The way I like to look at Oil or Mining businesses is to focus on the value of reserves, and ignore current earnings since any one year is heavily dependent upon how much they produce. And production can vary significantly from year to year depending on prices and their capacity. Lower prices don’t just directly lower revenues, but they can make some reserves uneconomic for production.
Unit Corp is an energy company (oil, natural gas, natural gas liquids) out of bankruptcy a few years. Management seems very sharp, and its been very profitable since oil prices recovered. It has two business units, Oil/Gas production and drilling services where it leases custom drilling equipment (In Q1 it sold off it’s share of a pipelines business) and quite a bit of excess cash on it’s balance sheet.
In January it started paying dividends, announcing a $10 special divi to kick things off and instituted a regular $2.50 quarterly dividend, quite a payout ratio for a $48 stock. So the natural question is, how long can this payout level last?
I’m going to focus on a very simple approach to valuing UNTC, for much deeper dives there are some good writeups on ValueInvestorsClub.com, here is the latest to reference for more details. My simple approach is how much is left, and how long will it take to get it?
First lets not forget the excess cash on its balance sheet. To estimate net available cash I deduct all liabilities from cash to leave $80M, or $8.40/share.
Valuing the oil and gas reserves is simple, as the company has to value them in the annual report, by estimating future revenues, production costs, taxes and resulting cash flows discounted at a 10% rate. For 2022 it estimates net after tax cash flows of $785M or $81/share. But note that the calculation was done at last year oil and gas prices which were near all time highs (unadjusted for inflation). Prices are significantly lower this year, more in line with historical norms (unadjusted).
Drilling made an operating profit of $24.6M ($2.55/share) in 2022, and $14M ($1.46/share or $6/share annualized) in Q1, 2023. Rigs are leased for up to a year at a time so Q1 day rates were likely set near peak prices in 2022, while some 2022 rates were set on lower 2021 oil prices. Those rates will get reset during this year as contracts expire. To be conservative I’m going to use 2022 as the base, and tax adjust it to $2/share as an estimate of earning power.
We could add all of these together, and give the drilling business a low multiple, such as 8x, and we’d arrive somewhere around $104 a share in our intrinsic value estimate. But I don’t like using reserve valuations done at peak oil prices or the 10% discount rate used to estimate it. So instead lets estimate the future net cash flows and what kind of annualized return they represent.
To do this first we need to know how long the reserves will last. Using their 2022 year end reserve estimates and 2022 depletion rate I estimate an average time frame of 8 years to depletion (Oil 6 years, NGLs 9.4 years, Natural Gas 8.8 years).
Reducing Unit’s reserve estimates by a third assuming future oil prices will be lower than 2022 gives $12/share in annual net cash flow until depletion. Add $1/share from excess cash and $2/share from drilling each year, totals $15/share in annual cash flows over the next eight years. Assuming at the end the drilling business is sold for 8 times earnings, our return over those eight years would work out to roughly 29% annualized from a $48 purchase price.
Obviously predicting oil prices is not easy, or its impact on monetizing their reserves. Lower oil prices will reduce the amount of oil they can extract and sell which not only lowers the revenues received but increases the time to extract them, a double whammy to lower annualized returns. And there is the impact of global warming to consider. But given how short their timeline is to deplete their reserves, it should impact Unit a great deal less than most other energy companies.
As usual, this is not investment advice, do your own due diligence and make your own decisions. As I write this I do not own UNTC, and could buy or sell it at any time.