It is difficult these days to find truly positive news in the oil and gas sector. Overall, the sector has been beaten down and the recovery might take longer than expected. However, I have always mentioned and believe that there are some excellent short-term and long-term opportunities in the sector.
Carrizo Oil & Gas (CRZO, Financial), which is engaged in the exploration, development and production of oil and gas primarily in the United States, is the stock in the spotlight after the company reported strong 3Q15 results on Nov. 4. Here is why the stock is good for the short term as well as for the long term.
Coming to the revenue reported for the first nine months of 2015, Carrizo reported revenue of $472 million in YTD15 as compared to $521 million in YTD14. The decline in revenue due to lower oil prices was partially offset by an increase in production coupled with gains from hedged positions. Carrizo reported EBITDA of $343 million for YTD15 as compared to EBITDA of $405 million for YTD14. Clearly, the company’s revenue and EBITDA have remained robust considering the steep decline in oil prices during the comparable period.
I want to emphasize the company’s production as total production for 3Q15 was 7% higher as compared to 3Q14. The company’s 3Q15 production exceeded the high end of company’s guidance due to robust production from Eagle Ford as well as Utica Shale assets. This point was important to mention as these are quality assets delivering low-cost oil (Eagle Ford asset breakeven is approximately $40 per barrel). Once oil prices trend higher, the EBITDA margin will be robust. This makes Carrizo interesting from a long-term perspective.
Another point that is worth noting from a long-term perspective is the fact that the company’s probable reserves are 495mmboe –Â 3.2 times the proved reserves. This makes Carrizo an interesting bet. When oil trends higher and capital investments increase, these probable reserves will translate into meaningfully higher proved reserves and production.
Coming to the balance sheet, Carrizo has debt of $1.4 billion as of 3Q15, and this translates into leverage of 3.0 considering annualized EBITDA of $457 million. In 3Q15, the company’s net debt to EBITDA covenant was revised from 4.0 to 4.75 for 2016 and 4.375 for 2017. This provides ample headroom considering current leverage is at 3.0.
Further, an adjusted EBITDA of $457 million would imply a strong EBITDA interest coverage for 2015. With increasing production and hedged positions, the EBITDA interest coverage ratio is likely to remain robust even in 2016. Therefore, Carrizo is well positioned from a balance sheet perspective and high financial flexibility implies that the company has room to leverage when market conditions improve.
From a valuation perspective, Carrizo is trading at trailing 12-month EV/EBITDA of 5.1 and I believe that these are attractive valuations considering the company’s production growth expectations, probable reserves potential and the IRR of Eagle Ford asset.
I would therefore consider the stock for the near term. In the next few months, the stock can rally on the back of strong results coupled with the point that winter can result in relative firming in oil and gas prices. However, I would still recommend only small exposure to the broad energy sector instead of a big plunge in the sector.
