Transcript The oil and gas drilling and extraction industry features regional
Evolution Petroleum Corporation (EPM)
Discussion Materials
Marnie Georges Qianyi (Cathy) Han Jason Mudrock Tuesday, April 1, 2014 1
Table of Contents
Section 1 Section 2 Section 3 Section 4 Section 5 Executive Summary Industry Overview Company Overview and Positioning Valuation Analysis Questions 2 8 13 3 4 21
Executive Summary
The Oil Drilling and Gas Extraction industry will benefit from strong global demand and rising prices despite high exploration risks Evolution Petroleum Corporation (EPM) possesses a solid asset base with a unique strategy and innovations to pose a competitive advantage We value the company at about $9.19 per share We recommend placing Evolution Petroleum Corporation on the Watch List so future analysts can evaluate its changing risks and growth strategies 3
Section 1
Industry Overview
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Industry Overview
The oil and gas extraction industry benefits from rising oil and gas prices and strong global demand Industry Trends
Oil and gas extraction is a mature, stable market in the United States Trends include rising global demand from emerging economies, increased crude oil output from offshore drilling, increased natural gas production from new fields, and pressures from regulations and alternative energy growth New technologies have allowed increased exploration of previously unattainable resources Price volatility and high capital costs continue to threaten smaller industry players
Oil Demand Correlation with Real GDP Growth (1969 – 2008) Industry Composition
The oil and gas drilling and extraction industry is worth $319.5 billion in the United States Crude oil makes up 58.4% of the market while natural gas represents 41.6% The United States sends 59% of its oil and gas exports to Canada and 19% to Mexico Texas, Oklahoma, and Louisiana contain the largest amount of industry output and revenue in the continental United States
U.S. Oil & Gas Drilling and Extraction Market Segmentation
1,0% 0,7% Petroleum refining industry 9,3% Natural gas distribution industry 11,1% Utilities 18,6% 59,3% Industrial users Oil exports Gas exports Sources: 1. Deutsche Bank Markets Research. “Oil & Gas for Beginners.” 25 January 2013.
2. Credit Suisse. Oil & Gas Primer. September 2011. 3. IBISWorld Industry Reports. 5
Industry Overview
The oil and gas drilling and extraction industry features regional dispersion and high revenue volatility Competitive Landscape
Low concentration due to high geographic dispersion Top four competitors account for 28% of industry revenue Economies of scale resulting from large oil and gas deposits help competitors spread high capital costs Largest players practice downstream vertical integration to guarantee buyers Stringent regulations threaten large and small competitors and increase capital requirements
U.S. Production of Crude Oil Dominant Players in Oil & Gas Drilling and Extraction
72,2% 8,2% 7,7% 6,1% 5,8% ConocoPhillips Chevron Corporation Royal Dutch Shell PLC BP PLC Other
Price Determinants
Prices remain volatile due to changes in supply and demand Global economic recovery increases transportation and industrial energy demands Different grades of oil (heavy, light) typically attract different prices with lighter oils earning a premium since they are easier to refine Impurities also affect the price of oil with sweet oils, or those with a low sulfur content, commanding a premium High barriers to entry result from security and regulation, capital investments, and the high risks associated with exploration Sources: 1. Deutsche Bank Markets Research. “Oil & Gas for Beginners.” 25 January 2013.
2. EIA 2014 Report.
3. IBISWorld Industry Reports. 6
Porter’s Five Forces
The oil and gas drilling and extraction industry is attractive with the potential for long-term profitability
Bargaining Power of Buyers • Few available substitutes • Price volatility can deter buyers Bargaining Power of Suppliers • Low concentration of industry players • Critical commodity product Entry of New Competitors • Economies of scale • High capital requirements • Stringent regulations • High risk and volatility Rivalry Among Existing Competitors • Limited oil fields and gas reserves • Smaller firms may share buyers • Larger firms vertically integrate Threat of Substitutes • Low use of alternative energies • Oil and gas serve separate markets
LOW MEDIUM LOW
Sources: 1. Deutsche Bank Markets Research. “Oil & Gas for Beginners.” 25 January 2013.
