Parsley Energy (PE, Financial) is among my favorite stocks in the energy sector, and it has not disappointed from a returns perspective. It has surged by 85% year to date, and the stock is likely to see a continued rally into 2017.
The big rally has been driven by robust fundamental developments coupled with oil trending higher from January lows.
Oil is likely to trend higher in 2017 given the point that lower oil prices are hurting key economies in the Middle East, and a production cap is likely even with the geopolitical friction among major oil producers in the region. I expect the dollar to weaken on a relative basis and that is likely to take oil and commodities higher. The oil price factor is likely to remain favorable in the coming quarters, and the focus will be on fundamental developments that will trigger growth.
Coming to company-specific factors, Parsley Energy has a strong balance sheet and liquidity profile that will help sustain strong growth. The company had $201 million in cash coupled with $600 million in available first lien credit facility as of the third quarter. In addition, Parsley Energy has an extended debt maturity profile with debt maturity coming only in 2022 and beyond.
The reason for starting with the company’s liquidity is the fact that Parsley Energy has been aggressive on the inorganic growth front, and I expect more purchases to come in the next six to 12 months. Parsley Energy has acquired 42,000 net acres for approximately $17,000 per acre year to date. With several oil and gas exploration companies still burdened by leverage, I see more appealing opportunities.
The second important reason to focus on the credit profile is the fact that Parsley Energy has witnessed stellar production growth and continued growth is only possible if the company has strong financial muscles. Just to put things into perspective, net production for the third quarter surged by 99% on a year-on-year basis, and oil production for the same comparable period surged by 131%. Aggressive production growth has been possible through the inorganic route coupled with robust capital expenditure. Both these growth factors are dependent on liquidity and financial flexibility.
Considering the current liquidity, Parsley Energy is funded for the next 12 to 18 months. Importantly, Parsley Energy has been issuing equity shares on a continued basis, and I don’t see that as a negative as long as growth remains robust and more than offsets the equity dilution. I therefore expect capital expenses to be met through available cash and any potential acquisition to be funded through equity issue.
From a cost perspective, Parsley Energy has been doing well with lease operating expense for the third quarter declining by 46% on a year-on-year basis. For fiscal 2016, Parsley Energy expects lease operating expense per BOE to be in the range of $4.25 to $4.75. If oil continues its uptrend, I expect meaningful expansion in EBITDAX margin in the next 12 to 15 months.
While I am expecting oil to trend higher, even if oil remains sideways, the company’s operating cash flow is likely to remain decent considering the point that Parsley Energy has well-hedged positions through 2017. The key point here is that liquidity buffer for growth will continue to swell through internal cash flows.
Parsley Energy has seen a big upside year to date, but the stock still remains appealing from a medium to long-term perspective. Inorganic growth is likely to continue, which is a key part of the company’s growth strategy. Further, a deep drilling inventory and strong financial flexibility will ensure that organic growth also remains strong.
Disclosure: No position in the stock.
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