Parsley Energy Common Stock Needs To Kiss And Make Up

Parsley Energy (PE) is a company that the market initially fell in love with.

Source: Seeking Alpha Website, September, 22, 2017, market close

Initially, the stock went public at a pretty decent price. The unanticipated fall off of commodity prices a few years back did not hurt this stock to the extent that other industry stocks were pummeled. In fact, management used the stock price to purchase more acreage and even fund the capital budget (or corporate needs). But now that the company is beginning to post meaningful cash flow and eventually earnings, the stock price is wobbling. Mr. Market appears to be losing some faith in this former Wall Street darling. Other story stocks are more attractive as reality sets in. So the increasing cash flow and the declining price may meet to form a reasonable relationship for the first time in the history of the company.

Source: Parsley Energy Second Quarter, 2017, Earnings Press Release

The company still issued a fair amount of stock in the latest six months. Plus outstanding shares have increased about 50% to more than 246 million shares outstanding. The shares outstanding will approach and probably exceed 300 million if and when the class B shares convert. Right now those shares are not dilutive.

What is rapidly changing is the sizable increase in both cash flow and earnings. This increase is currently outpacing the current increase in shares outstanding. So earnings have risen to $.30 per share for the six-month period and cash flow appears well on its way to pass $750 million for the year. Per share earnings will probably increase rapidly to more than $.25 per share in short order as production continues to climb. Earnings next year of $1.50 would not be unreasonable. The 2018 fourth quarter will probably point to a much higher 2019 earnings. In short, this growth stock may be priced as cheaply as it is going to get.

The rapid growth in earnings has a reasonable forward price-earnings ratio in the twenties for the first time in a long time. Fundamentals are beginning to take over from the “story” of future greatness. Depending upon one’s view of commodity pricing and view of management growth guidance, the forward ratio could be lower still. Before this the stock was really a story stock. Significant earnings were originally years away. Now those years have passed.

That future story is rapidly becoming the present. Though the price-earnings ratio may be high for a commodity priced business, the price is not that high considering the rapid production growth of the company. Second-quarter production was about 18% higher than the first-quarter production and 81% greater than the first quarter of the previous year. That kind of growth is normally only seen in the high tech industry.

Source: Parsley Energy Second Quarter 2017, 10-Q

The operating costs as shown above continue to be some of the best in the industry. Those lease operating costs rival the costs of some gas producers in the industry. The depreciation costs are up to $8 BOE lower than some competitors. This attests to the quality of the leases that the production amounts and corresponding reserves result in lower depreciation per BOE. As shown above, those depreciation costs are still falling. So the competitive advantage of the leases operated could be widening.

Interestingly, the land purchased does not depreciate. So shareholders will not really discern the true costs of production without a management presentation. Without the cost paid for leases per well, it is hard for shareholders to determine the true profitability of the properties purchased. The company now sports about $7 billion of oil and gas assets using the successful efforts method of accounting. A minimum acc eptable profitability of about 15% would imply an annual profit of about $1 billion on those assets. The decreasing costs as well designs and operations improve combined with the growth rate make that profit projection a reality within about 2 years assuming commodity prices do not collapse.

Another way to look at value is using the enterprise value of about $9 billion. Cash flow should be about double the current rate to justify that enterprise value. At current growth rates, cash flow should reach that annual rate during one of the quarters in the next fiscal year. Parsley Energy is ahead of many in the industry by reporting earnings (especially earnings) and rapidly increasing cash flow. So this may be one of the better values in the energy industry before considering its ideal location in the Permian.

Source: Parsley Energy September 2017, Investor Presentation At Barclays Conference

Continuing production improvements have not only decreased depreciation costs. They have also resulted in increased production guidance. The rapidly increasing cash flow means that the company will soon live within its cash flow. Much less, if any dilution will be needed in the future for the company to grow. Debt has so far been kept at a small percentage of the capital structure. The results above pretty much assure a continued conservative balance sheet. Only a severe and sustained price decrease would severely crimp the bright future outlook. So future rapid growth will soon be funded by the company cash flow. Very few companies in the industry can make that claim.

Source: Parsley Energy September 2017, Investor Presentation At Barclays Conference

The company was already getting a fantastic rate of return from wells drilled. Now that return is growing as production improvements continue to increase profitability. This low cost producer would be one of the last to suffer from a commodity price downturn. The low production costs shown above and the low debt levels ensure that this company can wait out the worst industry downturns.

A conservative estimate of $1 per share earnings over the next twelve months would mean a price-earnings ratio of about 26. But currently, earnings are growing far faster than that. Normally a stock is considered fairly valued if the price-earnings ratio approaches the growth rate. So this stock may be a bargain despite the lack of market attention currently.

The current stock price is relatively cheap considering the earnings two years from now. As long as management can grow production relatively rapidly, this stock could reward shareholders handsomely from the current price. The market loves earnings as much as it loves a good vision or a good story. So the increasing earnings could provide a return of the stock to market favorite.

If the market decides to attach more “Permian Charm” to the stock, then this stock could really soar. Mr. Market has fallen in love with far worse propositions than the future of this stock. An acquisition by another company of this one would probably be a sign that the Permian stock values are getting overheated. So it would be time for conservative investors to move onto other less overvalued areas.

Source: Parsley Energy September 2017, Investor Presentation At Barclays Conference

Currently, the latest wells definitely pay back in less than 2 years which is excellent. Current WTI pricing may allow a significant portion of the wells drilled to pay back within one year. Very few competitors have a significant number of wells that pay back within a year.

The graph above shows wells producing nearly 250 MBOE in the first year. Management showed about a $24 BOE cash margin before depreciation. So the wells with the latest designs cash flow at least $6 million the first year. The most productive wells sport even better results as continuing well design improvements continue to increase returns. Those kind of cash returns from the wells drilled build corporate cash flow very quickly. Cash flow could in fact more than double each year as production improvement results continue if WTI prices hold steady.

The stock price, which has traded in a wide range in recent years, now looks primed for a steady future climb. Rapidly increasing earnings and cash flow will push up the stock price to new highs. Management will have to continue to manage the rapid growth. Rapid growth has its own execution risks. But for the time being significantly larger profits are in the picture for the next five years. This management has a great l ocation. Finally, investors will reap the results of that great location. The latest pullback may represent a decent entry point.

Disclaimer: I am not an investment advisor, and this article is not meant to be a recommendation of the purchase or sale of stock. Investors are advised to review all company documents, and press releases to see if the company fits their own investment qualifications.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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