This week, we examine an oil and gas exploration and production company with superb interest coverage and a shrewd production strategy. Unit Corporation (UNT), a diversified energy company based in Tulsa Oklahoma, recently posted its Q2 quarterly results. Listed here are some of the highlights from those results.
For Q2, the Unit Corp posted exceptional interest coverage of 4.3x just months after oil hit its lowest price in 12 years.
Reduced bank debt by over $200 million during the quarter.
Q2 oil and gas revenues increased 19% over Q1 thanks to higher oil and gas prices.
In the company’s Wilcox play in Texas, it recorded record production of 97 MMcfe per day, a 25% increase over Q2 2015.
Unit Corp has completed several behind pipe pay zones in its Wilcox play which have significantly increased production. The cost for these recompletions is about 10% of a new horizontal well and with the additional recompletions planned for this year, Unit Corp expects this will add 15% to 20% annual growth for the Wilcox program. Consequently, Unit Corp is able to add production at a fraction of the cost. With the outstanding interest coverage, the company’s May 2021 bonds, currently selling at a healthy discount and yielding over 11.35% to maturity, are an excellent addition to income portfolios and we have marked them for addition to both our FX1 and FX2 global high yield fixed income portfolios.
Solid Interest Coverage
Digging into Unit Corp’s Q1 and Q2 results reveals a company that has solid interest coverage. On the surface, the company registered losses in both Q1 and Q2, with an adjusted net loss of $20.3 million in Q1 and a net loss of $72.1 million in Q2. A closer analysis, however, shows a company that has exceptional coverage. For Q1, removing the non-cash items of depreciation, amortization and impairment expense, the company had operating income of $35.15 million and interest expense of $9.62 million for a coverage ratio of 3.6x. Second quarter numbers are even more encouraging. Again, removing the same non-cash items, operating income was $45.43 million with interest expense at $10.61 million for a coverage ratio of 4.3x.
Unit’s Wilcox Play
Unit Corp’s Wilcox play in Texas has recently posted some outstanding production. In Q2, the company had record production of approximately 97 million cubic feet equivalent (MMcfe) per day in its Wilcox play, representing a 25% increase over Q2 2015 as well as a 9% increase over Q1. This production growth is attributed to new horizontal wells and behind pipe completions in the Wilcox area. According to Unit Corp, the average cost for a behind pipe recompletion is approximately $600,000 or about 10% of the cost for a new horizontal with an expected rate of return in excess of 100% at current commodity pricing.
Through the end of the second quarter, the company has completed a total of 4 behind pipe completions that are currently producing approximately 17 million cubic feet of gas equivalent per day. At the beginning of the year, prior to the completions, these same four wells were producing approximately 700 mcf (thousand cubic feet) per day or about 4% of the current rate. Unit Corp plans on recompleting four to six new behind pipe zones during the second half of this year that should result in 15% to 20% annual growth for the Wilcox program.
About the Issuer
Unit Corporation is a diversified energy company engaged through its subsidiaries in the exploration for and production of oil and natural gas, the acquisition of producing oil and natural gas properties, the contract drilling of onshore oil and natural gas wells, and the gathering and processing of natural gas. The company carries out operations through its three principal business segments. Its subsidiary, Unit Petroleum explores, develops, acquires and produces oil and natural gas properties for the corporation. Unit Drilling Company is the subsidiary that carries out contract drilling services for onshore oil and natural gas wells for outside companies and also for Unit Corporation. Lastly, Unit Corp’s subsidiary, Superior Pipeline provides mid-stream services for third parties including gathering, processing and treating natural gas. Unit Corporation generated total revenues for the first six months of 2016 of $274.5 million – 46% oil and gas, 23% contract drilling and 31% midstream services.
