巴克莱美股石油与天然气行业整装中小型企业pdp价值观察

CORE

U.S.IntegratedOil&E&P

UPDATE:LookatSMidCapPDPValues;InitiateonMGY,OAS,PDCE,WLLandXOG

ThisreporthasbeenupdatedtocorrectFigures2-5,whichnowemployWPX’sreported

INDUSTRYUPDATE

U.S.IntegratedOil&E&P

POSITIVE

Unchanged

EquityResearch

30August2019

Dec.31,2018reservesandPV10valuesvs.itsreportedDec.31,2017statisticspreviously.Itreplacestheversionpublished30August2019at04:10GMT.

VaryingshadesofSMidCapblues.It’sbeentoughsleddingforSMidCapE&Ps,whichhasbecomesomewhatofalandofmisfittoys.Ashasbeenourconcernsinceearlythisyear,theSMidCapE&Pshavecontinuedtode-rateasstructuralchallenges—poorcapitalefficiencyfromlackofscale,increasinginvestoraversiontoE&Pleverageandgrowthnotwithincashflow,socialandlogisticalfrictiontomergersofequals,andhighmaintenancecapexintensityrelatedtoimmatureproductionbases—haveledinvestorstocoreupintobest-of-breedLargeCapE&Passets,managementteams,andFCFandreturnofcapitalstories.Whenyouthrowincreditandregulatoryrisksandoperationaltrapdoors,suchaswellspacingcomplications,capexraises,infrastructurebottlenecks,wecanseewhythegeneralistshaveleftthegroupfordead.Thatallbeingsaid,somevaluationsarenarrowinginonproveddevelopedproducing(PDP)valueatstrippricing,whichisarguablytheE&Pequivalenttoprice/bookfloorsinothersectors;awindowhasopenedforno-premiummergerofequals(e.g.,PDCE/SRCI);anumberofSMidCaps(e.g.WPX,PDCE)continuetonarrowthequalitygapwithLargeCappeers;andthemineralspace(e.g.VNOM,MNRL)offersanoutsizedgrowthandFCFyieldcombo.

ExaminePDPvalues,upgradeCDEVtoOW.Thepresentvalueoftheproveddevelopedproducing(PDPs)reservesisarguablytheE&Pequivalenttoprice/bookinothersectors,providingavaluationfloorassumingnovalueforundevelopedreserves.Usingcompanydisclosure,wemodelPV10PDPvaluesfortheSMidCapE&Ps.WLL,CDEV,JAG,PDCE/SRCIscreenwell,whileSM,XOG,andOASscreenpoorly.WeupgradeCDEVasPDPvaluesimpliesonly$7kpernetacreforwhatwebelieveisgoodDelawarerock.

InitiatecoverageonMGY,OAS,PDCE,WLL,XOG.EagleFordpure-playMGY(OW,

$13PT)breaksthemoldwithadefensivestrategyofbalancingFCF,accretivebolt-ons,inventorydelineation,andaconservativebalancesheet.ThependingmergerofPDCE(OW,$42PT)andSRCI(notcovered)createscoreWattenbergcriticalmass,allowingPDCEtoprioritizeFCF(guided~8%2020FCFyieldat$55WTI)andreturnofcapitaloverproductiongrowthandDelawareexpansion.Willistonpure-playWLL(EW,$8PT)istradingnearPDPvaluebutat2.7xleveragewith$1.4bn+ofmaturitiesthroughearly2021andonly~5%ofits2020oilproductionhedged,creditriskand2020uncertaintywilllikelyremainanear-termoverhang.OAS(EW,$3.50PT)islikelyinthepenaltyboxfollowinga3-strike2Q19(capexraise,infrastructureconstraints,wellspacingoverhang),continuestofaceconsolidateoutspendwithelevatedleverage,andfutureWillistonFCFwillneedtogotoexpandingitsunder-scaledDelawareposition.At~3.1xleveredwithitsrevolverroughlyhalfdrawn,DJBasinpure-playXOG(UW,$4PT)appearstobepushingtheliquiditylimitdespiteongoinggasprocessingandColoradoregulatoryrisks,noroadmapto2020FCF,and2021maturities.

BarclaysCapitalInc.and/oroneofitsaffiliatesdoesandseekstodobusinesswithcompaniescoveredinitsresearchreports.Asaresult,investorsshouldbeawarethatthefirmmayhaveaconflictofinterestthatcouldaffecttheobjectivityofthisreport.Investorsshouldconsiderthisreportasonlyasinglefactorinmakingtheirinvestmentdecision.

