This week’s review is our second look at an oil and gas producer focused in the Gulf of Mexico. We first reviewed W&T Offshore in November 2016. The company’s latest quarterly results show a company that is accelerating in this increasing commodity price environment. Here are some highlights:
- Exceptional Q4 2016 interest coverage ratio of 5.3x.
- Continued reductions in both lease operating expenses and general and administrative expenses of 31.4% and 11% respectively.
- A return to high margins with adjusted EBITDA margin for Q4 2016 coming in at 60%.
W&T Offshore was able to keep its production relatively stable even in light of a much reduced capital budget in 2016. Looking ahead to 2017 and an increased capital budget, Tracy Krohn, CEO, says the company will focus on low risk projects that offer rates of return from 80% to over 100%. With commodity pricing recovering from historic lows, W&T has a great opportunity to increase revenues and profits in 2017 and beyond. The company’s 2019 bonds, which have a current yield-to-maturity of 18.5% are a fantastic opportunity for investors to participate in the recovery in the oil and gas industry. Already part of our Distressed Debt 1 fund, these short 26-month bonds also make a sound addition to our FX1 and FX2 managed income portfolios.
Outstanding Q4 Results
W&T Offshore recently reported its fourth quarter (Q4) 2014 results. What was revealed is a company beginning to reap the benefits of its meticulous two-year program of cost reductions, holding production steady with minimal capital investment, and debt reduction. Selected highlights from the company’s Q4 results include:
- An 11% increase in revenues as compared to Q4 2015. W&T registered revenues of $115.2 million as compared to $104.1 million in Q4 2015. This increase was primarily due to a 24% increase in commodity prices.
- Adjusted EBITDA grew from $41.1 million in Q4 2015 to $69.6 million in Q4 2016, an increase of 69%.
- Reduced Lease Operating Expenses (LOE) and General and Administrative Expense (G&A) over Q4 2015 levels.
- Interest expense decreased significantly due to last year’s bond exchange.
Valuable Gulf of Mexico Assets
In W&T’s last earnings call, company Chairman and CEO, Tracy Krohn, talked at length about the company’s assets in the Gulf of Mexico, specifically the low decline rate of the wells in the Gulf of Mexico as compared to an onshore well in one of pervasive shale plays located around the U.S. The point of his comments is best illustrated by one of the slides from the accompanying presentation.
(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 small 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. Furthermore, these low-decline assets are much more valuable than traditional onshore wells and can be a positive element if W&T looks to leverage these in the future.
Results of Bond Exchange
One of the most notable developments for W&T was the company’s bond exchange completed in September 2016. This bond exchange reduced the company’s outstanding long-term debt by 408.2 million as well as effectively pushing out the maturity of a large portion of the company’s long-term debt. The effects of this bond exchange have been revealed in W&T’s Q4 2016 results. Most obvious is the significant decrease in interest expense year-over-year. Q4 2016 interest expense was $11.5 million as compared to Q4 2015 interest expense of $26.8 million, a whopping decrease of 57%. This massive decrease helped to boost the company’s interest coverage to a level that should be extremely enticing to prospective bondholders.
Outstanding Interest Coverage
At first glance, W&T’s interest coverage is good, even comfortable. In its latest quarterly results, the company showed operating income of $21.3 million and interest expense of $11.5 million. This gives a comfortable interest coverage of just under 2x (1.9x to be specific). However, if one digs a bit deeper to remove the non-cash depreciation charge, operating income jumps to $60.2 million for the quarter. Using the same interest expense, this results in a fantastic interest coverage ratio of 5.3x. This interest coverage with a bond indicating a current yield-to-maturity around 18.5% is tough to find. Prospective bondholders take note.
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 54 fields in federal and state waters and have interests in leases covering approximately 750,000 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.
Continued Cost Reductions
As discussed in our earlier review of W&T Offshore (which can be referenced here), the company has done a masterful job of reducing its expenses in the prevailing low cost commodity environment that has dominated the domestic economy for the past two and a half years. Its latest quarterly review shows a continuation of management’s continued vigilance in keeping costs as low as possible. Q4 2016 results showcase decreased LOE (lease operating expenses) of $33.8 million, a reduction of 31.4% from Q4 2015. G & A expenses (general and administrative) also registered a notable decrease in Q4 2016, dropping by 11% or $1.7 million, to $14.4 million. W&T has worked diligently to decrease its costs during the last few years as illustrated here.
(Source: W&T Offshore Investor Presentation-March 2017)
Return to High Margins
In our last review of W&T Offshore from November 2016, we discussed the company’s traditionally high margins. Considering the state of commodity pricing over the past few years, it was not surprising that the company’s adjusted EBITDA margins fell in 2015 to 46%.
|Adjusted EBITDA Margin||
However, the W&T’s Q4 2016 results show a return to the company’s historically high adjusted EBITDA margins. Q4 2016’s adjusted EBITDA margins registered at 60%, up from 49% in Q3 2016, and showing a massive improvement over Q4 2015’s level of 39%.
The default risk is W&T’s ability to perform. As the low price oil environment has continued, the company has done a masterful job of keeping operating costs low while minimizing production decreases. Its latest quarterly results show a return to its historical adjusted EBITDA margins, a good sign for investors. The company’s focus in the Gulf of Mexico has helped the company to maintain relatively stable production with little capital investment. More impressive for current and prospective bondholders, is the company’s outstanding interest coverage of 5.3x. Although the yield-to-maturity has dropped on these 2019 bonds since our last review, the current 18.5% yield-to-maturity is still extremely attractive and outweighs the risks identified here.
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.
These June 2019 bonds, couponed at 8.5% and currently yielding an extremely competitive 18.5%, have similar duration and yield to other bonds reviewed on the Bond-Yields.com site, specifically 16% BakerCorp and 28.5% ION Geophysical .
Summary and Conclusion
W&T Offshore continues to stay the course – keeping expenses low, minimizing production decreases with a much reduced capex budget, while at the same time returning to the company’s historically high margins. The company’s successful bond exchange from Q3 2016 significantly decreased interest expense by 57%, resulting in an unbelievable interest coverage ratio of 5.3x, which is fantastic for current and prospective investors. These relatively short 26-month bonds, couponed at 8.5% and with a current yield-to-maturity of 18.5%, already represents one of our positions in our top-ranked Distressed Debt 1 hedge fund. Additionally, we have identified these bonds as a preferable addition to our FX1 and FX2 managed income portfolios.
Issuer: W & T Offshore Inc
Ratings: Ca / CC
Yield to Maturity: ~45.157%
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Disclosure: Durig Capital and certain clients may have positions in W&T Offshore 2019 bonds.
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