wpx energy
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8th annual Springvalue investing congress
May 7, 2013 Las Vegas, NV
A Rare Breed:Cheap Stock in a Pricey Market
Guy Gottfried, Rational Investment Group
Join us for the 9th Annual New York Value Investing Congress! To register and benefit from a special discount go to www.ValueInvestingCongress.com/SAVE
www.ValueInvestingCongress.com
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A Rare Breed: Cheap Stock in a Pricey Market
Guy Gottfried, Rational Investment Group (647) 346-0464 guygottfried@rationalig.com
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Agenda
One investing lesson
One investment idea
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Performance: Value Investing Congress Recommendations vs. Fund as a Whole
Closing Price
3-May-13 Dividends
Closing Price Prior to
Presentation Total Return Date
Presented MRC $115.50 $1.05 $59.00 98% 3-May-11 BRK 5.40 0.02 2.45 121% 17-Oct-11 HLC 3.40 0.10 2.80 25% 7-May-12 TWMC 4.39 0.47 2.25 116% 7-May-12 CLK 9.50 0.15 7.55 28% 1-Oct-12 CAM 9.62 0.00 5.05 90% 1-Oct-12
Average/weighted average: Date presented Mar. 2012 Holding period (months) 13 Total return 80% Annualized return - VIC picks 70% Annualized return - Fund (gross) 28%
*Note: prices in local currency. Gross return used for fund in order to compare pure investment performance (since VIC picks returns are not adjusted for any fees).
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Why Have VIC Picks Fared So Much Better?
Skeptical view: stocks pop because Ive spoken about them in public forum
However, recommendations gained approximately 10% on day I pitched them 10% on first day not enough to drive 80% gain year or two later
Returns driven by positive fundamental developments within
underlying businesses
So whats the explanation?
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Its Not You, Its Me
Difference is in my thought process in selecting what to recommend at VIC
Know that Ill be publicizing idea to hundreds of attendees, numerous others via internet
Also aware that some may invest in idea based on my analysis
When presenting at VIC, I know that Im putting my reputation on the line and therefore feel greater-than-usual pressure to not screw up
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Result: Greater Discipline
Particularly selective as far as choosing which investment to present
Even stricter in terms of my criteria (business, balance sheet, management and capital allocation, price)
Insist on even greater margin of safety
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The Million Dollar Question
If it works so well, why not apply same level of strictness to entire portfolio?
Of course, not every investment will work out like The Brick, Trans World, Canam etc. but thats not the point
If it can help enhance ones discipline and decision-making, then it is worthwhile asking question below
Next time you evaluate a potential investment, ask yourself: Is this something that Id feel comfortable recommending to a
large audience and staking my name on it?
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Investment Idea: WPX Energy (WPX)
Oil and Gas Producer
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Snapshot
Recent Price
Enterprise Value
Diluted Shares O/S
Market Cap
$16.40
$3.4 billion $4.9 billion
207 million
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Background
Former exploration and production (E&P) division of Williams Companies (WMB)
Spun off by WMB at start of 2012
Predominantly natural gas producer; production mix: 81% gas, 9% oil, 10% natural gas liquids (NGL)
Principal assets: Piceance Basin, Bakken and Marcellus Shales
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Why is WPX Worth Your Attention?
Metrics from 2012 disposition of non-core assets imply stock value 69% to 105% above current price Sale not only involved two of WPXs worst properties, but also
done with gas prices 40% below todays levels
Other industry transactions of far lower-quality assets imply upside of over 100%
Trades at 8x free cash flow (FCF) at $4 gas with material growth prospects
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Why is WPX Worth Your Attention?
Valued at 66% of tangible equity E&Ps normally trade at several times book value; rarely at discount
unless overleveraged
One of strongest balance sheets in E&P sector
Multiple catalysts and other positive near-term developments
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Why is It So Cheap?
Spinoff dynamics: WMB wanted to separate WPX in order to unlock value of its midstream assets
Spinoff occurred at worst possible time just as gas prices plunged to 13-year lows
Commodity weakness, managements conservative capital spending policy obscure growth prospects Grew rapidly as part of WMB but hasnt had chance to do so as independent
entity
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Comments by Sell-Side Analysts
Report #1 (Nov. 2012): Not to be understated, the balance sheet is a key attribute from a capital preservation
perspective, the stock is unique amongst our coverage group.
On its surface, WPX is one of the most attractively valued E&Ps of the peer group. We see the stock at a 40% discount to peers on a proved reserves basis.
Report #2 (Apr. 2013): We believe WPX has one of the strongest balance sheets in the sector, and especially among gas
levered names.
WPX shares also trade at a meaningful discount to its peers.
