, an increase of $145.2 million over 2016.
- Adjusted EBITDA margin was 55%, up from 45% in 2016.
- For Q4, the company boasted interest coverage of nearly 3x.
W&T effectively weathered the the storm of low oil prices experienced in the past few years and has emerged a leaner, more efficient oil and gas producer. With a new joint venture agreement recently signed, the company is ready to increase production of its high return inventory at a fraction of the normal cost. W&T has ample liquidity to pay off these June 2019 bonds and has indicated its ability to do so or to combine cash payment with refinancing. In light of these developments, and the bond’s yield-to-maturity of over 9% make these bonds ideal for additional weighting in our Distressed Debt 1 Hedge Fund, as well as our Fixed Income 2 (FX2) managed income portfolios, the recent aggregated benchmark performance of FX2 is displayed below.
Fourth Quarter and Full Year 2017 Results
W&T Offshore once again posted solid results for its fourth quarter and full year 2017. The company continues to turn in exceptional performance, aided now by increasing commodity pricing on oil and gas. Some of the highlights from the company’s fourth quarter (Q4) results:
- Revenues for Q4 were $129.1 million, up $13.9 million or 12.1% over the Q4 2016.
- Operating income was $33.2 million, representing an increase of 55.6% over Q4 2016
- Net income for Q4 was $23.4 million, as compared to $16.5 million for Q4 2016.
Full year 2017 results also show impressive increases.
- Adjusted EBITDA for 2017 was $268.4 million, up $89.3 million over 2016.
- Adjusted EBITDA margin was 55% for 2017, up from 45% in 2016.
- Cash flow from operating activities was $159.4 million in 2017. This represents an increase of $145.2 million over 2016.
- In 2017, W&T increased its cash balance by $28.8 million to 99.1 million as of December 31, 2017.
W&T continues to perform well, in spite of its low capital spending over the past few years. The company has recently announced a much sought after joint venture that will allow it to increase production with less capital spending.
In early March, W&T Offshore announced the terms of a joint exploration and development program with a group of investors. According to Tracy Krohn, W&T’s Chief Executive Officer, “The drilling program will allow us to accelerate the development of our high return inventory to bring significant cash back to the corporate entity, while maintaining the flexibility to manage our balance sheet and pursue additional accretive acquisition opportunities in the Gulf of Mexico as other operators exit.” Some key highlights of the program are as follows:
- W&T initially receives 30.0% of the net revenues from the drilling program wells for contributing 20.0% of the total well costs plus associated leases and providing access to available infrastructure.
- When the investor group achieves a certain return threshold, W&T’s share of net revenue from the wells increases to 38.4%.
- This agreement allows W&T to develop its inventory more quickly with reduced capital expenditures.
- This joint venture includes an agreement to drill up to 14 specified projects in the Gulf of Mexico over the next three years.
Together, the investor group along with W&T Offshore, have agreed to an aggregate initial capital commitment of $230.5 million. This amount is sufficient to fund the initial projects. W&T expects that more institutional investors will join the program in the near future. W&T’s initial cash commitment to the drilling program is $46.1 million. This program advances the company’s goal of increased production, but with a fraction of the needed capital outlay, truly a winning scenario for W&T.
About the Issuer
Founded in 1983, W&T is an independent oil and natural gas acquisition, exploitation and exploration company, with a focus primarily in the deep waters of the Gulf of Mexico. The company’s founder and CEO, Tracy Krohn, has been leading W&T for the past 31 years. It has developed significant technical expertise and has successfully discovered and produced properties on the conventional shelf and in the deepwater across the Gulf of Mexico. The company owns working interests in 50 fields in federal and state waters and have interests in leases covering approximately 710,000 gross acres. In 2015, W&T sold the West Texas Permian Basin properties that had been acquired in 2011. W&T began trading on the NYSE under the ticker symbol “WTI” in 2005.
Valuable Gulf of Mexico Assets
W&T Offshore is strictly an offshore oil and gas exploration and production company. While offshore drillers face different types of challenges than onshore drillers, one significant, positive trait of oil production in the Gulf of Mexico is the low decline rate of the wells as compared to onshore wells in one of the pervasive shale plays located around the U.S. This point is best illustrated by the following graphic.
(Source: W&T Offshore Investor Presentation-March 2017)
As is evidenced here, the production decline in the Gulf of Mexico well in the early years of production is much shallower than the well located in the shale play. This shallow decline curve represents many of W&T’s projects and directly contributes to the company’s ability to maintain steady production with very little capital expenditure (capex). This has been a significant factor in the company’s ability to maintain relatively stable production while maintaining a reduced capex budget. W&T’s abilities in producing in the offshore environment is a distinguishing feature that sets the company apart from many of its onshore competitors.
Interest Coverage and Liquidity
Interest coverage is of primary importance for bondholders as it indicates a company’s ability to service its debt. For its most recent quarter, W&T had operating income of $33.2 million and interest expense of $11.6 million. This gives the company interest coverage of nearly 3x (2.9x). This is superb coverage especially considering these bonds have a yield-to-maturity of over 9% at present time.
In terms of liquidity, as of December 31, 2017, W&T had total liquidity of $248.8 million. This was comprised of $99.1 million in cash and $149.7 million available under the company’s revolving bank credit facility.
With the extremely short duration left on these bonds, the risk for bondholders continues to decrease. Tracy Krohn, W&T’s CEO has mentioned on several occasions that the company will be in a good position to either cash out these bonds at maturity or do a combination of cash payment and refinancing. Cash payment of these bonds at maturity seems the most probable course of action for WTI especially considering the company was able to increase its cash on hand in 2017 by 28.8 million for a balance of 99.1 million as of December 31, 2017. Considering these points, the ~9.48% yield-to- maturity on these very short 13-month bonds appears to outweigh the risks identified.
Since W&T’s revenues come directly from the sale of the oil and gas it produces, it is exposed to the volatility in the commodities markets. Both oil and natural gas have seen appreciation in price over the past year. However, it is difficult to predict where prices will go next. Another significant and prolonged decrease in commodities pricing could have an unfavorable impact on W&T’s revenues and profitability.
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
With its low decline assets, W&T Offshore has been able to keep production stable over the past few years with a significantly reduced capital expenditure budget. This has proved extremely valuable, especially when commodity prices bottomed out nearly two years ago. The company has taken a brilliant financial step in its latest joint venture agreement that will enable it to increase production for less capital outlay. For bondholders, interest coverage is a solid 2.9x and the company has healthy cash and liquidity levels on the eve of the bonds’ maturity in June next year. These short-term 13 month bonds are already part of our Distressed Debt 1 Hedge Fund and with the most recent outstanding quarterly results, we intend to increase weighting in both the Distressed Debt 1 Hedge Fund and FX2 managed income portfolios, the most recent tear sheet of Distressed Debt 1 is shown above.
Issuer: W & T Offshore, Inc.
Ratings: Ca / CC
Yield to Maturity: ~9.48%
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Disclosure: Durig Capital and certain clients may hold positions in W&T Offshore June 2019 Bonds.
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