The case to be made that oil prices are going to eventually go a lot higher is solid. Rig counts are plummeting, demand continues to rise, and social unrest in OPEC nations grows.
There is a chance to get a lot of leverage to rising oil prices through the ownership of oil producers with stock prices beaten down because of debt concerns. The problem is that some of these producers are in real danger if that rebound takes longer than expected to arrive.
I believe the following two stocks are intelligent ways to get significant leverage to an oil rebound, for two reasons: the liquidity and term that exist in their capital structures. Here's why.
Baytex Energy -- nice assets, bad timing
Shareholders of Baytex Energy (NYSE: BTE) have had two sharp elevator rides down since the middle of 2014. The first took Baytex shares from $45 to $15 in a hurry. Then after some leveling off during the first half of 2015, Baytex shares plunged again, to under $5.
There are a couple of concerns the market probably has about Baytex. The first involves the amount of debt that the company now has after acquiring Aurora Resources for its Eagle Ford assets in late 2015. The second is that half of Baytex's production is heavy oil, which sells at a discounted price to lighter blends. Baytex has had to shut 7,500 barrels of that heavy oil production in because it bleeds cash at current oil prices.
Just to break even on drilling heavy oil wells at Lloydminster and Peace River Baytex needs $44 to $47 per barrel.
There's no beating around the bush here: If you think oil prices aren't going to recover to $60 or $70 per barrel, you shouldn't be owning Baytex. However, if you do think oil prices are going to recover, I think there's a lot of upside in Baytex's share price.
More importantly, this company can last a long time with low oil prices so that the turn higher in oil doesn't have to happen immediately. Baytex has a lot of term built into its debt structure, meaning it has no near-term debt maturities. None. There is nothing coming due until 2021.
Baytex also has plenty of liquidity, which means it has lots of money available to keep paying its bills and make interest payments.
Baytex has $850 million of room on its $1.05 billion bank facility and in 2016 expects to more or less live within cash flow. Baytex could have its bank line cut in half and still be in relatively decent shape.
Baytex shares suggest the company has been pushed to the precipice, and that is not the case at all. This company has the ability to wait for oil prices to recover.
Whiting Petroleum -- nice assets, bad timing, Part 2
Late in 2014, Whiting Petroleum (NYSE: WLL) closed on its acquisition of rival Bakken producer Kodiak Oil and Gas. Let's be honest -- the timing of the transaction couldn't have been worse, given that it added $2.2 billion of debt to Whiting's balance sheet just as the oil price collapsed.
In 2015, Whiting took measures to try to shore up its balance sheet by issuing 35 million shares at $30 each for just over a $1 billion of cash. At the time, Whiting shareholders who were used to a much higher share price probably cringed at the dilution. With the share price now at $9 and change, it looks like a pretty savvy move.
Despite raising all of that cash, Whiting is still faced with a very leveraged balance sheet. But like Baytex it also has lots of liquidity and no debt maturing anytime soon. Whiting's first debt maturity of significant size doesn't happen until 2019.
The current stated amount of Whiting's liquidity is $2.7 billion. Whiting CEO Jim Volker said recently at an energy conference that he could see the company's credit line reduced by up to $1 billion in the coming months. That would still leave Whiting with $1.5 billion of liquidity, which is more than enough for a company planning to live within cash flows.
For oil bulls only
For investors who believe that we're going to see oil above $70 again within the next couple of years, I think the term structure and liquidity that these two companies possess on their balance sheets make them good choices.
To be clear, though, if oil prices stay at current prices for four or five years, you aren't going to be wanting to own these companies because of the very high level of interest payments they are on the hook for relative to the cash flow that their operations generate. These stock prices are beaten down for a reason and it is because the debt levels here are high.
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