Reports recognize WPXs attractiveness yet neither rates it as Buy Telling remark (from report #2): Bottom line, we view WPX shares as inexpensive, and we like
the financial flexibility that its clean balance sheet provides, but we dont expect the stock to outperform without a continued increase in natural gas prices.
Two recent initiations of coverage produced interesting insights
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Accounting Creates Confusion
Two accounting methods for exploration and production activities: full cost and successful efforts Former allows overhead costs associated with exploration and
development to be capitalized; latter does not
WPX follows successful efforts, expenses all G&A Most peers follow full cost; some capitalize up to half their G&A
Company often criticized for having bloated G&A costs relative to peers who employ full cost
Penalized for using more conservative accounting
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Asset Quality: Piceance
Companys largest, most important asset
Most efficient producer in Piceance by far
In best part of basin: Piceance Valley; accounts for vast majority of reserves, production Structurally lower cost (drill from much lower elevation to reach same formation) Only player with meaningful presence in Valley
Recent major discovery in Niobrara shale Enormous reserve potential; more on this later
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Cost Advantage in Piceance
*Source: WPX
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Asset Quality: Bakken and Marcellus
Recognized among best, if not the best oil and dry gas shale plays, respectively
North Dakota Bakken: most prolific oil field in US Prudhoe Bay, largest US oil field to date, produced 1.5 million b/d of
oil for 9 years before going into decline; ND Bakken projected to sustain that rate for 25 years*
WPX in core of play
Marcellus: too early to tell whether company in core as operations have been hampered by infrastructure issues Despite bottlenecks, WPX has seen substantial reserve growth, cut
production costs in half last year alone
*Source: Oil and Gas Journal
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Proved Reserve Growth
137
286
480
0
100
200
300
400
500
600
2010 2011 2012
Bakken Proved Reserves (Bcfe)
28
142
322
0
50
100
150
200
250
300
350
2010 2011 2012
Marcellus Proved Reserves (Bcfe)
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Asset Quality: Additional Properties
Oil exploration: company drilling and leasing acreage in undisclosed oil play Announcement likely coming this summer
Others: San Juan Basin, Powder River Basin (PRB), Apco Oil and Gas (oil-weighted producer in Argentina and Columbia; WPX owns 69%) Lower-quality properties, directing almost no capital, pursuing disposition of
PRB and Apco
Above assets very small relative to size of company Piceance, Bakken and Marcellus account for ~90% of reserves and
production, even greater proportion of intrinsic value
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Finding and Development Costs
*Source: WPX, JP Morgan
One of lowest F&D costs in industry
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Management
CEO Ralph Hill joined WMB in 1981 straight out of college
Has been running WPX (E&P division of WMB prior to spinoff) for 20 years Largely built business into what it is today
WMB nearly went bankrupt in 2002; Hill forced to sell assets in order to raise cash for parent company Experience has helped shape attitude toward maintaining balance sheet strength
$21 million in WPX shares 12x 2012 cash compensation (much higher based on intrinsic value)
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A Few Words on Natural Gas Prices have rebounded from 13-year lows in 2012 but remain weak (now at $4)
$3.89 $4.27
$3.22
$5.39
$6.14
$8.62
$7.23 $6.86
$9.03
$3.99 $4.39
$4.04
$2.79
$4.89
0
1
2
3
4
5
6
7
8
9
10
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Median Ex-2012
Average NYMEX Price, 2000 to 2012
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Supply: Producers Cutting Back
Major declines in gas drilling, spending across industry Most E&Ps have portfolio of oil, liquids-rich and dry gas plays; returns on
first two (esp. oil) dramatically superior to gas
Shale boom has saddled industry with debt as firms feverishly leased acreage, drilled to hold by production
Production still stable due primarily to associated gas from shale oil and liquids-rich drilling but this highly unlikely to offset reduced gas drilling indefinitely
Will take sustained higher prices to stimulate growth by industry as a whole given preference for oil and NGL development
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Natural Gas Rig Count vs. Price
Gas rigs near 18-year lows, down 62% since 2011; continuing to fall despite recent price increase
*Sources: Baker Hughes, Reuters
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Rig Count: Gas vs. Oil
Oil rigs now account for 80% of US onshore rig count compared to approx. half two years ago, one-quarter in 2009
*Sources: Baker Hughes, Natural Gas Intelligence
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Demand: Long-Term Trends Favorable
Power: utilities have announced 40 GW of coal plant closures in next few years 13% of total US coal power capacity* Natural gas emits half the carbon dioxide per kilowatt hour, much more efficient
(therefore cheaper to operate), drastically cheaper to build Nuclear not viable alternative public concerns, very expensive; no nuclear plant
built in over 30 years
Industrial: companies spending billions to build or expand US capacity in
order to exploit cheap gas
Longer term considerations: export (LNG terminals), fuel (trucking/logistics companies)
*Source: Energy Information Administration
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Takeaways on Natural Gas
Gas price low, supply set to drop and demand set to rise
Importantly, WPX thesis not predicated on continued price increase
WPX compellingly undervalued in present commodity environment
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2012 Disposition
Last year, WPX sold its Barnett Shale and Arkoma Basin assets
Bad assets: had taken large write-downs, receiving no capex, dry gas (whereas WPX has significant oil, NGL reserves) Dramatically worse than Piceance, Bakken, Marcellus
Reached deal for disposition in April 2012 trough for gas prices (in low $2s then vs. $4 today)
In short, company sold lousy properties in terrible commodity environment
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Stock Price Implied by Barnett/Arkoma Disposition
Further, above calculation lumps together gas and oil reserves unlike gas, oil prices are strong and Bakken is arguably best oil play in US
WPX significantly undervalued even using metrics from sale of among its lowest quality assets in harsh price environment
Proceeds $306
Proved reserves (Bcfe) 225
P/Bcfe proved reserves 1.36
WPX proved reserves (Bcfe)* 5,339
Implied EV $7,261
Debt (1,511)
Equity value $5,750
Per share $27.79
Premium to stock price 69%
*Note: amounts in millions unless stated otherwise. Proved reserves as disclosed by company based on 2011 year-end commodity prices (gas: $3.68 per Mcf, oil and NGL: $86.75 and $51.83 per barrel).
