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Investment thesis

W&T at sea (NYSE: WTI) is a small independent oil and natural gas producer in the Gulf of Mexico. The company has grown thanks to the acquisition of mature properties, sold by larger players because they are not strategic. W&T’s production is currently around 40,000 boe per day, of which just over 50% is gas.

This article updates my previous investment thesis:

W&T Offshore: Value Play Vs. Debt Trap

W&T Offshore Looks Promising After Risk Reduction Event, Recent Correction

In summary, I saw W&T discounted compared to its net asset value (or NAV), but I was initially hesitant given its debt situation. However, the company eventually pushed back some of its debt maturities through a successful securitization deal.

Since my analysis a year ago was based on $60 oil/$3 gas, I’m even more bullish now with $90-100 oil (OIL) and $5-6 gas (UNG). Interestingly, while the stock price has risen from $3 to over $6 over this period, over the past two weeks, it nearly reversed last spring.

In my opinion, this is mainly related to short selling, which increased as the stock moved above $6. Yet the fundamentals have only improved since May 2021:

  • The price of the strip is much higher and the net asset value discount has only increased; W&T’s long-term inventory will also be an advantage as less capex in the inflationary environment is needed to maintain production.

  • Short-term cash flow is improving as unfavorable oil hedges have almost disappeared; gas blankets are still a drag, but W&T has partially mitigated their effect by buying calls.

  • The 2023 bonds are trading almost at par, showing that rollover risk is further mitigated.

The move above $6 made sense given these positive developments, and there is no logic for stocks to return below $4, where they were last spring. I took the opportunity to add to my long position.

Discount to NAV

W&T may generate additional production from 2P (or probable) and 3P (or possible) reserves due to the company’s geological advantages and superior drive mechanisms in the Gulf of Mexico. Because this future production is not initially recognized under the SEC’s reserve reservation system, over time W&T may movement some 2P/3P reserves in category 1P (proved) without additional drilling. The upside potential of 2P/3P is significant, and the company believes it can add $2 billion in PV-10 (measure of asset value) without material investment:

W&T Offshore Incremental PV-10 from Probable 2P and Possible 3P Reserves

Presentation W&T Offshore

For comparison, W&T trades at nearly $1 billion in enterprise value (or EV).

After weighting the probabilities of W&T’s PV-10 numbers using 100%/50%/10% weightings and adjusting for Asset Retirement Obligations (or AROs), Income Taxes, Hedges and net debt, I arrived at about $8.50 implied net asset value per share:

W&T Offshore PV-10 scenarios;  NAV per share

W&T data; Author’s calculations

Additionally, this result is based on the 2021 year-end SEC price of $66 Oil (CL1:COM) and $3.60 Henry Hub (NG1:COM). W&T reports in its presentation an alternative scenario based on the higher NYMEX strip from March 2022. Based on a simple linear interpolation, I estimate that every $10 increase in the price of oil could add $5 to the net asset value per share.

Despite the shortcuts in my calculation (e.g. I can’t estimate 2P/3P or ARO taxes based on the limited data points presented by the company), the bottom line is that at $70 oil, the value net asset per share exceeds at least the double market price. If the long-term oil price averages $90 or more, we’re probably looking at a 4-5x discount. From a NAV perspective, W&T is probably one of the cheapest companies out there.

W&T’s reserves are also reflected in a generous lifespan index:

Definition Reservations Estimated life
PDP only 138.8 million boe 9.6 years old
1P (PDP+PUD) 159.5 million boe 11.1 years
2P (PDP + PUD + Probable) 236.2 million boe 16.4 years old

Source: W&T presentation, author’s calculations

Proved Developed Reserves (or PDP) equates to almost 10 years for production. This longevity could be a key competitive advantage in the current inflationary environment that will make capital expenditure more expensive for many producers.

Long reserve lives are commonly associated with Canadian oil sands producers such as Canadian Natural Resources Limited (CNQ), and W&T’s offshore reserves are not as long, but likely exceed the potential of most shale producers. Americans. Finally, W&T’s assets sit right in the Gulf of Mexico, providing protection against US “pipeline politics” that ultimately results in significant price differentials for Canadian producers and many players. American shale. In 2021, W&T’s average realized oil price differential was 97% West Texas Intermediate and essentially 100% Henry Hub. The company’s market access is as good as it gets, and structurally that will be a big plus in the long run.

