November 19, 2001; What Went Right at Energy Partners?

 

More likely investors are asking the inverse of the question in our subtitle as the stock of the micro cap company has come under quite a bit of selling pressure.  Coming public a year ago, Energy Partners Limited now trades at less than half the stock price of its initial offering.  Although the stock appreciated 28% while our Strong Buy was in place from April 27 through June 29, it has declined sharply as we continue to carry a Buy rating on it. 

 

Our projections of natural gas and oil volume that the company would achieve this year were too optimistic.  For example, soon after the IPO our volume projection for the third quarter of 2001 just ended was about 21 thousand barrels equivalent daily (mbd) (see Chart).  Actual volume was closer to 15 mbd.  Instead of advancing sharply, volume has stayed basically flat. 

 

 

Here is what has gone right.  The company has low leverage with a debt to present value ratio of only 0.17.  That leaves EPL in a good position to do a deal when the market is depressed rather than having used up debt capacity when the market was overheated.  Half of the company’s current value, the East Bay field, was acquired on a timely basis in the previous downturn. 

 

Management has also limited risk in its spending program.  The guideline is to spend only cash flow and save debt for deals.  Yet that sensible rule is contributing to lower volume in the current quarter.  EPL has already spent most of its budget for the year while lower commodity prices are resulting in a lower current rate of cash flow generation.  With little new drilling taking place now there is little new production expected in the next few months to offset natural decline of existing production.

 

Within the spending program, management limits uncertain exploration to about 10%.  The other 90% is spent on more certain development.  That rule too makes sense, but there is a subtle point that creates another short-term problem for the stock.  More than half of the exploration went to a single well that was unsuccessful.  The well happened to be on the largest prospect that we highlighted as having a chance to expand greatly the company’s reserves. 

 

In the future management is more likely to seek more partners to share exploration risk.  The dry hole was in the Bay Marchand area where EPL has an 80% interest.  Had the well been successful, 80% would have looked good.  Since the well was unsuccessful, 50% would have looked more prudent. 

 

Having been too optimistic we are going to be more cautious.  We are now looking for a volume decline in the current quarter and a flat trend thereafter.  Considering that the company is reinvesting all of its cash flow, there are good chances that the volume trend can show some upward movement next year.  We keep our Buy rating intact and will be patient about expecting gratification.

November 19, 2001; Meter Reader: Upward Slope