Pick Up Over 40% YTM with EP Energy, Bonds Mature June 2023


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  • Adjusted EBITDAX increased by 35%
  • Net cash provided by operating activities increased by 28%
  • Interest coverage of 1.9x

This week, Durig Capital takes another look at EP Energy, an oil and gas producer who has assets in the Eagle Ford, Permian and its newly renamed Northeastern Utah (NEU) asset. The company just posted exceptional results for its most recent quarterly results (three months ending September 30, 2018). Some of the highlights include:

 

  • Adjusted EBITDAX increased by 35%

  • Net cash provided by operating activities increased by 28%

  • Interest coverage of 1.9x


EP Energy had some impressive firsts in Q3 – quarterly free cash flow, as well as drilling its most productive well in the company’s history in its NEU asset. The company has continued to refine its well designs, which has translated to increased production in its newer wells, and also continues to use joint ventures to maximize its capital expenditures. The company’s 2023 bonds are currently trading at a significant discount, which translates to an outstanding yield-to-maturity of over 40%. In light of the company’s historic quarter, these bonds are excellent candidates for additional weighting in Durig Capital’s
Fixed Income 2 (FX2) Managed Income Portfolio.

 


Third Quarter 2018 Results

 

EP Energy recently reported quarterly results for the three months ending September 30, 2018. The company continues to execute well, with new success in its renamed asset, Northeastern Utah (formerly called Altamont). Also, the third quarter was the first quarter in the company’s history to be free cash flow positive (excluding hedging settlements). This result was driven by a combination of improved capital efficiency, cost reductions as well as higher commodity prices. In addition to the historic free cash flow, EP Energy also delivered additional excellent financial results in Q3.

 

  • Generated positive free cash flow of $4 million.

  • Adjusted EBITDAX was $214 million, as compared to $159 million in Q3 2017, an increase of 35%.

  • Net cash provided by operating activities in Q3 was $380 million, as compared to $298 million in Q3 2017, an increase of 28%.

  • Oil production in the third quarter increased by 3% over Q3 2017, increasing from 45.1 MBbls/d to 46.4 MBbls/d.


In addition to the above accomplishments, over the past twelve months, EP Energy has reduced its adjusted cash G&A (General and Administrative Expense) by 26%, which translates to annualized go-forward savings of $30 million.

About the Issuer

EP Energy was formed in 2012 when the former El Paso Corporation sold its exploration and production assets to an investment group for $7.2 billion. Today, EP Energy is an oil and gas exploration and production (E&P) company with assets located in the Wolfcamp / Permian Basin in Texas, the Uinta Basin in Utah and Eagle Ford Shale formation in South Texas. EP Energy is active in key phases of the E&P value chain—acquiring, developing and producing oil and natural gas. Based in Houston Texas, 44% of EPE’s stock is owned by Apollo Global Management, a private equity firm based in New York.  Everest Acquisition L.L.C., which is a co-issuer of the company’s senior secured notes and unsecured notes, was the acquisition vehicle formed by Apollo Global Management LLC, Riverstone Holdings LLC, Access Industries Inc., Korea National Oil Company, and other investors to acquire all of El Paso Corporation’s oil and gas exploration & production assets. Upon closing, Everest was renamed EP Energy, LLC (EP Energy).

 

Capital Efficiency with Current Assets

 

EP Energy has done a fantastic job in maximizing its production from the assets it currently owns, primarily through well design. For example, in the third quarter 2018, the company drilled its most productive oil well in the company’s history. This well, located in the company’s renamed Northeastern Utah (NEU) asset, has produced 110,000 barrels of oil in the first 78 days. This well is a lateral well, with a total length at approximately 9,500 feet. EP Energy has 159,000 net acres in this asset and is extremely bullish on the opportunities in this area. In fact, the company currently has 57 wells in the permit process for its NEU asset, and has indicated that this area will be a major focus in the coming months.

 

(Source: EP Energy November 2018 Investor Presentation)

 

In addition to the company’s NEU asset, its well designs in the Eagle Ford are also beginning to show dividends as well. The company’s 2018 designed and landed wells are showing to be about 8% more capital efficient to 160 days and ultimately, the company forecasts that those designs will be about 20% more capital efficient at EUR (estimated ultimate recovery). Russell Parker, EP Energy CEO provided additional information on this topic in the company’s most recent earnings call. “As the wells continue to produce, you see our new designs actually have a shallower decline and therefore are producing more oil over time, and are actually more capital efficient, Or, said in another way, if you take the older offset well designs and you were to spend a dollar on those wells, after 160 days, the new design is returning an incremental $0.08 just in that short time period.”

 

Oil Price Volatility

 

As recent as the beginning of October 2018, the price of Brent crude was at $87 per barrel with many predicting the return of $100 per barrel oil. Now, only a few months later, that price has been cut by nearly a third. At last check Brent crude was around $60 per barrel and WTI was around $50 per barrel. There are many factors playing into this unexpected drop, including the situation with sanctioning Iranian oil and the rising inventories of U.S. crude oil. Many are looking to the upcoming meeting of OPEC nations, anticipating some form of supply cut to counter an emerging glut.  While many are nervous about the prospect of returning to the oil slump of 2015 to 2016, EP Energy appears still profitable, even at current WTI prices. In its most recent quarter, the company provided its production costs per barrel, around $32 per barrel.