2. EIA 2014 Report.
3. IBISWorld Industry Reports.
HIGH LOW
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Section 2
Company Overview
8
Evolution Petroleum Company (EPM) — Company Overview
The company has attractive investments and dedicated management that could sustain future growth Firm Overview
EPM is a petroleum company engaged primarily in acquisition, exploitation and development of properties for the production of crude oil and natural gas Differentiates through innovative proprietary technology, reliance on unconventional drilling techniques, and exploration of previously uneconomical reserves Management and employees own 21% of shares Market capitalization of $414 million in 2014
Primary Asset Locations
MS Lime Giddings Field Delhi Field
Customer Relations
EPM sells commodities so purchasers retain little buying power in the long term
Revenue Growth Purchaser
Plains Marketing L.P.
Enterprise Crude Oil LLC Flint Hills DCP Midstream, LP Kinder Morgan Enervest, LLC Orion Exploration Partners, LLC
2013
90.0% 4.0% 2.0% 1.0% 1.0% 1.0% 1.0% 9
Evolution Petroleum Corporation (EPM) — Company Overview
EPM earns money through Enhanced Oil Recovery, Bypassed Primary Resources, and Unconventional Development.
Enhanced Oil Recovery
Increase the production and recovery of oil and natural gas Enhanced Oil Recovery from the Holt Bryant Unit in the Delhi Field in Louisiana Purchased in 2003 for $2.8 million Operated by Denbury Resources, Inc.
Owns 7.4% interest and 23.9% revisionary interest
Carbon Dioxide Oil Recovery at Delhi Field Bypassed Primary Resources and Unconventional Development
Focus on horizontal drilling Mississippi Lime, North Central Oklahoma GARP Artificial Lift Technology 10
SWOT Analysis
Evolution Petroleum Corporation’s reliance on innovative technology and alternative production and exploration methods differentiate it from the competition and provide a foundation for future growth. Strengths
Proprietary GARP Artificial Lift technology and patents Rich in assets and proved reserves Generates scalable reserves potential at a low unit cost with long-term growth potential Experienced, trained management team with deep experience in innovative oil and gas exploration and production strategies Royalty and interest contracts reduce risk and increase revenues
Weaknesses
Depends on a few large clients Depends on crude oil for revenues No presence in growing global markets Relies on third party operators, marketers, and technologies Light debt use may limit exploration opportunities
Opportunities
Delhi Field previously produced millions of barrels of oil indicating future success GARP technology provides licensing opportunities Increased demand from transportation and industrial sectors Cash reserves can help secure future investment opportunities Increased push for domestic energy output could spur demand
Threats
Exposure to commodity risk stemming from changing world prices of oil and gas Cyclicality of end markets Uncertainties inherent in reserve estimations Increased competition from large, vertically-integrated peers Price-elastic, highly competitive environment Sources: 1. Company website.
