COMPANY ANALYSIS–AUG 25, 2016
LILIS ENERGY (LLEX:NYSE)
UPDATED AUGUST 13, 2018
This is a small investment in an old Permian name from 2016–Lilis did very well for me and OGIB subscribers, going from my $2.80 purchase price to over $5. It was (and is) a small company with lots of cheap stock…but management has done a GREAT job at executing: raising more money to buy more land and drilling good wells. It was just OTC listed when I first bought it (the only one ever in OGIB history) and it now is listed NYSE.
The stock came back on my radar when they reported in early August 2018 that they were at 7300 boepd, and would spend $46 million on nine wells during the rest of the year, and exit at just 8000 boepd. Each of these wells will likely start producing at 1500 boepd for mile long horizontals.
So I expect the an exit rate closer to 11,000 boepd, if not more. If the oil price holds in here, Lilis hits the Holy Grail of being cash flow neutral next year, and with a large well inventory–makes it a prime takeover target (Resolute would still be a great fit).
Now, the stock isn’t cheap, yet…but if oil holds and this team continues to execute as well as they have…it will be. Note that we don’t know yet what the discount is on their oil production (Permian now getting huge discounts) because Lilis just gave an ops update but not financials. Big differentials could change my mind here.
Share Price: $4.12
Basic Shares Outstanding: 66.5 million
Diluted Share Count: 112.3 million (pref shares converted)
Market Cap (diluted): $462.7 million
Net Debt: $185.0 million
Enterprise Value (EV): $647.7 million
Q2 2018 Exit Production: 7,300 boe/day (70% oil)
Exit 2018 Guidance Production: 8,000 boe/day
Likely Exit 2018 Production: 11,000 boe/day
Average 2019 Production Consensus: 10,000 boe/day
Consensus EBITDA 2018: $52 million
Capex Estimate 2018: $120 million
Consensus EBITDA 2019: $120 million
Capex Estimate 2019: $120 million (cash flow neutral!)
Enterprise Value / 2018 EBITDA:12.4 times
EV / 2019 EBITDA: 5.5 times
Debt to Current EBITDA: 3.4 times
Estimated Debt to 2019 EBITDA:1.5x
– Lilis will blow away their year-end production guidance
– The Delaware Basin can generate positive IRRs under $50
– Nearby land has seen a lot of activity from proven producers
– Potential for up to 1,200 drilling locations on just 20,000 acres
– Balance sheet needs tidying up
– Lack of Permian takeaway capacity creating big pricing differentials
– Just now rolling out development drilling so need to prove they are capable of full-scale development
LILIS ENERGY – PROPERTIES
Lilis Energy’s stock price is down year to date through mid-August 2018 but it isn’t because the company isn’t making progress.
Today this is a much bigger and better company than it was going into this year. The company has successfully delineated (proved up) a significant portion of its acreage, added key pieces of infrastructure, is rolling out a development drilling program and has done a decent job of managing its balance sheet.
Lilis Energy is a pure-play on the Delaware Basin portion of the Permian.
In total Lilis now has built up 20,000 net acres of Delaware Basin acreage. On that land management believes there is ultimately potential for up to 1,200 net drilling locations…..a pretty astonishing number to be taken with a bit of a grain of salt.
That would be the blue, blue, blue sky scenario. Still though, this land is obviously loaded with oil.
Some of that acreage was acquired on March 19 of 2018 when Lilis purchased 2,978 acres (150 net drilling locations!) in the eastern portion of the Delaware Basin for $70 million ($40 million of cash and $30 million of stock). With 425 boe/d of production valued at $40k per flowing acre the cost per acre worked out to $17,424.
You can see in the map below that this acquired acreage (the blue and green shaded part) adds to the small amount of land that Lilis already had in Lea County, New Mexico.
The yellow blocks relate to the acreage Lilis had pre-acquisition mostly in Winkler County, Texas.
On the surface the purchase price certainly appears attractive relative to recent transactions in the area.
In particular it looks very good next to the $79,130 per acre that Concho Resources paid for RSP Permian. RSP Permian is right next door to the majority of the Lilis acreage in Winkler/Loving Counties in Texas.
