Will the Shorts Get Crushed on EXCO Resources Inc.?

With 34.5% of its shares sold short, EXCO Resources Inc could be a short squeeze waiting to happen.

Apr 21, 2014 at 11:46AM
 Peakerig Mast

Photo credit: Chesapeake Energy 

Investors really hate the stock of EXCO Resources (NYSE:XCO). As of the end of last month, 34.5% of its shares were sold short. This gives it one of the highest short interests in the energy sector. Is this a wise bet by the shorts or will those selling EXCO Resources short get crushed?

Drilling deeper into EXCO Resources
There are a few good reasons why investors don't like EXCO Resources. The company's production and reserves are heavily weighted toward natural gas. Worst yet, the company's balance sheet is weighed down with debt. Add to that the fact that the company's oil production is contained in a pretty complex deal structure, while the company has a number of other ventures that complicate its business. When investors add it all up there is a lot could go wrong and sink the company's shares. It's not wonder why so many investors are short shares of EXCO Resources.

That being said EXCO does have some pretty compelling assets that it can use to create value. Topping the list is its position in the gas-rich Haynesville/Bossier Shale as well as acreage in  the Marcellus Shale. Further, EXCO does have oil-rich assets in the Eagle Ford Shale that it's developing. Overall, EXCO has a solid reserve base of 1.1 trillion cubic feet natural-gas equivalent proved reserves as detailed on the following slide.

Exco Overview

Source: EXCO Resources Investor Presentation (Link opens a PDF

Why these assets should worry short-sellers
While natural gas drilling isn't as hot as it was a few years ago, the prospects for gas do appear to be getting brighter. A bitterly cold winter thawed out natural-gas prices while increased future demand should come from a growing economy, increased petrochemical demand and future natural gas export projects. This is one reason why we are beginning to see some increase in industry activity in the Haynesville Shale this year.

Chesapeake Energy (NYSE:CHK), for example, is planning to spend 10% of its 2014 capital budget on the play. That's a 25% jump from last year's plan. While Chesapeake did recently unload a portion of its Haynesville assets to EXCO, this is still a sign that it's still positive on the play's potential.

EXCO Resources, meanwhile, is becoming a much more efficient driller in the Haynesville. Its drilling optimization program has the company drilling faster wells while its drilling costs are down to about $7.5 million per well. This will enable the company to earn better rates of return on each new well.

This is also a concern for short-sellers
One of the biggest concerns investors have had with EXCO is its balance sheet. The bad news for short-sellers is the fact that EXCO's balance sheet is improving. After closing a billion dollars in acquisitions from Chesapeake Energy, EXCO has lowered its leverage through a number of asset sales as well as the complex Eagle Ford Shale drilling partnership and a rights offering. The net result is a $314 million improvement in the company's liquidity over the past few months as seen on the following slide.

Exco Liquidity

Source: EXCO Resources Investor Presentation

As of the end of last year EXCO's liquidity stood at $537 million, which is plenty considering its 2014 capital budget of $368 million is within its adjusted EBITDA range of $400 to $425 million. That suggests the company has adequate capital to continue operating its strategic plan. It's a plan that should enable it to execute on its acquisition pipeline of well buybacks from its Eagle Ford Shale partner starting next year. While that buyback plan will use up of some of its liquidity, it will grow adjusted EBITDA, which in turn should enhance returns.

Investor takeaway
While a lot could go wrong with EXCO's strategic plan, there's enough positive momentum that short-sellers could get crushed. So, while I'm not compelled to buy EXCO's stock, I'd certainly not be going short either. 

OPEC is absolutely terrified of this game-changer
While EXCO Resources ins't a great oil stock to buy, that doesn't mean you can make money in energy. So, if you want to buy a great energy company, buy the one that has OPEC terrified. We just happen to know that stock and in an exclusive, brand-new Motley Fool report we reveal the company we're calling OPEC's Worst Nightmare.

Matt DiLallo has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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