Denbury Resources (NYSE:DNR) recently had to make a tough decision as to keep or divest its non-core oil assets in the Williston Basin in North Dakota and Montana. Perhaps as a sign of the times, it opted for the latter. The decision will help to pay down debt and allow the company to focus on its core asset production. While the divestment might prove to be a smart long-term move, Denbury still has a long way to go before it's worthy of your investment. Here's why.
Strategy for 2016
The divestment of the Williston Basin assets netted Denbury $58 million, which fits in nicely with its near-term strategy that it presented at the UBS Global Oil and Gas Conference in May. Denbury described its focus as reducing costs, optimizing business, reducing debt, and preserving cash and liquidity. Selling off non-core assets helps to accomplish all four.
Further, by selling noncore assets, Denbury can focus on developing assets within its two main CO2-enhanced oil recovery target areas -- the Rocky Mountain region and the Gulf Coast region. This is likely why it felt comfortable parting with the 1,350 barrels of oil equivalent per day (BOE/D) that it produced from the Williston Basin. It can now cut costs while focusing its efforts on its main Montana and North Dakota assets such as the Bell Creek field and the Cedar Creek Anticline. By continuing to optimize costs and focus on core assets, its total operating costs per barrel have dropped nearly 50% since 2013, creating potential for higher future returns.
This is where companies like Denbury have to weigh the costs and benefits of acquiring and divesting assets. Denbury's daily production has already fallen from last year, and the latest divestment increases that drop. Its first-quarter production was 69,351 BOE/D, which is 5,000 barrels less than one year prior. The divestment of the 1,350 barrels from Williston furthers that decline, which contributes to the company's significantly reduced 2016 average daily production expectation of between 64,000 to 68,000 BOE/D.
Even as Denbury cuts operating costs and makes moves to clean up its balance sheet, its financials don't yet support it as a long-term investment target. While the company plans to use the Williston money to pay down part of the $300 million it has drawn from its $1.05 billion credit facility, that's a drop in the bucket compared with the $3.2 billion in long-term debt it reported at the end of the first quarter. With stockholder equity at $1.08 billion, its debt-to-capitalization is a very unsightly 64%.
You can take some comfort in the fact that it's working to pay that debt off and its first maturities aren't until 2019, but out-of-control debt can be a significant burden on a company's future growth and returns. To make matters worse, its cash on hand as of March 31, 2016, was a relatively minuscule $8 million. That means it will have to rely on its credit facility -- which has $641 million remaining -- to pay for most expenditures that go beyond its cash flows. That leaves very little flexibility, aside from taking on further debt.
Its balance-sheet issues are particularly troubling, given its recent earnings statements. It recorded $185 million in net losses in the first quarter, which actually looks decent when compared with the $885 million in net losses incurred in the fourth quarter of 2015 caused by a $1.3 billion write down of oil and natural gas properties. Denbury, like many oil companies, also suffered from deflated oil prices over the past year, and it will have to figure out a way to turn a profit in order to reverse its fortunes.
It's promising to see Denbury focusing on its core business while trying to strengthen its balance sheet and reduce debt. Divesting proven production for $58 million to pay off part of its credit facility might prove to be savvy, but it now needs to show it can take the reduced costs to not only replace that production but also increase the returns on its core assets. Until that becomes a trend and Denbury begins to turn a profit, you should steer clear of this heavily debt-ridden company.
David Lettis has no position in any stocks mentioned. The Motley Fool owns shares of Denbury Resources. 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.