PLEASESEEANALYSTCERTIFICATION(S)ANDIMPORTANTDISCLOSURESBEGINNINGONPAGE36.

Forafulllistofourratings,pricetargetandearningschangesinthisreport,pleaseseetableonpage2.

U.S.IntegratedOil&E&PWilliamThompson

+12125268641

william.s.thompson@

BCI,US

KaneChen

+12125266180

kane.chen@

BCI,US

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SummaryofourRatings,PriceTargetsandEarningsChangesinthisReport(allchangesareshowninbold)

Company Rating Price PriceTarget EPSFY1(E) EPSFY2(E)

Old

New

29-Aug-19

Old

New

%Chg

Old

New

%ChgOld

New%Chg

U.S.IntegratedOil&E&P Pos

Pos

CallonPetroleum(CPE)

OW

OW

4.36

9.00

6.00

-33

0.81

0.75

-7

1.21

1.30

7

CentennialResourceDevelopment(CDEV)

EW

OW

4.86

9.00

6.00

-33

0.23

0.24

4

0.20

0.35

75

ExtractionOil&Gas(XOG)

N/A

UW

4.53

N/A

4.00

-

N/A

-0.49

-

N/A

0.12

-

JaggedPeakEnergy(JAG)

EW

EW

7.06

10.00

8.00

-20

0.49

0.50

2

0.98

0.96

-2

MagnoliaOil&Gas(MGY)

N/A

OW

10.24

N/A

13.00

-

N/A

0.28

-

N/A

0.52

-

OasisPetroleumInc.(OAS)

N/A

EW

3.31

N/A

3.50

-

N/A

0.11

-

N/A

0.03

-

PDCEnergyInc.(PDCE)

N/A

OW

32.23

N/A

42.00

-

N/A

1.30

-

N/A

2.51

-

SMEnergy(SM)

UW

UW

9.99

13.00

9.00

-31

-0.54

-0.25

54

0.18

0.55

206

WhitingPetroleum(WLL)

N/A

EW

7.20

N/A

8.00

-

N/A

-0.62

-

N/A

1.20

-

WPXEnergy(WPX)

OW

OW

10.89

16.00

14.00

-13

0.18

0.22

22

0.45

0.56

24

Source:BarclaysResearch.SharepricesandtargetpricesareshownintheprimarylistingcurrencyandEPSestimatesareshowninthereportingcurrency.FY1(E):CurrentfiscalyearestimatesbyBarclaysResearch.FY2(E):NextfiscalyearestimatesbyBarclaysResearch.

StockRating:OW:Overweight;EW:EqualWeight;UW:Underweight;RS:RatingSuspendedIndustryView:Pos:Positive;Neu:Neutral;Neg:Negative

FIGURE1

BarclaysSMidCapE&PCompTable($mmexceptpershare)

SharePriceSharesMarket NetDebt EnterpriseValue

Debt-adjustedCash

Company TickerRating O/S Cap Flow

8/29/19 2019 2020 2021 2019 2020 2021 201920202021

EV/DACF

20192020 2021

PriceTargetMultiples

OnBarclaysCommodityDeck(~$57,$61,$75/BblWTIin'19,'20,'21)

Callon

CPE

OW

$4.36

228

$996

1,098

1,038

643

2,094

2,034

1,639

490

666

1,096

4.3x

3.1x

1.5x

CallonProForma

CPE

$4.36

422

1,839

2,935

2,682

1,720

4,774

4,521

3,560

1,089

1,363

2,086

4.4x

3.3x

1.7x

Centennial

CDEV

OW

$4.86

276

1,343

1,019

1,194

1,116

2,362

2,537

2,459

594

682

970

4.0x

3.7x

2.5x

Extraction

XOG

UW

$4.15

138

572

1,572

1,520

1,502

2,329

2,276

2,259

602

785

904

3.9x

2.9x

2.5x

JaggedPeak

JAG

EW

$7.06

214

1,507

722

757

525

2,230

2,265

2,033

447

632

929

5.0x

3.6x

2.2x

Magnolia

MGY

OW

$10.24

260

2,662

107

(206)

(749)