2. EIA 2014 Outlook.
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Recent Stock Performance
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Section 3
Valuation Analysis
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EPM WACC Calculation
Risk Free Rate Beta MRP CAPM 2-Year Return Annualized Div Yield ROE CAPM ROE Cost of Equity
WACC CAPM
3.50% 1.28
5% 9.90%
Return on Equity
35.48% 16.40% 3.20% 19.60%
Cost of Equity
9.9% 19.60% 11.84% Weight Cost of Debt Tax Rate After-Tax Cost of PE 80% 20% WACC Premium Adj WACC Debt
Captial Structure
18% Common Equity Perferred Equity 70% 12% 100%
Cost of Debt
4.54% (online source) 35.00% 2.95%
Cost of Preferred Equity
8.50% (dividend yield)
WACC
9.84% 0.5% 10.34% 14 Source: Capital IQ and Consensus Estimates as of 12/31/2011
EPM Discounted Cash Flow Analysis
EBIT Tax Expense Depreciation
2014E
$ 12,504,025 $ (4,418,764) $ 1,264,843 $ 9,350,104
Discounted Cash Flow Analysis 2015E 2016E
$ 16,526,333 $ 21,778,393
2017E
$ 28,631,191 $ (5,839,278) $ 1,373,196 $ 12,060,251 $ (7,694,018) $ 1,490,995 $ 15,575,370 $ (10,113,972) $ 1,619,013 $ 20,136,232
2018E
$ 37,567,162 $ (13,269,478) $ 1,758,103 $ 26,055,787 Change in NWC CapEx FCF $ (322,071) (3,320,192) $ 5,707,841 1 WACC $ (1,169,816) (3,611,775) $ 7,278,660 2 10.34% $ (3,268,762) (3,926,620) $ (2,885,949) (4,267,272) $ 8,379,988 3 $ 12,983,011 4 Terminal Growth Terminal Value $ (1,979,261) (4,636,332) $ 19,440,194 5 3.50% 294,023,795.75
Discounted FCF $ 5,172,808 $ 5,978,061 $ 6,237,446 $ 8,757,765 $ 179,744,183 Valuation Shares Outstanding $ 205,890,264 28,205,467 Implied Price $ 7.30
15 Source: Capital IQ and Consensus Estimates as of 12/31/2011
EPM Sensitivity Analysis $ 7.30
8.34% 9.34% 10.34% 11.34% 12.34% 2.500% 9.08
7.56
6.44
5.58
4.90
Senstivity Analysis
3.000% 9.88
8.12
6.84
5.88
5.13
3.500% 10.85
8.77
7.30
6.22
5.39
4.000% 12.04
9.54
7.84
6.61
5.69
4.50% 13.54
10.47
8.47
7.06
6.02
16 Source: Capital IQ and Consensus Estimates as of 12/31/2011
EPM Comparables Analysis
Comparable Companies Analysis
VOC Energy Trust (NYSE:VOC) ECA Marcellus Trust I (NYSE:ECT) Cross Timbers Royalty Trust (NYSE:CRT) Enduro Royalty Trust (NYSE:NDRO) Hugoton Royalty Trust (NYSE:HGT) Synergy Resources Corporation (AMEX:SYRG)
P/E
8.59
5.33
13.5
8.59
9.34
51.5
Forward P/E EV/Revenue EV/EBITDA
7.18
6.56
10.1
8.23
20.9
8.4
6.6
13.0
8.5
8.5
13.9
8.56
5.27
13.38
8.60
8.83
34.99
P/B
2.2
0.67
15.9
0.73
3.21
3.32
MC/Proved reserves
0.04
0.08
0.02
0.09
0.12
Evolution Petroleum Corp. (AMEX:EPM) Average Median 105.3
16.14
8.97
10.59
19.7
8.23
18.9
9.8
8.5
39.52
7.31
0.03
13.27
8.72
4.34
2.71
0.06
0.06
17 Source: Capital IQ and Consensus Estimates as of 12/31/2011
Recent Stock Performance
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EPM Comparables Analysis Cont.
P/E Forward P/E EV/Revenue EV/EBITA P/B MC/Proved reserves
Implied Price
Mean $ 3.39
$ 6.78
$ 7.10
$ 4.58
$ 7.48
$ 26.45
Median $ 1.88
$ 5.26
$ 6.16
$ 3.01
$ 4.66
$ 27.02
Weight 15% 15% 15% 15% 15% 25%
Weighted Price
Mean $ $ $ $ $ $ $ 0.51
1.02
1.06
0.69
1.12
6.61
11.01
Median $ 0.28
$ 0.79
$ 0.92
$ 0.45
$ 0.70
$ 6.76
$ 9.90
Implied Price $ 10.46
19 Source: Capital IQ and Consensus Estimates as of 12/31/2011
EPM Valuation/Recommendation
DCF Comps Price
Implied Price
$ 7.30
$ 10.46
$ 9.19
Weight 40% 60% Recommendation: Watch List
Source: Capital IQ and Consensus Estimates as of 12/31/2011 20
Section 5
Questions?
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