That huge potential drilling location number of 1,200 comes from the ‘stacked pay’ nature of land in the Permian that we have come to know and love.
Stacked pay is industry slang for the many oil-charged layers of geology stacked on top each other down from the surface that can be drilled. This part of the Delaware Basin has up to 9 different layers that could be developed:
- Wolfcamp (A, B, C, D, XY)
- Brushy Canyon
- Bone Spring (1st, 2nd, 3rd benches)
- Avalon Shale
For a smaller company like Lilis there is a huge advantage in letting larger surrounding companies like EOG, Devon, Apache, Concho and Devon spend big bucks ‘cracking the code’ (figuring out the best way to frack to maximize production and recovery) on the various formations.
The boxes ticked in the slide below shows you who has been drilling where. Every zone but the Wolfcamp C has been hit by someone.
Of the formations with production potential on Lilis acreage we know the following work as of mid-August 2018:
Wolfcamp B – The primary target to date with nine active horizontal wells producing and showing strong results.
Wolfcamp A – One horizontal well drilled with results just disclosed in the Q2 earnings release.
Wolfcamp C – There are no horizontal wells on Lilis acreage, just a producing vertical well on the New Mexico land that was put on production in 2015. A competitor has a successful horizontal well producing two blocks to the south.
Brushy Canyon – There are numerous vertical wells on Lilis acreage and a horizontal test well that indicates good potential.
Avalon Shale – No wells drilled on Lilis acreage, but this formation has been well developed in nearby Lea County with several operators testing down spacing.
1st Bone Springs – No wells drilled to date, not a lot of activity by competitors either.
2nd Bone Springs – Untested but viewed as having the best potential of untested zones on the acreage. Over 1,500 feet of pay.
3rd Bone Springs – One successful well and the formation is well developed by nearby Concho and RSP Permian activity
Wolfcamp XY – Three horizontal wells just drilled with details in the Q2 2018 earnings release plus this formation is well developed in Loving County by Concho and RSP Permian.
LILIS ENERGY – DRILLING AND PRODUCTION
Up until this point in 2018 Lilis has mainly been focused on delineating its acreage and getting comfortable with what it has. The next step will be to roll out a focused development drilling plan.
The drilling that has been done has been focused on the Wolfcamp B in Winkler County. Those wells have averaged 350 bopd per 1,000 lateral feet drilled — which is as good as any wells drilled in the Delaware Basin.
In Q2 18 Lilis tested out (delineated) three new benches –the Bone Spring, Wolfcamp A, and Wolfcamp XY.
In total Lilis drilled and completed seven horizontal wells in the second quarter. One Bone Spring, three Wolfcamp XY, one Wolfcamp A and two Wolfcamp B.
The slide above shows in the map on the right where each of these wells were drilled. Details of the wells are as follows:
Hippo #2H – Wolfcamp B: Lilis’ highest recorded IP per 1,000 ft Wolfcamp B well drilled to date.
24-hour rate of 2,149 Boepd (77% liquids) or 478 Boepd per 1,000 lateral ft.
IP30 rate 1,733 BOE/D – 75 % Liquids
IP60 rate 1,451 BOE/D – 76 % Liquids
Meerkat #1H – Wolfcamp XY: The first Wolfcamp XY well drilled by Lilis and one of the top two wells in the Wolfcamp XY in the surrounding area.
24-hour rate of 1,823 Boepd (56% liquids) or 393 Boepd per 1,000 lateral ft.
IP30 rate 1,527 BOE/D – 56 % Liquids
IP60 rate 1,184 BOE/D – 56 % Liquids
AG Hill #1H – Wolfcamp B: The furthest eastern well drilled on the Company’s acreage. It has shown an IP 24 rate consistent with the Wildhog #1H and Prizehog #1H, which further proves up the Company’s eastern acreage.
24-hour rate of 1,000 BOE/D (87% liquids) or 223 BOE/D per 1,000 lateral ft.
IP30 rate 787 BOE/D – 88 % Liquids
Prizehog #2H – Wolfcamp A: The first Wolfcamp A well drilled by Lilis in New Mexico, registering the highest IP 24 the Company has completed in New Mexico to date.