2,770

2,456

1,913

700

772

984

4.0x

3.2x

1.9x

Oasis

OAS

EW

$3.31

315

1,043

2,758

2,579

2,244

3,666

3,487

3,152

997

949

1,006

3.7x

3.7x

3.1x

PDCEEnergy

PDCE

OW

$32.23

66

2,125

1,039

750

(2)

3,164

2,875

2,123

868

1,131

1,675

3.6x

2.5x

1.3x

SMEnergy

SM

UW

$9.99

113

1,128

2,833

2,884

2,156

3,961

4,012

3,284

930

1,157

1,905

4.3x

3.5x

1.7x

Whiting

WLL

EW

$7.20

91

657

2,752

2,557

1,782

3,409

3,214

2,439

1,045

1,208

1,736

3.3x

2.7x

1.4x

WPXEnergy

WPX

OW

$10.89

424

4,612

1,953

1,695

572

6,565

6,307

5,184

1,358

1,618

2,563

4.8x

3.9x

2.0x

Average

4.1x

3.3x

2.0x

OnStripPricing(~$57,$54,$52/BblWTIin'19,'20,'21)

Callon

CPE

OW

OWUWEWOWEWOWUWEWOW

$4.36

228

$996

1,098

1,125

1,116

2,094

2,121

2,112

490

579

711

4.3x

3.7x

3.0x

CallonProForma

CPE

$4.36

422

1,839

3,022

2,970

2,788

4,861

4,809

4,628

1,089

1,162

1,306

4.5x

4.1x

3.5x

Centennial

CDEV

$4.86

276

1,343

1,019

1,303

1,610

2,362

2,646

2,953

594

572

585

4.0x

4.6x

5.0x

Extraction

XOG

$4.15

138

572

1,572

1,653

2,021

2,329

2,410

2,778

602

651

518

3.9x

3.7x

5.4x

JaggedPeak

JAG

$7.06

214

1,507

722

849

955

2,230

2,357

2,462

447

540

592

5.0x

4.4x

4.2x

Magnolia

MGY

$10.24

260

2,662

107

(100)

(283)

2,770

2,563

2,379

700

665

624

4.0x

3.9x

3.8x

Oasis

OAS

$3.31

315

1,043

2,757

2,580

2,309

3,665

3,488

3,217

998

936

941

3.7x

3.7x

3.4x

PDCEEnergy

PDCE

$32.23

66

2,125

1,039

862

714

3,164

2,987

2,839

868

1,019

1,071

3.6x

2.9x

2.7x

SMEnergy

SM

$9.99

113

1,128

2,833

3,003

2,960

3,961

4,131

4,088

930

1,038

1,220

4.3x

4.0x

3.4x

Whiting

WLL

$7.20

91

657

2,738

2,720

2,656

3,395

3,378

3,313

1,059

1,031

1,025

3.2x

3.3x

3.2x

WPXEnergy

WPX

$10.89

424

4,612

1,943

1,851

1,820

6,555

6,463

6,432

1,368

1,452

1,471

4.8x

4.5x

4.4x

Average

4.1x

3.9x

3.8x

Source:RefinitivandBarclaysResearch

Stockratings:OW:Overweight;EW:EqualWeight;UW:Underweight;NR:notrated(forstocksofnon-coveredcompanies).Forfulldisclosuresoneachcoveredcompany,includingdetailsofourcompany-specificvaluationmethodologyandrisks,pleasereferto

PDPPV10:TheE&PValuationFloor?

Thepresentvalueoftheexistingproductionbaseshouldprovideavaluationfloor.WithSMidCapE&Pshavingsharplyde-ratedtoapointwhereimplied$pernetacrevaluationsarewellbelownot-too-distantcomps,wewererecentlyasked:ifanE&Pdoesn’tgenerateFCFanddoesn’tgrow,isitworthanything?Theanswerisyes.Whileitisdifficulttoputvalueonundevelopedacreage,mainlyattributedtoprovedundeveloped(PUDs)reserves,themarketshouldbeabletovaluetheproveddevelopedproducing(PDP)reservesassociatedwithallthewellsthatalreadyproducing.IfanE&Pweresimplytodropallitsrigsandneverdrillanotherwell,itwillgenerateapositivefreecashflowfromaproductionstreamthatarguablyshouldbeworththepresentvalueofitscashflowatsomediscountrate(e.g.,apresentvalueat10%orPV10).Inourview,thePV10oftheproveddevelopedproducingreservesisarguablytheE&Pequivalenttoprice/bookfloorsinothersectors,providingavaluationfloorifwethemarketwon’tgiveanycreditforundevelopedreserves.Luckilyforus,perSECrequirements,E&PsdoprovideannualreservereportswithPV10disclosure,whichcanusuallybefoundinthelastcouplepagesoftheir10Kfilings.Whilethereisvaryinglevelsofdisclosure,wethinkusingthedataishelpfulinunderstandinghowmuchthemarkethasdiscountedfuturecashflowsrelatedtodevelopmentofnewwells(PUDs)vs.thepresentvalueoftheexistingproductionbase(PDPs).

