CRC

Publicly traded companies mentioned herein: California Resources Corp (CRC), Occidental Petroleum Corporation (OXY)

Highlights

The presenter is long shares of California Resources Corp (CRC) and sees upside to $35-40/ share (from ~$21) if the price of Brent Crude can sustain its recent gains and close in on the $60/ bbl. level. CRC is an enhanced oil recovery (EOR) play and is generally misunderstood because it is a “totally different animal” than the shale plays that have garnered so much attention over the past seven years. The stock represents a cheap call option on oil and is undervalued today, based on $56-57 Brent. There is substantial optionality if the price of oil continues to rise and so long as Brent doesn’t trade below $43 CRC will not be in breach of its debt covenants. The company has time - through March 2018 - to benefit from the recent uptrend in oil prices and can delever. At $55 Brent he sees CRC generating $126mm in FCF (a 14% FCF yield) and if Brent is $60 this jumps to $272mm for a 31% FCF yield, based on his model.

• Occidental Petroleum completed the spin-off of CRC in November 2014, which was - with the benefit of hindsight - “horribly timed” because the company was stranded with $6 billion of debt on $2 billion of EBITDA (at $80-90/ bbl. oil) just before oil’s crash. As the price of oil fell from September/October (2014) through February 2016, CRC’s EBITDA plunged as well. The company went from $2 billion of EBITDA on $6 billion of debt to just $500-600mm of EBITDA and it became a “highly distressed” situation (the stock crashed and the unsecured bonds dropped from par to 18 over the same period).

• All of CRC’s assets are based in California and there are no environmental issues (no fracking risk, their assets generate more water than they consume, etc.). While the underlying rate of decline is typically around 33%, CRC’s is closer to 10-15% because of EOR. And, maintenance capital needed to keep production flat has gone from $1 billion to $325mm over the last 18 months and can remain at this level.

  • The relatively low decline rate means CRC has “a lot more time to figure things out”, and a higher oil price will allow for investment in production that increases cash flow.

• Management has been dealing with the deleveraging as well as can be expected. A $1 billion secured first lien, second-out term loan was issued in 3Q 2016, which gives CRC a longer runway to work with. The presenter said, “The only way CRC will breach its covenants is if oil is below $43 for an extended period, and they likely don’t ‘need’ $55 Brent to get an extension”. The covenants are not an issue until March 2018, he added.

  • The presenter noted that banks seem to be willing to work with the company and have been lenient overall, which is likely because the assets are low-decline and they don’t want to own them.

  • As of early November, CRC’s total debt was down to ~$5.25 billion (from over $6.7 billion in early 2015).

• $55 Brent - or slightly below that level - is the price required for CRC to keep production flat and maintain operating cash flows. Thus, the presenter views CRC stock as a “relatively cheap call option” on oil (with a ~32% FCF yield) with a $55 strike. The duration of the call option is essentially when covenant waivers run out, so looking at the market he can buy the call option for ~$2 with CRC, versus paying a $7.50 premium on oil.

  • Additionally, the theta on CRC should be lower [than it is on the actual call options] because there are multiple ways to win with the stock, including: crude continues to rise; further restructuring of debt; or asset sales, which management has discussed and investors have speculated about; and the odds of getting another waiver - if it comes to that - are “pretty good”, in his opinion.

• With the stock trading at ~$21 - after the 2016 1:10 reverse split - he can make a case for the stock to trade up to $40 based on how levered the company’s FCF is to the price of oil. At $60 Brent (just a few dollars per barrel from where it trades today) and holding maintenance capex constant annual EBITDA would be ~$996mm and FCF would be $272mm (~$6.60 per share). This equates to an extremely attractive FCF yield of ~31%, and if 14% is the “right” FCF yield then the implied stock value is > $40 per share. This is why he believes CRC is extremely undervalued today, and sees a high probability of the stock reaching $40+ in the next 12 months.

  • The main risk is that Brent trades down and through $43/ bbl. and stays there. FCF was positive in 2016 at slightly lower Brent prices than we see today, but production was also down. In 2017 he expects CRC to use its cash flow on production, but if oil trades above $60 “it becomes a totally different asset and would start growing”. In his opinion, the latter point fortifies that CRC is both a cheap call option on crude, and a very cheap stock.

Presenter’s estimates based on company data and his model.