Production and Price Recoveries
Houston-based oilfield services company Baker Hughes Inc. generates a weekly report on the number of active rigs in the U.S. currently drilling for oil and natural gas. This report is an important measure for energy service providers in gauging the overall health of the oil and gas industry. In its latest weekly report (for the week ending September 2, 2016), Baker Hughes reported a rise in the U.S. rig count, the ninth increase in 10 weeks. The increase can be mostly attributed to gains in the number of natural gas rigs. The oil rig count has also improved, with the number of active domestic rigs increasing in nine of the past 10 weeks. Unit Corporation has also begun to see some rebounding in the number of its rigs under contract, from a low of 13 in Q2, to now 16 rigs under contract (of a fleet total of 94 rigs).
Prices for natural gas and oil have also seen a recovery since the first of the year. Natural gas prices have rebounded this year after hitting 17-year lows in the first quarter around $1.50 per MMBtu. Recent prices for natural gas were around $2.97 per MMBtu, a year-to-date increase of nearly 100%. Oil prices have seen similar increases from a low of under $30 per barrel (West Texas Intermediate or WTI crude oil) to its most recent price around $47 per barrel.
These increases have been felt by Unit Corporation as well. In Q2, the company’s average oil price received was $41.52 per barrel, a 28% increase over Q1 2016. Also, Q2 oil and gas revenues increased 19% over Q1 due to higher oil and gas prices.
Strategy for Lower for Longer Oil Prices
In addition to its exceptional coverage, Unit Corp has taken additional steps in 2016 to ensure the competitiveness and longevity of the company. In Q2, the company reduced its bank debt by over $200 million. In addition, it also successfully completed the amendment of its credit agreement in early Q2 with its borrowing base set at $475 million, which provides the company with ample liquidity to meet its operational needs. As of June 30, 2016, the company had outstanding borrowings under its credit revolver of $236 million, leaving $239 million available.
Unit Corp is also committed to selling non-core oil and gas properties and using the proceeds to pay down debt. Through June 30th, the company sold non-core properties for approximately $43.6 million with most of the proceeds going toward reducing the company’s bank credit agreement.
The company has also right-sized some of its operations, consolidating from five to two the number of divisions within its drilling segment, as well as implementing reductions in office and field staff. These measures are beginning to have an effect on expenses, with General & Administrative expenses for the first six months of 2016 decreased by 10% as compared to 2015.
The default risk is Unit Corporation’s ability to perform. The company currently has superb interest coverage which should assure bondholders. It has taken steps to reduce costs, but also ensure production (like in its Wilcox play in Texas), which should provide sufficient support for the company as commodity prices recover. The excellent coverage and 10.6% yields on these nearly 5-year bonds appear to outweigh the risk we were able to identify.
Unit Corp’s success depends to a large degree on the prices it receives for its oil and natural gas production, the demand for oil and gas and the demand for its drilling rigs. The drastic decrease in both oil and natural gas prices since mid-to-late 2014 have affected all oil and gas exploration and production companies in the U.S. Continued low prices and / or decreasing prices in oil and gas could have a detrimental effect on Unit Corp’s continued revenues. The price appreciation seen in both oil and gas since early 2016 have been encouraging. Many feel that prices will eventually recover, although the rate of recovery will be significantly slower than earlier predictions.
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
Like many oil and gas exploration and production companies, Unit Corporation has made adjustments to its operations to weather the significant downturn in oil and gas prices over the last two years. At first glance, it is difficult to see the outstanding interest coverage and the brilliant strategy the company is using to keep production up with less cost (like in its Wilcox play). For those investors who are willing to look more deeply, Unit Corporation is showing resilience in the wake of the most challenging oil and gas market in recent history, and appears to be positioning itself to increase revenues significantly as commodity prices recover. Therefore, we have marked Unit Corp’s May 2021 bonds, couponed at 6.625% and currently priced about 83.25, for addition to both our Fixed-Income1.com and Fixed-Income2.com income portfolios.
Issuer: Unit Corporation
Yield to Maturity: ~11.37%
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Disclosure: Durig Capital and certain clients may have positions in Unit Corporation 2021 bonds.
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