FIGURE2

SMidCapE&PCompCable:ProvedDevelopedProduced(PDP)PresentValueat10%DiscountRate(PV10)

CDEV

CPE

CRZO

CPE/CRZO

JAG

SM

WPX

OAS

MGY

XOG

PDCE

SRCI

PDCE/SRCI

WLL

SharePrice(8/28/19)

4.58

4.21

8.20

4.21

6.72

9.99

10.76

3.21

10.11

4.15

30.59

4.85

30.59

7.01

EnterpriseValue($mm)

2,130

2,051

2,689

4,780

2,060

3,889

6,586

3,544

2,921

2,435

3,145

1,869

5,010

3,480

NetDebt/EV

41%

53%

71%

63%

30%

71%

31%

81%

10%

69%

38%

37%

38%

82%

ReportedPV10($mm)

1,870

2,120

2,384

4,504

1,400

3,084

3,774

3,574

1,317

1,741

2,585

1,268

3,853

4,573

PDP/EV

88%

103%

89%

94%

68%

79%

57%

101%

45%

71%

82%

68%

77%

131%

NetPDPperShare

$3.64

$4.51

$5.01

$3.56

$3.63

$2.86

$4.12

$3.30

$3.94

($0.89)

$21.80

$2.39

$19.28

$18.99

PricetonetPDPValue

1.3x

0.9x

1.6x

1.2x

1.9x

3.5x

2.6x

1.0x

2.6x

-4.6x

1.4x

2.0x

1.6x

0.4x

BarclaysPDPPV10@Strip($mm)

1,582

1,788

1,876

3,664

1,383

2,679

3,833

2,651

1,148

1,552

2,276

1,224

3,500

3,530

PDP/EV

74%

87%

70%

77%

67%

69%

58%

75%

39%

64%

72%

66%

70%

101%

NetPDPperShare

$2.59

$3.06

($0.31)

$1.58

$3.55

($0.72)

$4.26

$0.37

$3.29

($2.27)

$16.94

$2.21

$15.83

$7.56

PricetonetPDPValue

1.8x

1.4x

(26.3x)

2.7x

1.9x

(13.8x)

2.5x

8.6x

3.1x

(1.8x)

1.8x

2.2x

1.9x

0.9x

$perBbl/d

37

57

42

48

48

45

39

43

33

39

42

46

43

43

$perBoe/d

21

44

29

35

36

20

24

31

18

19

17

20

18

28

Source:Refinitiv,Companyfilings,&BarclaysResearch

WeranourownPDPPV10calculationsatstrippricing.Tobehonest,thereportedPV10valuesinthe10Ksaresomewhatuselesssince(i)theyarebackwardlookingoncommodityprices,(ii)providelittledisclosureintooperatingcostassumptions,and(iii)notwocompaniesseemtousethesamecommoditydeck,makingrelativecomparisonsdifficult.However,manycompaniesdobreakoutthePV10fortheirPDPsaloneandgiveenoughdisclosurethatallowsonetoreverseengineerintoahyperbolicdeclinetypecurvethatreconcileswiththereportedPV10output.Inlayman’sterms,wecanreplicatetheirpotentialproductionprofileifanE&Pweresimplytoproduce,or“blowdown”,theircurrentproductionwithoutdrillinganotherwell.Usingthis,wecancalculateourownPDPPV10valuesusingourowncommoditypriceandcostassumptions.Thepushbackis(i)PDPreserveestimatesandoperatingcostandtypecurveassumptionsmayprovetoooptimistic;

(ii)PV10calculationsarepre-tax(albeitmostE&Psarenotlikelynear-termcashtaxpayers)

anddon’tincludeSG&Acosts;and(iii)investorsmaycommandahigherreturnthan10%.

