I wrote on Parsley Energy (PE, Financial) in 2016 when sentiments were significantly bearish for the oil and gas industry. The stock did not disappoint value investors and has surged by 120% in the last 12 months. While the rally has been big, I see the positive momentum sustaining for Parsley Energy. There are several key factors that will keep the bull run going for this quality stock in the exploration sector.
Oil is likely to trend higher through 2017, which will keep sentiments positive for the industry. Parsley reported further acquisitions and provided some growth guidance for fiscal 2017 on Jan. 10. I will focus on this recent news to elaborate on the bullish thesis.
First, Parsley announced on Jan. 10 that the company will be initiating a public offering of 20 million shares of Class A common stock. Subsequently, the company revised the offering to 22 million shares of Class A common stock for total gross proceeds of approximately $770 million. In addition, the underwriters have an option for 30 days to purchase up to an additional 3.3 million shares.
The reason I wanted to mention this at the onset is because equity dilution is on the cards and is likely to impact the stock in the near term. It is worth noting, however, that Parsley has issued shares on a regular basis and the equity dilution has been more than offset by the company’s robust production growth and quality acquisition. Therefore, any correction in the stock due to equity dilution will be a good opportunity to accumulate Parsley Energy.
Coming to the acquisition that was announced, Parsley entered into agreements to acquire assets in the Midland and Southern Delaware Basins for an aggregate purchase price of $607 million in cash. The company also acquired mineral interests in the Southern Delaware Basin for an aggregate purchase price of $43 million.
Backed by these acquisitions, Parsley Energy is now targeting 60% production growth in fiscal 2017 as compared to fiscal 2016. This will keep the stock trending higher and Parsley has an excellent record of delivering returns through inorganic routes. Also, the acquisition will be entirely funded through the equity offering and the company’s existing liquidity buffer remains for capital expenditure in 2017.
Parsley is targeting capital expenditure in the range of $700 to $900 million for 2017. As of December 2016, the company had $201 million in cash and $600 million in first lien credit facility. With total liquidity buffer of $801 million, Parsley is fully funded for 2017. In addition, the company’s operating cash flow will provide a liquidity buffer that could ensure leverage does not increase significantly in the next 12 months.
Another important point to note is Parsley is targeting production of 57,000 to 63,000 barrels of oil equivalent per day for fiscal 2017. For the fourth quarter of 2017, the company expects production in the range of 70,000 to 80,000 barrels of oil equivalent per day. Therefore, Parsley is well positioned for strong production growth even in fiscal 2018. Considering the company’s aggressive inorganic growth strategy, it would not be surprising to see 30% to 50% production growth in 2018. This will ensure the positive sentiments for the stock sustain beyond 2017, with oil trending higher being another key stock upside trigger.
In 2017 and beyond, I expect margins to expand for Parsley Energy. In 2017, the factors that will trigger an improved EBITDAX margin are higher production, higher share of oil in total production and oil prices trending higher. Parsley is also working towards lower development costs, which provides additional margin upside.
In conclusion, Parsley Energy remains one of my favorite stock picks from the energy sector in fiscal 2017. I believe the current sideways movement or potential correction on equity dilution should be used as an opportunity to accumulate the stock. While the stock looks interesting for 2017, investors with a three to five-year investment horizon can also consider the stock for stellar returns.
Disclosure: No positions in the stock.
Start a free 7-day trial of Premium Membership to GuruFocus.
