It has been a truly awful year for investors in Energy XXI's (NASDAQ:EXXI) stock, which is down 76% over the past year:
While those owning the stock are probably cursing the day they bought, those without a position might be a bit tempted by the massive price cut. As humans we tend to be drawn to things on sale, with the hope that a real bargain might be had. However, the problem with perceived bargains is that there's usually a reason why an item has been steeply discounted, such as a crack or other deformity. So, let's take a look to see if there's actually some value at Energy XXI or if it's just another trap for our investment dollars.
The value of oil in the ground
One way to look at the underlying value of an energy company is to look at the oil and gas reserves it holds. These reserves hold varying degrees of value based on the certainty of future production as well as commodity prices. The more certain investors are that a company's reserves will be produced, the higher the value. We see this certainty scale in the following chart, which shows that proved reserves are by far the most certain resource category.
The farther away we go from proved reserves (also known as 1P) the less certain we are that the reserves will be produced so these have less value to investors. However, in some cases investors can grow so bearish on a company that they ascribe absolutely no value to these reserves. So, it's quite possible that a company is sitting on a lot more oil and gas in the ground than the value of a company would indicate.
A look at what Energy XXI has in the ground
When we look at Energy XXI we see that investors are valuing the entire business, as measured by enterprise value, at about $5 billion. However, as of the end of the company's fiscal year in June it held proved reserves, or 1P, totaling 246 million barrels of oil equivalent, or BOE. Those reserves had PV-10 value, or a present value discounted by 10%, of $7.6 billion at the then current oil price of $103.63 per barrel.
In addition to that, the company held another 70 million BOE of probable reserves, 2P, with a PV-10 value of $3.6 billion and 65 million BOE of possible reserves, 3P, with a PV-10 value of $3.4 billion. Add it all up and the company was estimated to have been sitting on upward of $14.6 billion worth of oil and gas in the ground, which is noted on the following chart.
What this slide is suggesting is that Energy XXI is sitting on as much as three times more oil and gas in the ground than its current value would indicate. That's of course if we ascribed full value for possible and probable reserves, which are less certain than proved reserves. Further, it also assumes a much higher oil price than what we're seeing just a few months later. Still, factor all of that into the equation and we're still looking at a company sitting on substantially more oil and gas reserves than the current stock price would suggest, which would seem to scream value.
The weight pulling everything down
There is, however, one big blemish and that's the company's massive debt load. The company is weighed down by $3.6 billion in debt. This is a big burden as it leaves Energy XXI with little wiggle room. We saw this last quarter as the company generated $204 million in operating cash flow. However, its interest burden was $65 million in the quarter so 32% of its cash flow went just to pay the interest on its debt. Meanwhile, the rest of its cash flow, and then some, was used to fund the company's capex plan. Last quarter alone the company spent $280 million in capex, so that leaves the company to look to outside sources, like issuing more debt or equity, to fund capex. The worry here is that as oil prices keep sliding it will make it much harder for Energy XXI to maintain production while also keeping up with its interest payments. So, in the future it might have no choice but to sell its oil and gas assets at fire sale prices just to keep from going under if oil prices keep sliding.
There is a case to be made that Energy XXI is a bargain as we can buy oil and gas in the ground for a discount to present value. However, the trap here is the company's debt as it sucks up way too much of the cash flow, which could have been used to profitably develop its oil and gas assets. This debt trap has turned too many value stocks into value traps, so until the company improves that picture I'd stay away from this sale item.
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.