Little-known Denbury Resources (DNR) has been one of the best performing oil stocks over the past year, rocketing a breathtaking 220%, thanks to higher oil prices and its improving balance sheet. However, as impressive as that run has been, it might only be the tip of the iceberg. That's because shares remain more than 70% below their most recent peak and the company recently sanctioned a high-return expansion project that has the potential to deliver a gusher of cash flow in the coming years.
Rising from the ashes
Shares of Denbury Resources tumbled along with oil prices a few years ago, falling from a perch above $15 a share in late 2014 to a low of around $1 a share by early 2016, as crude prices hit rock bottom. Driving Denbury's decline were concerns about its balance sheet due to its debt level, which stood at more than $3.5 billion at the end of 2014. While that was manageable when crude was in the triple digits, it became a burden as oil tumbled.
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Denbury Resources took several steps to address that problem, including eliminating its dividend, cutting back on investment spending, and undertaking several debt exchanges. These moves have enabled the company to reduce debt by $1 billion over the past few years, which, along with higher oil prices, has helped improve its credit metrics. Its leverage ratio, for example, has gone from an average of 5.3 times debt to EBITDA over the last 12 months -- more than double the comfort level for most oil companies -- to 4.5 times in the first quarter, and an even lower 3.7 times after adjusting for its oil hedging contracts, which are well below the current price.
While Denbury still needs to get that number lower, it's clearly heading in the right direction. The company's improving financial picture is a big reason why the stock is up so sharply over the past year.
Setting the stage for the next gusher
With its finances improving, Denbury Resources now has the flexibility to invest in new growth projects. This has allowed the company to sanction the development of an enhanced oil recovery (EOR) project at the Cedar Creek Anticline (ACC), which is a massive oil reservoir that stretches across parts of Montana, North Dakota, and South Dakota -- and initially held an estimated 5 billion barrels of oil. While the field has produced some of that oil over the years through conventional production techniques, there's still plenty left for Denbury to recover using an EOR method that injects carbon dioxide into the reservoir to coax out more oil.
Denbury will initially invest $250 million over the next few years to recover another 30 million barrels of oil from one section of this field. The company will spend $150 million to build a 110-mile pipeline to transport carbon dioxide to the ACC and another $100 million in initial field development costs before it will see an uptick in oil production. This should come in late 2021 to early 2022. These investments will position the ACC to eventually produce an incremental 7,500 to 12,500 barrels of oil per day (BPD), which is a big jump for a field that produced an average of 14,750 BPD in 2017.
That initial investment will set Denbury up to generate significant free cash flow in the future. According to the company's estimates, this project could generate $3 billion in free cash flow in the coming years if oil averages $60 a barrel, and more than $4 billion at $70 oil -- and that's after factoring in the roughly $1 billion of incremental capital it will need to reinvest into the field in future years as part of the development process.
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But wait, there's more
On top of that lucrative long-term project, Denbury has a large set of near-term development opportunities. Earlier in the year, the company revealed that it had successfully drilled three wells into the Mission Canyon formation of the ACC that exceeded expectations after producing an average of 1,050 BPD during their first month online. Those results confirmed that Denbury has a low-risk, low-cost development area -- with an average well cost of $3.5 million -- that can drive growth in the coming years.
In addition to that, the company plans to begin testing its acreage in the Powder River Basin of Wyoming after several other oil producers announced successful well results near its position. It owns land adjacent to EOG Resources, which completed several high-rate wells in the first quarter, including a three-well package that produced an average of 1,325 barrels of oil equivalent per day (including 775 BPD) in its first month online. EOG Resources noted that these wells only cost about $2.9 million apiece, which enables it to earn very high returns at current oil prices.
The fuel to continue rising
Denbury's balance of compelling near-term development opportunities and a needle-moving long-term project position the company to steadily grow production and cash flow in the coming years. As that happens, it will help relieve more of the pressure on the company's balance sheet, which should provide a further boost to its stock price. While Denbury remains riskier than other oil stocks due to its debt level, it has the potential to generate big-time returns over the long term, even after its run-up in the last year.