24-hour rate of 1,825 Boepd (76% liquids) or 411 Boepd per 1,000 lateral ft.
Wildhog #2H – Wolfcamp XY: The first Wolfcamp XY well drilled by Lilis in the Wolfcamp XY in New Mexico further validating the Wolfcamp XY in Lilis’ eastern New Mexico acreage.
24-hour rate of 1,756 Boepd (55% liquids) or 386 Boepd per 1,000 lateral ft.
Howell #1H – Wolfcamp XY: The furthest eastern well drilled by the Company in the Wolfcamp XY, validating additional benches and the prolific nature of the Company’s eastern acreage.
24-hour rate of 1,401 Boepd (49% liquids) or 350 Boepd per 1,000 lateral ft.
Antelope #1H – 3RD Bone Spring: The first Bone Spring well drilled by Lilis in Texas, completed in the 3rd Bone Spring, confirming another viable bench.
24-hour rate of 1,309 Boepd (53% liquids) or 235 Boepd per 1,000 lateral ft.
These wells are all shorter wells with reduced cost, designed to prove up the acreage not to maximize recoveries. That is why all of the production results are on a “per lateral foot” basis in addition to the absolute amount of production.
The per lateral foot numbers shows us that Lilis has been keeping up with the production results of the competition.
For the second half of 2018 Lilis is focusing on drilling longer 1.5 mile laterals which will result in greater recoveries and higher IRRs. The company is on to development drilling and maximizing results — no longer just feeling out the acreage.
Management expects to drill 9 additional wells and spend approximately $46MM on drilling and completion during the second half of 2018.
Currently, Lilis has three 1½ mile lateral length wells in the completion and flowback stage targeting the Wolfcamp A, Wolfcamp B, and the 2nd Bone Spring formation.
In the second quarter of 2018, Lilis’ average daily production was 5,297 boe/day. As of early August average daily production is 7,300 boe/day.
The company has guided for an exit rate of 8,000 boe/day. With nine more wells coming on production……I believe that they have lowballed to an almost absurd degree.
Simple math says they should exit somewhere north of 11,000 boe/day –not 8,000 boe/day.
That isn’t conservative guidance. We are talking about almost a 40 percent sandbag job here on guidance that is only looking four months into the future.
INFRASTRUCTURE – THE BIG DELAWARE BASIN ISSUE
The big overhang on Lilis–and other operators in the region–has been the lack of takeaway capacity in the Delaware Basin. Production has grown so fast, the pipelines can’t keep up. Too much oil, not enough pipe and producers bid each other lower to get their product to market.
The Bakken went through this in 2012, and the big oil hub there, Clearbrook, traded at a huge discount to WTI for almost a year. It’s great for refiners in whatever area in experiencing this.
Western Canada is going through that now as well, for mostly heavy oil but also light oil. This problem will last a lot longer here as getting a pipeline built in Canada takes years.
And now the Permian is going through the same issue, and it’s causing localized price discounts. US brokerage firm Raymond James did a report on this back in May 2018 and they had some great charts to help investors understand what’s happening.
This first chart shows the Midland hub discount blowing out earlier this year:
This chart outlines what pipeline capacity is coming on when in the next year:
And this third chart shows what the Market thinks (from May 2018) what the Permian discount will be to WTI pricing:
During the second quarter of 2018, Lilis realized WTI differentials of $4.91/Bbl.
Lilis has entered into five-year agreement with Salt Creek Midstream to secure firm takeaway and pricing but it doesn’t start until the second half of 2019.
Starting in the second half of 2019, the agreement locks down firm long-haul pipeline capacity to the Gulf Coast as well as Gulf Coast pricing–which is different than WTI. Gulf Coast pricing is usually called LLS–Louisiana Light Sweet, and it usually trades at $2-$5/b premium to WTI.
Lilis will average a differential price of Magellan East Houston less roughly $5.50 over the term of their agreement.
Long story short…..Gulf Coast pricing less $5.50 should get them equivalent to WTI pricing.