 

(Source: EP Energy 10-Q, September 2018)

 

Interest Coverage and Liquidity

 

Interest coverage is of paramount importance for bondholders as it indicates an issuer’s ability to service its existing debt. For its most recent quarter, EP Energy had operating income (without the effects on non-cash depreciation and amortization) of $176 million and interest expense of $95 million for an interest coverage of 1.9x. This is excellent coverage, especially considering the outstanding yield-to-maturity on these 2023 bonds of over 40%. In terms of liquidity, as of September 30, 2018 EP Energy had ample liquidity, with $56 million in cash and zero borrowings on the RBL Facility, resulting in $666 million of available liquidity.

 

Risks

 

The risk for bondholders is whether EP Energy can continue to realize capital efficiencies that it started to see in Q3. The company clearly has improved its well designs and has identified the areas within its assets where these types of wells will likely bring maximum production. It appears that the company has lucrative drilling locations in its NEU, Eagle Ford and Permian assets. The company’s most recent historic quarter, with the first quarterly free cash flow in the company’s history, should encourage investors as to the company’s persistent and tenacious management team. These 2023 bonds, with a yield-to-maturity of over 40%, provides investors with a high yield addition to their portfolios.

 

As EP Energy’s revenues are tied directly to the prices of oil and gas, there is commodity price risk present for bondholders. If prices were to decrease significantly, this could affect EPE’s ability to fund it operational needs, including interest expense for bondholders. The company does have an active hedging program that it uses to negate some of the ongoing volatility of commodity prices.

 

In general, bond prices rise when interest rates fall and vice versa. This effect tends to be more pronounced for lower couponed, longer-term debt instruments.  Any fixed income security sold or redeemed prior to maturity may be subject to a gain or loss. Higher yielding bonds typically have lower credit ratings, if any, and therefore involve higher degrees of risk and may not be suitable for all investors.

 


Summary and Conclusion

 

EP Energy had a historic quarter, generating free cash flow for the first time in the company’s history. In addition, it drilled its most productive oil well in company history in Q3. Drilling and completion techniques for its wells have continued to evolve and be refined in order to maximize oil production at the most efficient cost. The company continues to work on bringing down costs, while also increasing production. And with its RBL Facility borrowing base recently reaffirmed, the markets appear to still have confidence in this well managed oil and gas exploration and production company. In light of these factors, these 2023 bonds, with a yield to maturity of over 40%, make an ideal candidate for additional weighting in Durig Capital’s Fixed Income 2 (FX2) Managed Income Portfolio.

 

Issuer:  EP Energy / Everest Acquisition Finance LLC

Ticker: NYSE:EPE

Coupon: 6.375%

Maturity: 06/15/2023

Ratings: Caa3 / CCC-

Pays: Semiannually

Price: ~30.03

Yield to Maturity: ~42.47%

 

Disclosure: Durig Capital and certain clients may hold positions in EP Energy’s 2023 bonds.

 

We track thousands of bond issues and their underlying fundamentals for months, sometimes years, before finding any that achieve or surpass the targeted criteria we have found to be successful.  Our main priority is to provide the best opportunities for our clients.  Our bond reviews are first distributed to our clients, then published on our website and our free email newsletter, and lastly on the Internet and distributed to thousands of prospective clients and competitive firms. Bond selections may not be published if they have very limited availability or liquidity, or viewed as not being in the best interests of our clients. When high yielding bonds with improving fundamentals are acquired at lower costs, Durig Capital believes that investors will appreciate earning higher incomes with our superior high income, low cost, fiduciary services.

 

Please note that all yield and price indications are shown from the time of our research.  Our reports are never an offer to buy or sell any security. We are not a broker/dealer, and reports are intended for distribution to our clients. As a result of our institutional association, we frequently obtain better yield/price executions for our clients than is initially indicated in our reports.  We welcome inquiries from other advisors that may also be interested in our work and the possibilities of achieving higher yields for retail clients.

 

Disclaimer: Please note that all yield and price indications are shown from the time of our research.  Our reports are never an offer to buy or sell any security. We are not a broker/dealer, and reports are intended for distribution to our clients.

 

In general, bond prices rise when interest rates fall and vice versa. This effect tends to be more pronounced for lower couponed, longer-term debt instruments.  Any fixed income security sold or redeemed prior to maturity may be subject to a gain or loss. Higher yielding bonds typically have lower credit ratings, if any, and therefore involve higher degrees of risk and may not be suitable for all investors.

 

The high yield strategies presented in this review by Durig Capital may not be suitable for all investors.  This is not investment advice from Durig Capital, nor a specific recommendation to buy or sell securities. If you have any questions or concerns about its suitability for your personal investment, you should seek specific investment advice from a registered professional before making an investment decision.

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