Denbury Resources (DNR, Financial) is a good example of the kind of stellar returns that near-term trading opportunities can create in oversold stocks and sectors.
On Feb. 24, Denbury Resources was trading at 95 cents; as industry sentiments witnessed some improvement, the stock surged by 311% and traded at $4.27 per share. After a huge rally within three months, is there more upside for the stock?
I will start my analysis with the company’s first-quarter results as they have some important points that will back my view that Denbury Resources can be avoided at current levels after a big rally in the last three months. For the first quarter, Denbury Resources reported revenue of $195 million as compared to revenue of $308 million for the first quarter of 2015. While the sharp decline in revenue was likely, I see the following points as concerns in the company’s quarterly numbers.
For the first quarter, the company’s cash flow from operations slumped to $2.0 million as compared to $138 million for the first quarter of 2015. With Denbury Resources reporting capital expenditure of $58 million for the same period, the company’s free cash flow remains negative, and this is a concern in challenging times for the company.
The company’s total debt was $3.3 billion as of December 2015 and total debt remained at $3.3 billion through March. In difficult industry conditions, reducing debt is the biggest priority, and I would like to see more on that front before being bullish again on Denbury Resources.
The company’s total production for the first quarter was 69,351boepd as compared to 74,356boepd for first-quarter 2015 and 72,002boepd for fiscal year 2015. With a declining production profile, I see further strain in revenue and cash flow in the foreseeable future. Importantly, asset sale is critical to reduce debt and the company’s production profile is likely to take a further hit in the coming quarters.
Further, as of December 2015, the PV-10 value of reserves was $2.3 billion, and Denbury Resources had debt of $3.3 billion, which clearly implies that current PV-10 valuation is not sufficient to cover debt. While Denbury Resources has secured bank covenant relief through the end of 2017, I don’t see that being enough. The stock can regain bullish momentum only if there are clear plans on asset sales in the next 12 to 24 months.
Amid these concerns, Denbury Resources focuses on enhanced oil recovery and the long-term outlook is bright with CO2 EOR delivering as much production as primary or secondary oil recovery. In the U.S. itself, there is huge potential in terms of technically recoverable oil in the coming years. Therefore, the problem is not with the business model even when the production profile is on a decline.
Denbury Resources might have witnessed a big surge in the last three months, but the company’s leverage is one key reason to be cautious on the stock, and I fear cash burn if the oil price recovery does not sustain. Only when the company plans debt reduction, the stock can be interesting. Further, operating cash flows need to improve in the coming quarters and if that does not happen, the company’s investment target will take a hit along with further decline in estimated production. Therefore, several challenges need to be addressed and investors need to wait on the sidelines for more clarity on these issues.
Disclosure: No positions in the stock.
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