The oil and gas sector has been beaten down significantly in the last year, and the coming year is likely to be challenging for the sector as well. The steep decline in oil prices has exposed companies that were significantly leveraged and has tested the management of almost all companies.
Amid the challenges, there are opportunities, and Laredo Petroleum (LPI, Financial) is an attractive investment opportunity in the energy sector. Investors should consider only limited exposure to the oil and gas sector. A big plunge in the sector is still not advisable. However, attractive stocks can be gradually accumulated.
Laredo Petroleum operates as an independent energy company in the United States with focus on the Permian Basin in West Texas. As of September, the company had 143,861 net acres with 3,000 operated development ready horizontal wells. Laredo Petroleum has been on a robust growth trajectory from a production perspective, and the company expects 17% to 19% production growth for 2015. From a reserves perspective, the company’s developed and undeveloped reserves have grown at a CAGR of 35% in the last four years with YE-14 reserves being nearly 300mmboe. An important point to note here is that, of the reserves, 47% are oil and 28% are natural gas liquids.
Coming to the positives, the company’s balance sheet is the first factor. As of June, Laredo Petroleum had debt of $1.4 billion and debt to capitalization of 42%. The company has an excellent debt maturity profile with maturities coming only on or after 2018. Therefore, the overall balance sheet strength is robust, and the credit metrics will be excellent if the company’s debt servicing metrics are also healthy.
From a debt servicing perspective, Laredo Petroleum reported an adjusted EBITDA of $236 million for 1H15 and this translates into an annualized EBITDA of $470 million. Considering an annualized interest expense of approximately $120 million, the EBITDA interest coverage comes to 3.9. Therefore, debt servicing is also likely to be smooth for 2015 as well as 2016.
The reasons to remain positive on 2016 cash flow are as follows:
- First, the company’s production growth is likely to continue into 2016, and that will contribute to higher revenue and cash flows.
- Second, Laredo Petroleum has strong hedges with nearly 65% of 2016 oil production hedged at a floor price of $77.25 per barrel.
- Third, oil is likely to trend higher gradually, and the company’s average realized price (excluding hedges) in 2016 probably will be higher than 2015.
Considering these points, it is clear that Laredo Petroleum’s balance sheet and credit health will remain strong through 2016. I am not very focused on the company’s asset discussion as the assets are in the Permian Basin, one of the most prolific onshore oil and natural gas producing regions in the United States. Once oil prices recover, the company’s asset is likely to deliver strong IRR.
Laredo Petroleum is considering strategic divestment of noncore assets, and this will provide the company with liquidity for investments in 2016 and beyond. Further, with the company planning to operate within resources, its leverage isn't likely to increase in the next 12 to 15 months.
Considering these positives, it is not surprising to see Laredo Petroleum having trended higher by 26% so far this year. The stock still has significant upside potential from a long-term perspective, and investors willing to hold the stock for the next three to five years can consider some exposure at these levels.