Cash flow improves despite hedges

W&T is a good value buy not only from a net asset value perspective, but also relative to its near-term cash flow. Under SA’s valuation metrics, W&T is valued at 3x EV to defer EBITDA and 1.7x market cap to defer (operating) cash flow. These metrics receive grades A and A+ respectively.

Assuming $90 oil / $5 gas, I estimate that W&T is trading at around 3x EV through 2023 unhedged and unlevered free cash flow (or FCF) or 4x FCF hedged and leveraged the sink. The year 2022 may also be an outlier due to a large plug & drop (P&A) cash outlay to offset delayed spending in the previous two years:

We also have capital allocated for three plateau wellbores, as well as support capital for facilities, seismic leases and refills. Additionally, our P&A budget has increased from previous years and is driven by prior obligations and deferrals, primarily due to COVID-19 on terminated leases with BSEE.

Source: W&T earnings call transcript

This is why I would expect the P&A cost to fall in 2023 closer to historical averages.

W&T Offshore forecasts free cash flow and price multiples for 2022 and 2023

Author’s calculations for $90 oil and $5 gas based on W&T 2022 forecast

An elephant in the room is the huge drag on the hedges in 2022. The good news is that the oil hedges are nearly depleted and only account for 3,000 bbl/d out of total oil production of 15,000 bbl/d.

Gas blankets will remain through 2028 though and much of that is driven by last year’s funding deal through the Special Purpose Vehicle (or SPV). Luckily, W&T had the foresight to buy a few calls when they saw which way the winds were blowing:

We – luckily we bought a bunch of gas calls which improved a lot of our unrecognized gas gains and losses over the next few years. So we’re covered – we bought calls until 2025, so on gas and it turned out pretty prophetic. It was – we spent, I don’t know, around $20 million on this and it was a tough decision to make at the time, but it turned out to be a pretty good answer.

Source: W&T earnings call transcript

In summary, the cash flow view appears to confirm NAV’s conclusion that W&T is very cheap.

Refinancing prospects have improved

When I first watched W&T, oil was $60 and rollover of 2023 tickets was a potential concern. At $90 oil / $5 gas, W&T is at nearly 1.0x net debt / EBTIDA, which should be very supportive in any refinancing discussion.

Liquidity is also good at $245.8 million in cash plus $50.0 million available under a new credit facility.

The obligations market also notices improvements and until recently problematic 2023 ratings are now trading near parity for the first time in a long time:

W&T Offshore 2023 notes price history

Markets Insider

W&T CEO Tracy Krohn also sounded rather optimistic on the earnings call:

Jeff Robertson (Analyst)

And then last question, if I may. Can you talk about who you are or shed some light on what you think in regards to the notes maturing next year and how you plan to refinance them?

Tracy Krohn (CEO)

Yeah. I’ll — to some extent, I mean, I think it’s better than it was a month ago and a lot better than it was a year ago. We have higher prices. We have more cash. The bonds are currently trading at par and this is the first time in a long time that this has happened. So I’m very optimistic that we’ll come back with a better solution than the one we had before.

W&T is indeed behind the curve compared to many E&Ps that are already nearly debt-free and have turned to returning cash to shareholders. However, for this same reason, W&T may appreciate much more in the future. The worst is clearly in the past, but I believe that risk reduction has not yet been fully addressed by the stock market.

The recent decline is a buying opportunity

W&T is certainly not performing well on the momentum indicators. In fact, the SA quantitative indicator, which I vehemently disagree with here, flagged it as having a “high risk of poor performance”:

Seeking Alpha quant indicator W&T Offshore warning

Looking for Alpha

In my opinion, the negative momentum is related to frequent short selling:

Chart
Data by Y-Charts

Short-term interest in W&T has never been low, but it certainly grew rapidly as the stock broke above $6.

To be clear, I am not putting forward any “short squeeze” argument. However, given that fundamentals have only been improving since May 2021, I see no merit in the short thesis and view periodic dips as a buying opportunity. I luckily added to my position below $4 recently and will buy more on the dips. I think as long as the stock is in the $4-$4.50 range, it’s a “no-brainer”.

Conclusion

W&T Offshore’s assets in the Gulf of Mexico are well positioned to take advantage of the current bull markets in oil and natural gas. The company is significantly discounted on both a net asset value and cash flow basis, and has greater upside potential compared to oil and gas producers that are further along the payback curve. debt. The recent price decline appears to be driven by short selling and presents an excellent buying opportunity for long-term investors.