What does George Soros see in Penn Virginia Corp (NASDAQOTH:PVAHQ)? this company hasn't posted a profit in the past five years! That hasn't stopped Soros from buying up 9.2% of Penn Virginia's shares though. Should you follow suit or has Soros made the wrong call?
All about the Eagle Ford
The only reason why Soros would take such a large stake in Penn Virginia is because of its Eagle Ford assets. To be fair, the Eagle Ford has treated Penn Virginia very well, which is why Penn Virginia is betting it all on the play this year: 98% of its budget is going toward the Eagle Ford.
Through several acquisitions, Penn Virginia collected 84,300 net acres in the Eagle Ford, but its ultimate goal is to have a 100,000 net acre foothold in the region. To do so, Penn Virginia has budgeted $40 million-$70 million toward purchasing additional acreage. By growing its presence in the Eagle Ford, Penn Virginia is guiding for oil production to increase 72% this year.
To achieve such high levels of growth, Penn Virginia has been utilizing the best drilling techniques around. After growing initial and 30-day production rates per frac stage by ~25% and ~33% respectively last year, Penn Virginia is doing its best to make the most out of each well.
A trend investors should love
Innovation in the Eagle Ford is widespread, which points toward a bullish trend forming in the area for E&P players. EOG Resources (NYSE:EOG), the largest crude producer in the Eagle Ford, has been able to significantly boost the ultimate recovery rate per well in the region. To do so, EOG Resources increased the average initial production rate per well by 10.5% in 2013. EOG Resources is bringing better wells online, but it is also keeping a tight lid on costs. Completed well costs fell by $800,000 last year to $6.1 million, and management is guiding for that to fall even further, down to $5.5 million this year.
Penn Virginia plans on following suit. By using pad drilling and zipper fracs, completion costs have trended downwards by ~20% while total well costs fell ~25% last year. Regardless of size, E&P players in the Eagle Ford are benefiting from better industry standards and drilling techniques. Cheaper, more efficient wells translate to a fatter bottom line for shareholders.
Cash flow problems
Unfortunately for Penn Virginia, it seems to have a problem living within its means. Over the past five years Penn Virginia has posted a net loss each year, even as EBITDAX grew from $179.7 million to $316.2 million over that time period. To fund a continuous loss someone has to be footing the bill. In this case, Penn Virginia issued senior notes, $300 million of which is due in 2019 and $775 million is due the year after. On top of issuing debt, Penn Virginia also took out $206 million from its $425 million revolving credit facility.
Map of Penn Virginia's assets
To get its interest expenses under control, Penn Virginia plans on divesting non-core assets so it can pour all its cash into the Eagle Ford while paying down debt. Penn Virginia is going to divest its Granite Wash and Selma Chalk assets sometime in the middle of 2014, after it sold off its Eagle Ford gas gathering assets for $100 million at the beginning of the year. Through these asset sales, Penn Virginia hopes to raise between $250 million-$300 million to pay down its credit revolver and fund operations. Beyond asset sales, Penn Virginia is guiding for its EBITDAX to grow to $440 million-$485 million this year to help close the gap, as Penn Virginia is going to spend a little over $600 million this year.
While Penn Virginia will lose 24.8 MMBoe of proven reserves and 4,200 boe/d in production by divesting those two assets, but that's nothing compared to what the Eagle Ford can offer. Penn Virginia has 75.6 MMboe of proven reserves in the Eagle Ford, which pales in comparison to the possible 190 MMBoe of recoverable resources Penn Virginia could be sitting on top of in Southern Texas. To makes things even better, 75% of Penn Virginia's Eagle Ford reserves is oil and 13% is NGLs, making each barrel all the more valuable.
Foolish final thoughts
What does George Soros see in this company? Massive upside in the Eagle Ford. Several analysts have speculated that Penn Virginia could be sold to a larger oil producer, like EOG Resources, to gain a stronger foothold in one of America's best shale oil plays. I'm not saying you should bank on Penn Virginia being sold for a hefty premium, but due to its relatively small size (market cap of around $1 billion) versus its peers (EOG Resources has a market cap of $52 billion), it seems that could be a possibility, especially since George Soros has taken such a large stake in the company.
Even if George Soros' end game isn't to get management to sell the company, Penn Virginia still has a lot to offer investors. Only 29% of its Eagle Ford acreage is developed, leaving room for massive reserve upside. Penn Virginia is also steadily moving toward a more liquids-weighted production mix. Management is calling for Penn Virginia's production mix to shift from 58.4% liquids in the first quarter of 2013 to 75% in 2014, which will propel margins upwards and help alleviate its funding problems.
The biggest downside to Penn Virginia is that it isn't a profitable company yet and carries a heavy debt burden. Even so, investors who are willing to tough it out could stand to make market-beating returns. Asset sales and the building of an oil gathering system in the Eagle Ford create plenty of catalysts this year, but the biggest catalyst of all would be Penn Virginia achieving fully self-funded operations by 2016-2017. If that happens the sky's the limit, assuming management keeps a watchful eye on debt maturing as well.