Denbury Resources (DNR, Financial) has been among the worst hit exploration stocks with the stock declining by 71% in the last 12 months.
While oil has trended higher recently, providing some comfort for exploration companies, there are still several challenges lined up for Denbury Resources.
The first challenge for Denbury Resources is limited financial flexibility due to debt of $3.3 billion as of December 2015. For 2015, the company had reduced investments by 60% as compared to fiscal year 2014 and for fiscal year 2016; investments are likely to decline by another 50% as compared to fiscal year 2015. With limited financial flexibility, Denbury Resources has no option but to reduce capital expenditure.
The decline in capital expenditure directly impacts the production profile and outlook. Just to put things into perspective, the company expects 4% to 8% decline in production in 2016 due to lower investments and declining production in mature assets. Until the financial flexibility is increased, I expect 2017 investment to remain at muted levels.
Denbury Resources has no debt maturity in the near term, but the company’s debt is high considering the fact that, as of December 2015, the company’s PV-10 was $2.3 billion and debt was $3.3 billion. Clearly, debt needs to decline and I see that happening only through asset sales with the company’s operating cash flow likely to be insufficient to reduce debt meaningfully in the next 12 to 24 months.
Therefore, the company’s balance sheet needs to deleverage, and the cash position needs to improve in order to provide some buffer for challenging times. While oil has trended higher recently, it is too early to assume that the worst is over. If there is renewed decline in oil prices, Denbury Resources needs to position itself to survive the downturn.
Among the positive points, Denbury Resources has reduced lease-operating expense from $25.68 in first quarter 2014 to $19.31 as of fourth quarter 2015. Further, the company has also reduced G&A cost during this period and cost control provides some support to the company’s EBITDAX margin.
Also, with fiscal year 2016 capital expenditure at $200 million, I expect free cash flow of at least $300 million for the year. With Denbury Resources having a very low cash buffer, the FCF can be used to partially repay debt and increase near-term cash buffer. However, debt repayment from FCF will not be very meaningful from leverage reduction perspective.
From a long-term perspective, Denbury Resources has a robust oil field inventory and the company’s CO2 EOR is likely to see further success (enhanced oil recovery is the key focus for Denbury Resources).
However, the first priority remains deleveraging, and the next 12 months will be challenging for the company as it tries to reduce debt while maintaining a decent production profile. Once there is more clarity on the level of debt reduction and the timeline, Denbury Resources can be interesting. For now, the big hurdles remain.
Disclosure: No position in the stock.