FIGURE3

CompanyReportedPDPPV10vs.BarclaysPDPPV10atStripPricing

$mm CompanyReportedPV10 BarclaysPV10@Strip Barclays/Reported

$5,000

$4,500

$4,000

$3,500

$3,000

$2,500

$2,000

$1,500

$1,000

$500

$0

Source:Companyreports&BarclaysResearch

120%

100%

80%

60%

40%

20%

0%

Moreartthanscience.RecognizingthatreservereportsandreportedPV10valuesarefairlysubjective(oneauditorcanmakeverydifferentEUR,typecurve,andcommoditymixassumptionsthananother)withthebiaslikelytotheupside,wedotrytoreconcileourmodelswithPDPbasedeclinedisclosure/commentaryprovidedbythecompanies.GivenreportedPV10valuesarebackwardlookingoncommodityprices,ourPDPPV10estimatesarebelowthereportedPDPPV10estimates,althoughthisissomewhatoffsetbyourcashopexassumptionsbeingbelowthoseimpliedinthereportedvalues,whichseemtoincludeSG&Asometimes,aswellasotherundisclosedcapitalizedcosts.Wealsotrytogivethecompaniescreditfortheir1H19netreserveadditions(wellscompletedxEURsless1H19production)–iftheyhavespent$1bnofdevelopmentcapexYTD,theyshouldgetcreditforthatsunkcapital(theironyisthatatcurrentstrippricing,thePV10ofreturningthat$1bnisarguablylessthan$1bnspent).

FIGURE4

PDPPV10atstrippricingas%ofEnterpriseValuevs.NetDebtas%ofEnterpriseValue

PDP/EV NetDebt/EV

120%

100%

80%

60%

40%

20%

0%

Source:Companyreports&BarclaysResearch

WLL,CPE(standalone),CDEV,andPDCE(standalone)arethecheapestonPV10PDP.WhenwecomparecompanymarketcapstonetPDPvalue(PDPPV10lessnetdebt)atstrippricing,WLL,CPE(standalone),CDEV,andPDCE(standalone)standoutasthecheapest.WLLisarguablytradingbelowitsPDPvaluegivencreditrisks.CRZO,SM,andXOGcarry

morenetdebtthanPDPvalue,resultinginnegativemultiples,whileOASscreensrelativelyexpensive.CPE’spendingacquisitionofCRZOisdilutivetoitspricetonetPDPvalue.

FIGURE5

SharePricetoNetPDPPV10

3.1x

NegativenetPDP

(netdebt>PDP)

1.8x1.8x

1.9x

1.9x

2.2x

2.5x

2.7x

0.9x

1.4x

9x8x7x6x5x4x3x2x1x0x

Source:Companyreports&BarclaysResearch

8.6x

InitiateonPDCE,MGY,XOG,WLL,andOAS

PDCEEnergy(OW,$42PT):PDC+SRC=FCFwithPDP.DespiteColoradoregulatoryrisksandongoinggasinfrastructureconstraints,thependingmergerofPDCEandSRCI(4Q19expectedclose)createsenoughpro-formacoreWattenbergcriticalmasssuchthatPDCEcanshiftprioritiesawayfromproductiongrowthandDelawaredelineation/expansionandtowardsFCFandreturnofcapitaltoshareholders.

MagnoliaOil&Gas(OW,$13PT):TheybroketheSMidCapE&PMoldwithMagnolia.EagleFordpure-playMGYbreakstheSMidCapE&PmoldwithadefensivestrategyofbalancingpositiveFCF,accretivebolt-ons,inventorydelineation,andaconservativebalancesheet.WhileexpensiveonPDPvaluewithrisktoGiddings’futureprospects,webelieveMGYwillcontinuetoberewardedforitsstrongFCFyieldandconservativebalancesheet.

ExtractionOil&Gas(UW,$4PT):PushingLiquidityLimitDespiteDJrisks,no2020Roadmap,&2021Maturities.DJBasinpure-payXOGisnotonlyunder-scaled,butispushingtheliquiditylimitsleveredatnearly3.5xannualized2Q19EBITDAwithitsrevolverroughlyhalfdrawndespiteongoinggasprocessingconstraints,Coloradoregulatoryrisks,and2021maturities.