Under the terms of the agreement, 6,000 Bbl/d of firm capacity will be delivered to Gulf Coast for one year–but not beginning until July 1, 2019. During the next four years, from July 1, 2020 through June 30, 2024, firm capacity will adjust to 5,000 Bbl/d.
Prior to the completion of the SCM gathering system, Lilis has trucking arrangements with Texican for 100% of production. The Company has approximately 1,500 Bbl/d with basis hedges at Mid Cush Differential of $5.62.
So in essence, Lilis has hedged their “diffs” very well starting a year out from now, in July 2019…the risk for shareholders is between now and then.
IMPORTANT–As of writing (Aug 19 18) Lilis has only issued an OPERATIONAL update for Q2, not its financials which would outline what pricing they got for their production. When this gets announced and if it shows a big discount, I may sell the stock because these diffs have been big enough for long enough now that we can assume whatever diff they get for Q2, they will continue to get for the next three quarters. If the diffs aren’t good, their financials won’t be good and I might re-evaluate this trade.
FINANCES / VALUATION
For 2018 Lilis will bring in cash flow of $34 million ($50 million EBITDA less interest expense) and spend close to $120 million.
That is quite the overspend, almost 3 times cash flow–but they got something back for it. Production which averaged 1,700 boe/day in 2017 will exit 2018 (if I’m accurate in my numbers) at 11,000 boe/day.
That level of scale advance is a big deal for a number of reasons–pricing from service companies, lessen the risk of drilling one bad well and most importantly provides new windows of much less expensive financing.
In 2019, analysts are guiding for cash flow and capex to be pretty much matching at close to $120 million.
In Q2 18 Lilis increased the amount of liquidity that the company has available by $55 million through two infrastructure deals. $27.4 million of that is from cash on the balance sheet — the rest is from cash coming from the sale of water gathering infrastructure.
Management expects to create more liquidity in Q3 18 by establishing a revolving credit facility. They needed to gain some scale before the banks would line up to do that.
Management also stated in the Q2 ops update that they would be cash flow neutral by early 2019 at current oil prices.
On 2018 EBITDA Lilis looks very leveraged–3.4 times EBITDA. With cash flow neutrality hit in early 2019 and production up to 11,000 boe/day that leverage should come–analysts see 1.5x D:CF and that will shrink further in 2020 as production grows.
Early in 2018 Lilis issued $100 million of Convertible Preferred shares to Varde Partners. These preferred shares pay quarterly dividends at an annual rate of 9.75% and have a conversion price into common equity of $6.15. The dividends are payable in kind (means paid in shares) through April 2021 after which they are payable in cash.
Those are the kinds of financing deals that really small companies have to do. That is why scale is so important.
Lilis is trading at 5.5 times analyst estimates for 2019 EBITDA….but those estimates use the lowball production numbers that management has provided. I think it trades at an even lower multiple than that.
If Lilis hits 11,000 boe/day my simple math suggests then this company is going to be trading at closer to 4 times EBITDA versus peers that will be valued at least 75% higher.
Beyond that I think it is fair to say that if a company has guided for 8,000 boe/day and it hits 11,000 boe/day–almost a 40% positive surprise…then it will not be a bad thing to be owning the stock when the news of the reaches the ears of the market.
Crazy thinking….I know.
WHAT THE ANALYSTS SAY
FIRM TARGET PRICE
I bought a small amount of this stock (5000 shares at $4.21) because I think Lilis management has lowballed its 2018 exit production guidance by almost 40%. The problem is, everyone else can do the same math I do from that Q2 ops update.
How do you spend $46 million on 9 wells from August through year end–and these wells produce IPs over 1000 boepd–and guide to a 700 boepd increase in production from August to December?
That isn’t being conservative…..that is just being downright silly. You don’t want to disappoint the market but you don’t want to lose credibility either.
That said…management is right that wasting their bullets in this market is a waste of time…and they will be able to give themselves a beat for Q3 and year end reporting. How surprised the market will be by that is up for debate.
Despite the crazy sandbagging here, the stock continues to drop amid oil price volatility and Big Board fears of a trade war.
A stock and chart like this really doesn’t deserve more than a 10% stop loss, which would be about $3.70.
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