Lone Pine’s share price has plummeted in the past few months on poor earnings and a distrust of management. The position is deeply underwater since I recommended it and bought it, but I have doubled down below $3.00 a share and still feel that this will be a very profitable investment for those who are patient and can stomach the volatility in the shares.
Lone Pine reported results in mid may that disappointed the street. While they had already warned in march about some drilling issues that resulted in some wells not coming on stream on time, they waited to lower their full year forecasts until they reported Q1 numbers. The new forecast calls for $110 million in free cash based on $2.50 NYMEX gas and $95 WTI. We are well below that oil price and are slightly above that gas price currently. Fortunately, management hedged about 3/5 of their oil production for the rest of the year at a price on $101.50 and still has 40% of their gas hedged at over $5.00, so this should help protect Lone Pine from feeling the full effects of any further decrease in price in the energy markets
While the wells that experienced the issues are now on stream and producing as expected, their lack of performance will still be felt. The estimate of average cost per barrel of expenses (transportation, SG&A, operating costs) was raised as the fixed costs are now spread over a lower production number and due to the costs associated with the extra work required to fix the problem.
With this new lower free cash flow number, the debt to cash flow ratio for this year rises enormously. While before I said it was below 2-1 and thus moderate, it now jumps to around 3.8-1 using probable year end debt levels and new cash flow estimates. The only positive here is that Lone Pine was able to issue $200 million in 5 year debt at 10 3/8% in February. This long term stable financing means they can operate without a liquidity fear for the next few years. The rest of their debt is in the form of a bank line of credit. At 1.7x cash flows currently and forecasted to stay the same next year (debt should increase at the same rate as cash flow), the bank should be comfortable enough to at least maintain their line of credit.
Lone Pine also announced this quarter that they shut in 2 gas wells as the lowest selling price for Nat Gas in years makes it more economic to wait until prices recover in the future than to produce now. With that in mind, I would not be surprised to see LPR reduce their CAPEX this year from their range of $200 to $220 million to something closer to $190. The market, via the share price, is telling them to wait and be more conservative with their capital.
The above is bad, but not bad enough to justify the intense selloff we have seen in the share price. The final reason that the shares have come under such pressure is that the market has lost faith in management. So far they have promised big things but not delivered. They come from their old parent company, Forest Oil, which is known to have terrible management and just last week fired their CEO. They had problems with new wells in Q1 this year. They had a few wells this year that didn’t deliver as expected. The street will continue to place a below average multiple on LPR until management proves they are not Forest Oil. I spoke to an analyst who covers the company and he said as far as he knew there was nothing inherently wrong with management, so we’ll see if they can start delivering.
In terms of price, LPR is now incredibly cheap. It is trading at $2.50 a share and at this price is going for 4.3x this years EBITDA. Valuing it at 5 times next years EBITDA gives us a price of $4.70. I think this is a more realistic price that LPR should be trading at later this year, and is almost 100% above the current price. Long term I still believe that LPR can get back to double digits, but not before early 2014 most likely.
The above is backed up by the only bit of good news on LPR out there, namely that management have been active buyers of the stock in the past few weeks, ever since the share price collapse post earnings report. They have been in blackout period for the past few weeks (quarter end until reporting is normally a blackout period for insider trades) but I wouldn’t be surprised if they bought more post earnings in August.