Over a month ago we presented a ranking of "America's most levered energy companies." Since then they have all, without exception gotten clobbered, not only in their publicly traded stock but also their debt.
Today, long after the liquidation whirlwind has left junk bond owners dazed and confused, Goldman catches up, and lays out a matrix of shale companies sorted not only by leveraged (they see 2.5x as the cutoff; we used 4.0x) but also by shale asset quality. From there, it also lays out the various opportunities, if any, available to the management teams in the resultant 4 quadrants.
Readers will be most interested in the "restructuring/bankruptcy" option, most applicable for Group 4, because these are the names which, all else equal, will file for bankruptcy first.
This is what Goldman's Jason Gilbert has to say:
We believe oil market weakness presents H&Y E&P management teams with difficult decisions. For certain stronger companies, the challenge may be one of deciding if and when to high grade the portfolio through M&A. For some weaker companies, the decisions may be more stressful, with many lower-quality names being forced to consider (1) selling themselves, (2) restructuring/filing for bankruptcy protection, and/or (3) bolstering liquidity through asset sales and/or second lien debt issuance.
We have created a 2x2 matrix, shown in Exhibit 1, where we classify E&Ps according to both asset quality and balance sheet strength. In Exhibit 2, we provide the backup data on each company that justifies its classification in the chart below.
The matrix in question:
Group 1: Strong balance sheet/strong assets
Companies in this group have assets we rate “B+” or higher and leverage below 2.5x. Names that we place in this group include Chesapeake Energy (OP), Concho Resources (NC), Cimarex Energy (NC), and Diamondback Energy (NC). The average yield for this group is 6%.
From a strategic standpoint, we view companies in this grouping as having high optionality on both the buy and the sell side. In other words, these are companies we could envision as targets for IG upstream players looking to add high-quality shale exposure. However, these companies could also be acquirers of distressed assets or companies with complementary portfolios. From a bondholder perspective, we believe this group is well positioned for consolidation in the industry.
Group 2: Strong balance sheet/weak assets
Companies in this group have assets we rate “B” or lower and leverage also below 2.5x. Names include QEP Resources (NC), Newfield Exploration (OP), WPX Energy (OP), SM Energy (NC), and PDC Energy (NC).
Similar to Group 1 above, we see these companies as adders of acreage, with a focus on core positions in key shale plays. Unlike companies in Group 1, however, we do not view these names as likely targets for IG upstream. With an average yield of 7.1%, we believe bond pricing somewhat reflects this lack of upside optionality vs. Group 1.
Group 3: Weak balance sheet/strong assets
This group includes companies with 2015E leverage above 2.5x and assets we rate “B” or higher. Companies include Antero Resources (NC), EP Energy (OP), Laredo Petroleum (NC), Oasis Petroleum (NC), Range Resources (OP), Rosetta Resources (NC), and Whiting Petroleum (U).
We see companies in this group as being the most attractive targets for Group 1 and Group 2. One theme we heard consistently at the GS Global Energy Conference earlier this month is that management teams are willing to pay up to be in the “cores” of shale plays vs. buying “fringier” acreage at discounted prices. While this theme is not new, we believe it is even truer at $50/bbl WTI.
From a seller’s perspective, we believe the rationale for strategic combinations has also changed. Group 3 companies are the ones that have accumulated strong assets at the expense of limited financial flexibility. Facing likely negative ABL revisions and an unsecured HY E&P debt market that is essentially closed, we believe management teams that were previously committed to corporate independence may reconsider their options.
In short we believe the “bid/ask” spread for Group 3 has shrunk, and, as a result, we view this group as being the current sweet spot for E&P credit investors. At an average yield of 7.5% and bonds typically trading in the low/mid-$90s, we see potential for double digit returns if our $65/bbl WTI oil price in 2016 plays out. However, we do not see the same downside risk as in Group 4 below if crude remains lower for longer.
Group 4: Weak balance sheet/weak assets
This group includes companies with leverage above 2.5x and assets we rate “B-“ or lower. Names we highlight are Approach Resources (NC), Exco Resources (NC), Goodrich Petroleum (NC), Halcon Resources (IL), Magnum Hunter (NC), Midstates Petroleum (NC), Rex Energy (NC), Sabine Oil & Gas (U), Samson Investment (NC), Sandridge Energy (IL), and Swift Energy (U).
We view management teams in this group as facing the most difficult decisions. Given the general lack of “core” assets, we believe strategic interest from a larger acquirer is less likely than for Group 3. Furthermore, with the bonds in this group generally trading below $80, we believe 101% change of control provisions act as de facto “poison pills” for acquirers.
Given high leverage and the lack of strategic interest, we believe many companies will need to seek alternative sources of capital. While the options here will vary case by case, we note that most of these names have secured debt baskets that can be used to bolster liquidity. Based on the phone calls we receive, investor interest in this type of security remains high, which suggests to us we will see robust second-lien issuance as soon as the conclusion of 1Q earnings. The bottom line is that, for now, we think investors should tread lightly in this group, despite the average bond yield of 19% (excluding obviously distressed names Swift Energy, Samson Investment, and Sabine Oil & Gas).
Worth noting: the above is actually an optimistic baseline:
Our ratings are predicated on a $65/bbl WTI oil price in 2016. While we believe the consensus largely shares this view, there are clearly risks to the downside. Therefore – and all else being equal – we believe investors should prefer names with lower base portfolio decline rates. On average, we believe lower decline names will have more flexibility to cut capex and hibernate while waiting for an eventual recovery in prices.
And here is the backup data used by Goldman to justify the blessing (or curse) of any one given company in its quadrant.