WhitingPetroleum(EW,$8PT):NearPDPValuebutCouldGetStuckinCreditRiskVortex.WhileWillistonpure-playWLLscreensclosetoPDPvalue,westruggletogetpastrefinancingriskgiven2.7xnetdebt/EBITDA,over$1.4bnofmaturitiesthroughMarch2021,andapotentiallychallenging2020withuncertaintyrelatedtoWillistongasprocessingconstraints,deterioratingwellresults,andverylimitedoilhedges.

OasisPetroleum:(EW,$3.50PT):OnefootintheDelawareandanotherintheWilliston.DespitethepromiseofsignificantFCFattheE&Plevel,leverageremainsstubbornlyhighat2.7x,andOAScontinuestooutspendonaconsolidatedbasisasitsrelatedMLPOasisMidstreamPartners(OMP)continuestobuildoutDelawareinfrastructuretosupportOAS.

UpgradeCDEVtoOW

UpgradeCDEVtoOWwith$6PT.WithourupgradeofCentennialResourcesfromEWtoOWwith$6PT,we’vecomefullcircleonCDEVfollowingourdowngradefromOWtoUWinJanuary2019onde-ratingconcernsgivenabrokengrowthE&PmodelandsubsequentupgradefromUWtoEWinlateApril2019onour,nowobviouslymistaken,beliefthatCDEVwouldgeta$pernetvaluationfloorsupportasalikelyM&Acandidate.AswestartedtoteaseoutinCDEV:ThrowingOutPDPValuewiththeBathwater?(07/08/19),webelievethemarkethasbeentoopunitiveonde-ratingCDEV’svaluationduetothelackofFCF,ascribingverylittlevalueforitsundevelopedacreage.AsoutlinedinCDEV:IntheM&AMix?UpgradetoEW(4/30/19),webelieveCDEVhasacashflowproblem,notanassetqualityissue.WithgoodrocktradingwithafairamountofPDPvalue,wehavetobelieveCDEVpiquestheinterestoflarger,wellcapitalizedpeerslookingtoaddpremiumPermianinventory.Our$6pricetargetisbasedonour$1.6bnPDPPV10valueatstripand~$12kpernetacre,backstoppedby~4.2xour2020Edebt-adjustedcashflowontheBarclaysstrip.Ourprior$9PTwasbasedour$1.6bnPDPPV-10atstrippricingand$18-24kpernetacre.

Wealsoupdatedpricetargetsfor:

SM(UW,$9PT):Wecutourpricetargetto$9from$13basedon~3.4xour$1.16bn2020Edebt-adjustedcashflowwiththeBarclaysdeck(~3.9xonstrip).OurpriorPTwasbasedon~9.5xour2020EoilmaintenanceadjustedDACF,backstoppedby~3.7xour2020DACF.

CPE(OW,$6PT):Wecutourpricetargetto$6from$9basedon~3.8xour~$1.36bn2020Eproformadebt-adjustedcashflowwiththeBarclaysdeck(~4.7xonstrip).OurPTwasbasedon~11xour2020EoilmaintenanceadjustedDACF,backstoppedby~5.3xour2020DACF.

JAG(EW,$8PT):Wecutourpricetargetto$8from$10basedon~3.9xour~$630mm2020Eproformadebt-adjustedcashflowwiththeBarclaysdeck(~4.7xonstrip).OurpriorPTwasbasedon~10.5x,backstoppedby~4.5xour2020DACF.

WPX(OW,$14PT):Wecutourpricetargetto$14from$16basedon~4.7xour

~$1.6bn2020Eproformadebt-adjustedcashflowwiththeBarclaysdeck(~5.4xonstrip).OurpriorPTwasbasedon~11xour2020oilmaintenanceadjustedDACF,backstoppedby~5.4xour2020DACF.

