Halcon Resources Corp: Management Potential Can't Overcome High Debt Load

Lofty valuations and debt levels caused investors to overpay for Halcon Resources, which only now near 52-week lows trades at comparable valuations to competitors like Kodiak Oil & Gas and Oasis Petroleum.

Feb 17, 2014 at 10:03AM

As Halcon Resources (NYSE:HK) gets prepared to report earnings on Feb. 26, a few key points will pique investor interest. The oil exploration and production company holds plenty of promise due to the experienced management team that sold Petrohawk Energy to BHP Billiton for $12.1 billion, yet the balance sheet, loaded with $3.3 billion of debt, has constrained its growth prospects.

While debt can be used to grow a company faster if it can produce more cash than the interest costs, in many cases a large debt load can reduce growth rates below maximum potential. With Halcon Resources, the growth rate has constantly been scaled back due to the divestiture of non-core assets. Unfortunately, the sell-off of assets often creates a downward spiral in production, even though the proceeds from the sales can be utilized to fund core asset growth.

Another major issue with Halcon Resources is that the large debt load and the original bullishness over the management team led to a significant enterprise value out of the gate when the company was created. Investors looking at the current stock price now significantly lower than 2012 highs around $13 needs to realize the stock currently sits near the enterprise valuations of Kodiak Oil & Gas Corp. (NYSE:KOG) and Oasis Petroleum (NYSE:OAS). These equally or larger sized producers have smaller debt loads and possibly better financial flexibility to grow production and reserves gong forward. Investors will watch these numbers very closely when the company reports.

2014 capital spending program
Recently, Halcon Resources lowered its drilling and completions budget for 2014 by 14% to approximately $950 million. The reduced spending is not suppose to impact production guidance of 38,000 to 42,000 barrels of oil equivalent per day, or boe/d. The key, though, to investors is that the funding for growth comes from increased borrowings and the sale of more non-core assets. These additional sales will come on top of selling $300 million worth of assets that amounted to 21.2 million boe worth of proved reserves. Those assets produced 4,500 boe/d. Now the company is discussing unloading another $300 to $400 million worth of assets in 2014.

On the flip side, Oasis Petroleum sits at multi-year highs. The energy producer focused on the North Dakota's Bakken shale forecasts growing production to 46,000 to 50,000 boe/d this year. The production forecast is for 40% growth along with an equivalent bump in capital spending to $1.43 billion. At the midpoint of 2014 guidance, Oasis will only produce 20% more boe/d than Halcon, but the much higher capital spending due to a better capital structure sets up the company for better growth in 2015 and beyond.

Having a slightly higher enterprise value, Kodiak predicts full-year 2014 guidance of 42,000 to 44,000 boe/d after averaging 29,200 boe/d in the prior year. The company guided toward a 2014 capital spending program of roughly the same $1 billion that it spent in last year.

Proved reserves  
Another major focus will be the proved reserves that Halcon ended with at the end of 2013. Based on divestitures, Halcon sits at around 85 million boe. Oasis Petroleum reported a 59% increase in proved reserves at the end of 2013 to reach 228 million boe. Importantly, 87% of estimated net proved reserves consist of oil. Kodiak saw proved reserves jump 77% to 167 million boe. The mix for Kodiak is roughly 83% oil.

Bottom line
Over the last couple of years, investors in Halcon have learned the difficult lesson that exceptional management teams can't overcome excessive valuations and high debt levels. 

Unless, Halcon Resources can generate a significantly larger growth in proven reserves, the stock trades at a similar enterprise value ratio to annual production forecasts to both Oasis Petroleum and Kodiak. Investors that overpaid for the stock in the past will probably not see a solid rebound in the stock unless the sector gains as a whole. If anything the smaller debt loads of Oasis and Kodiak probably leave those stocks with less risk for investors if oil prices were to plunge. So far management hasn't proven any exceptional ability to grow production and reserves faster than other comparable stocks so investors need to be careful paying a premium price.

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