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Stock Price Implied by Barnett/Arkoma Disposition Adjusted for Bakken
Over 100% upside using separate (still conservative) value for Bakken
Value: proved reserves excl. Bakken $6,604
Bakken value* 1,863
EV $8,467
Debt (1,511)
Equity value $6,957
Per share $33.62
Premium to stock price 105%
*Note: amounts in millions. Bakken value estimated based on original purchase price, industry transaction.
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Recent Piceance Transactions
Two recent deals involving Piceance assets (both announced Nov. 2012)
Bill Barrett: sale of assets in Piceance, Wind River and Powder River basins; Piceance accounted for ~60% of proved reserves Sold at $1.38/Bcfe of proved reserves Values WPX at $34.01 per share (107% above current price)
Antero Resources: sale of all assets in Piceance Sold at $7,051 per Mcfe of production* Values WPX at $35.91 per share (119% above current price)
Based on above transactions, value of WPXs Piceance asset alone justifies its enterprise value, providing rest of business for free Same applies to aforementioned Barnett/Arkoma disposition
*Note: proved reserves not disclosed for this transaction
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FCF Multiple at Current Gas Price
Attractive multiple for company capable of double-digit annual growth for years to come in stable price environment
*Note: amounts in millions
2012 EBITDA $1,000 Interest (102) Taxes (65) Maintenance capex (900) Incremental FCF: cost improvements 124 Incremental FCF: higher gas price 367 Adjusted FCF $425 Per share $2.05 P/FCF 8.0
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Price to Tangible Book
WPX has lowest P/BV in group; every other peer trading below book is over-leveraged (e.g. Chesapeake) while WPX has one of strongest balance sheets in
sector
E&P companies typically trade at several times book value; conversely, WPX trades at meaningful discount
*Peer group includes 14 E&P firms cited by sell-side analysts covering WPX and additional companies selected due to comparability (US-based, heavily gas-weighted)
Book value (mil) $5,151
Per share $24.90
P/BV 0.66
Peer group median 2.86
Peer group mean 3.53
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Catalyst: Cost Structure Improvements
Company burdened by several uneconomic contracts expiring or being replaced this year and next
Also negotiating to buy out unutilized transport commitments
Estimated cumulative pre-tax benefit of $150 to $210 million per annum starting in 2015
Approx. 40% boost to FCF at $4 gas*
*Note: FCF benefit already incorporated in preceding FCF multiple calculation
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Catalyst: Sale of Company
Cheap valuation means buyer can pay sizeable premium and still execute accretive deal Larger acquirer can create enormous value on PV basis by spending
more capital to bring reserves into production
Attractive asset base
Low-risk: 100% drilling success rate last year, 99% in 2011 and 2010
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Additional Developments
Progress with Niobrara shale WPXs first well most productive ever drilled in Niobrara formation;
additional wells planned this year Potential to double 3P reserves Infrastructure in place formation lies in Piceance just below where
companys already drilled 4,000 wells
Sale of non-core assets Marketing stake in Apco, PRB; already received offers on latter Will improve cost metrics (PRB in particular has very high costs),
provide capital to invest in higher-return opportunities
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Conclusion
Special thanks: David Ahl Energy expert who sacrificed many hours helping me better understand the oil and gas business
Any way you slice it (transactions, FCF, book value), WPX a serious bargain
Existing asset base offers considerable growth opportunities for foreseeable future
Several catalysts and near-term value-enhancing initiatives
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