Parsley Energy (PE, Financial) is an oil and gas exploration company that operates in the Permian Basin and is involved in the acquisition, development, production, exploration and sale of crude oil and natural gas properties.
The company operates primarily in the Midland and the southern Delaware basins in North America. Though the company has already given year-to-date returns of nearly 100%, there is upside potential for the stock based on the company’s fundamentals.
Permian Basin operations
The Permian Basin is a rich and resourceful acreage in the U.S. It lies in Western Texas and Southeastern New Mexico. The basin has complex geology with accumulation of oil and gas in stacked layers. It has depths ranging from 1,000 feet to more than 25,000 feet with Midland and Delaware being the largest basins in the Permian acreage.
Parsley Energy has its operations in the largest subsidiary basins of Permian making it accessible to huge undiscovered and recoverable oil assets. According to the latest report, approximately 20 billion barrels of undiscovered and recoverable oil is available in the Wolfcamp shale of the Midland Basin alone. The geology of the Permian Basin is rich and complex both horizontally and vertically. That is the reason why even after drilling for more than 100 years the asset still has a high percentage of recoverable oil and gas.
Drillers can produce crude cheaper in the Permian Basin than in many other U.S. basins. This is the reason why drillers prefer to acquire assets here as the break-even cost is relatively low. Also, with the oil price hovering around $50 per barrel, cost reduction is a priority for companies, and that has further helped in reducing per barrel cost. Parsley Energy has an advantage over peers as it is a big player in the Permian; with a spike in drilling activity the company is well positioned to extract oil profitably.
Huge demand for Permian assets has resulted in higher prices and with increasing competition in the basin; the asset valuations are likely to remain robust. This is the primary reason why Parsley Energy is trading at a high multiple. However, since the company is a big player in the Permian and has delivered good results in the past, production growth will sustain as oil also moves higher.
High production growth
There has been almost 100% growth in total production for the third quarter as compared to the last year from 21,565boed in third-quarter 2015 to 43,000boed in the third quarter this year. The growth is accompanied by a positive effect on the company’s EBITDA margins and average realization. The company has a strong history of production growth, and the production momentum is sustainable keeping in mind the rich assets along with significant resource expansion potential.
One such example of asset is Wolfcamp A & B which has 800 feet to 900 feet thickness and can afford 600 feet to 700 feet between top and bottom targets. With current inventory of 24 per section, the asset alone has a potential of 60 inventories per section. Acreage footprint and operational capacity is expected to increase rig count which would help in growth along with increase in inventory through multizone expansion and down spacing.
Liquidity profile
Parsley Energy has a strong financial position with current liquidity of $801 million. As of Sept. 30 the company had cash in hand of $201 million and has reported an 89% increase in the borrowing base up from $475 million to $900 million.
This reflects strong production and reserve growth for the company. However, based on its current cash position and ample liquidity, Parsley Energy has elected a commitment level of $600 million which bring its total liquidity to $801 million. In addition to this, the company also has a nine-month operating cash flow of $175 million.
For fiscal 2016 the company estimates capital expenditure of approximately $1.0 billion to $1.2 billion. Considering the fact that Parsley Energy will increase its capex in fiscal 2017 by around 50% and at the same time estimating a 50% increase in OCF due to improving oil prices (estimated fiscal 2017 OCF equals $240 million), the company will still have sufficient liquidity to meet its capex requirements {$900 million (revolving credit facility) plus $201 million (cash in hand) plus $240 million (estimated OCF) equals $1.34 billion}.
Thus, with earliest notes maturity in 2022 and an improving borrowing base, Parsley Energy is well positioned to meet both its debt and capex requirements. With excess liquidity the company also has the flexibility to provide consistent dividends.
Conclusion
With strategic acquisitions in the Permian basin along with continuous effort to cut down on their D&C and G&A cost, Parsley Energy has the capability to improve its EBITDA margin. The company also has a decent liquidity profile which further convinces me to be bullish on the stock in spite of the big rally this year.
Disclosure: No position in the stock.
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