FIGURE6

BarclaysSMidCapE&PRatingsandPriceTargetChanges

8/29/19

New

Old

New

Old

Downside

E&POperators

Callon

CPE

4.36

OW

OW

6.00

9.00

38%

Centennial

CDEV

4.86

OW

EW

6.00

9.00

23%

Extraction

XOG

4.15

UW

NR

4.00

NR

-4%

JaggedPeak

JAG

7.06

EW

EW

8.00

10.00

13%

Magnolia

MGY

10.24

OW

NR

13.00

NR

27%

Oasis

OAS

3.31

EW

NR

3.50

NR

6%

PDCEEnergy

PDCE

32.23

OW

NR

42.00

NR

30%

SMEnergy

SM

9.99

UW

UW

9.00

13.00

-10%

Whiting

WLL

7.20

EW

NR

8.00

NR

11%

WPXEnergy

WPX

10.89

OW

OW

14.00

16.00

29%

Minerals

Brigham

MNRL

20.32

OW

OW

30.00

30.00

48%

Viper VNOM 29.20 OW OW 44.00 44.00 51%

Source:BarclaysResearch

PDCEEnergy:InitiateOWwith$42PriceTarget

PDC+SRC=FCFwithPDP

DespiteColoradoregulatoryrisksandongoingWattenberginfrastructureconstraints,webelievethependingmergerofPDCEnergyandSRCEnergy(4Q19expectedclose)willcreateenoughcriticalmass(2ndonlytoOXYintheDJbasin)inthecoreWattenbergsuchthatPDCEcanshiftitsprioritiesawayfromproductiongrowthandtowardsFCFgrowthandreturnofcapitaltoshareholderswiththesupportofasizeableproformaPDPbase.Withplanstomoderateslong-termgrowthto5-10%y/y,PDCEforecasts~$275mmand

~$325mmofFCFin2020and2021,respectively,equatingto~8%and10%FCFyields,assuming$55/BblWTIand$2.70/McfHH.PDCEseemscommittedtoreturnhalfofitsFCFtoshareholdersthroughbuybackswith$400mmremaining(~13%ofproformasharesassuming$30averageshareprice)onitsupsized$525mmauthorizationthrough2021.WhiletheSRCImergerarguablydoublesdownonPDCE’sexposuretoWattenberg’sgasprocessingconstraintsandColoradoregulatoryrisks,thepriorshouldprovetransitoryandthelatterismutedsomewhatwithnearly100%of~182,000proformanetacresconcentratedinmoreO&G-friendlyWeldCounty,including~80%inunincorporatedWeld.Importantly,themergeralleviatesPDCE’sneedtoaddressitsunder-scaledandarguablyTier-2Delawareacreage,plusitsdwindlingWattenberginventorydepthandquality,whichwebelieveplayedanoverhangonPDCE’smultiple.Our$42pricetargetisbasedon~3.0xour~$1.1bnstandalonePDCE2020Edebt-adjustedcashflowwiththeBarclayspricedeck(~3.4xonstrippricing)andbackstoppedby~3.5x$1.6bnguidedproforma2020EEBITDAassuming$55/BblWTIand$2.70/McfHH.

Denver,Colorado-basedPDCEnergy(NASDAQ:PDCE)operatesintwobasins:(i)theWattenbergregionoftheDenver-Julesburg(DJ)basininColoradowith~96,000netacresand~920grossoperatedlocations,allinWeldCounty;and(ii)theSouthernDelawarewith~36,000netacresand~365grossoperatedlocations,primaryinReevesCounty,Texas.InlateAugust2019,PDCEagreedtomergerwithfellowWattenbergoperatorSRCEnergy(NYSE:SRCI)inanall-stockdealwithPDCEshareholderssettoown~62%ofthepro-formacompany.Denver,Colorado-basedSRCIhas~86,000netacreswithover1,600grosslocations.Thedealexpectedtoclosein4Q19andrequiresapprovalofPDCEandSRCIshareholders.

Guidanceimplies8%2020EFCFyield.Assuming$55/BblWTIand$2.70/McfHH,PDCEprojectsonaproformabasis:(i)$1.6bnof2020EBITDAX,implying~3xEV/2020EBITDAmultiple,with$1.2-1.4bnofcapexat5rigs(3Wattenberg,2Delaware)and0-10%y/yproductiongrowthto200-220MBoe/d(targets5-10%y/ylongerterm)withupsidefromalleviatedgaslinepressures;(ii)~$800mmofFCFfrom2H19through2021,including

$275mmin2020(implies~8%FCFyield),withacommitmenttoreturnabouthalfwith

$400mmremainingonitsupsized$525mmbuybackauthorizationthrough2021;(iii)thebalanceofFCFwillgotodebtreductionwithPDCEtargeting~1.0xnetdebt/EBITDAXatyear-end2020vs.1.3xcurrently;(iv)lessthan$5/Boeof2020cashcosts(LOEpluscashG&A)with$40mmG&Asynergiesin2020andadditional$10mmin2021,whichisallincrementaltoPDCE’sprior15%headcountreductionduring2Q19(hadguidedG&A/Boefallingto$2.50-2.75).Additionally,themergerextendsPDCE’sinventoryrunway,whichhasbeensomewhatofanoverhangforPDCE,withover~10yearsinventoryat5rigs(3Wattenberg,2Delaware)withupsideifPDCimplementsSRCI’sspacingassumptions.ItalsopresentspotentialoperationalupsidebeyondtheSG&AsynergiesandmayhelpsmoothPDCE’s2020cashflowprofileas2020waslikelytomirror2019withcapex1HloadedandproductiongrowthandFCFmore2Hweighted.

