Investor sentiment surrounding Baytex Energy (OTC:BTEG.F) has been as volatile as any other company operating in the energy industry over the past 24 months. After averaging $45 a share from 2011 to 2014, the company's stock dropped to an all-time low of just $1.08 earlier this year. While collapsing energy prices certainly caused the drop, an overbearing debt load has kept bankruptcy fears alive despite oil's recent rebound to $40. Net debt is currently twice as large as Baytex's depressed market cap.
Management still has some financial tricks up its sleeve, including an attractive hedging program and $820 million in undrawn credit facilities, but investors must start to ask how long Baytex can continue surviving if oil markets don't rebalance soon.
Financing costs are set to rise
Billionaire investor George Soros is famous for his ideas surrounding what he calls reflexivity. In popular culture, most people refer to this as a self-fulfilling prophecy -- once something is set in motion, it often will help perpetuate a certain outcome. For a company like Baytex, which is burning cash and needs to rely on outside financing to keep the company afloat, this is a very important concept.
On Feb. 3, Moody's downgraded Baytex's debt below investment grade, giving the company a negative outlook. "The downgrade reflects the material decline in Baytex's cash flow we expect in 2016 and 2017, which will result in weak cash flow-based leverage metrics," a Moody's analyst said. "Baytex will also breach financial covenants in 2016 and will need to get relief from its banks." While rating downgrades are typically backward looking, it has a real impact on the short-term cost of financing. Most companies that fall below investment grade see their bonds forcibly sold off by mutual funds that are mandated to only hold investment-grade securities. This also creates lower demand for future debt rounds. So Baytex's struggles seem to beget even more troubles.
Hedges may allow the company to manage 2016
Baytex has a large hedging program in place this year that takes a lot of pressure off its cash flow situation.
About 80% of 2016 oil production is hedged through a variety of contracts, the biggest of which, covering 45% of production, is a combination of fixed hedges at roughly $60 a barrel and a WTI three-way option. The latter has the following terms: With oil at $35-$39, Baytex will realize $45-$49; with oil at $40-$50, Baytex will realize $50; with oil at $50-$59, Baytex will realize spot prices. If oil pops above $60, the company will realize only $60 prices.
In all, the hedges give Baytex a boost in profitability with prices under $50 a barrel. Currently, the company has an all-in breakeven of about $40-$45 a barrel, so along with the hedging program, the company has a decent chance of breaking even unless oil dips back down below $30.
2017 is up for grabs
As mentioned, it's strongly believed that Baytex may breach its debt covenants later this year. Even if the company's hedging program allows it to eke out the rest of 2016, only 6% of next year's production is hedged. If oil doesn't stage a sustained rebound above $50 a barrel, a liquidity crisis is inevitable.
To invest in Baytex stock today, you have to be certain about both the direction and timing of an oil recovery. Even if a bullish stance proves correct, Baytex may not survive if it occurs six months later than you expected. If you own or plan on buying shares, stay cognizant that there are short-term factors in play with much more potential impact than the long-term movement of oil markets.