Wattenberggasconstraintsshouldprovetransitorybutnotoutofthewoodsquiteyet.AsshowninFigure7,bothPDCEandSRCIsitinthecoreoftheWattenbergbasinbuttheirrecentproductionresults,asshowninFigure8,havebeendisproportionatelyimpacted(SRCIarguablymoreso)bythehighlinegaspressuresrelatedtoDCPMidstream’sgasprocessingconstraints.InPDCE’sownwords,guidanceformodestWattenbergq/qproductiongrowthin3Q19is“largelydependentuponDCPperformance”.However,accordingtoPDCE,proformaguidancefor200-220MBoe/din2020assumeslittleupliftfromimprovedgaslinepressures.DCPisexpectedtoincreaseitscapacityfrom1.1Bcf/dto

1.7Bcf/dbymid-2020(proformaPDCEwillmakeup40-50%)with:(i)Tallgrass’sCheyenneConnectorFERCapprovalandlate1Q20in-servicedate(DCPsecured50%of600MMcf/dresiduegastakeaway);(ii)NGLtakeawayexpansionsonFrontRanger,SouthernHills,andTexasExpressduring4Q19;(iii)DCPPlant11reachingfull200Mmcf/dcapacity,plusadding100Mmcf/dofbypassbyendof3Q19;and(iv)upto225Mmcf/doffloadagreementwithWesternMidstreamPartners(WES),includingLathamIIplant,bymid-2020(currentlyinlieuofgreenlightingpermittedDCPPlant12,whichcouldcomeatalaterdate).

FIGURE7

PDCE(blue)SRCI(green)Acreagevs.OilCum.HeatMap(red)

FIGURE8

DJCumulativeOilper1,000ftbyOperator

First6MoOil 7to12MoOil

Avg.ofFirst6MoOil Avg.ofFirst12MoOil

25

Avg.Oil.Cum.MBoper1,000'

20

15

10

5

0

NBLBCEICOPPDCEOXYXOGWLLHPRSRCIERF

Source:DrillingInfo,BarclaysResearch. Source:DrillingInfo,BarclaysResearch.

WeexpectsomeheadlinerisksasColorado’sSenateBill181getschallengedinthecourts.WhiletheinkhasdriedonColorado’sSenateBill181,shiftingmorecontrolawayfromthestateandtothelocallevel,thebill’svaguelanguage(e.g.,“necessaryandreasonable”qualifiersforrestrictions)willlikelyhavetobeclarifiedbythecourts,creatingcontinuedheadlinerisk,assomemunicipalitiesarelikelytotakeextremeinterpretationstostuntO&Gdevelopment.Thatbeingsaid,proformaPDCEisarguablywellpositionedamongitsDJpeerswiththenearly100%ofits~182,000proformanetacresconcentratedinmoreO&G-friendlyWeldCounty,including~80%inunincorporatedWeld.

SRCImergerhelpsalleviateDelawaredelineationandM&Arisks.In2016,PDCEacquiredwhatwewouldcallatoeholdpositioninDelaware,whichnowmakesup~36,000netacresmainlyintwoblocks(Block4andNorthCentral).Earlywellresultshavebeenmixed(Figure9)withafairamountofvariabilityasPDCEcontinuestodelineatetheacreagewithbenchandspacingtestsandcompletionenhancements.WebelievetheSRCImergertakespressureoffPDCEfromcontinuingtobuildontoitsDelawareposition,allowingPDCEtoreturncapitaltoshareholders,asopposedtopursuingbolt-onM&A.

FIGURE9

DelawareCumulativeOilper1,000byOperator(2015-present)

First6MoOil

7to12MoOil

Avg.ofFirst6MoOil

Avg.ofFirst12MoOil

35

Avg.Oil.Cum.MBoper1,000'

30

25

20

15

10

5

0

EOGXOM