EPL Oil & Gas Inc (EPL), Stone Energy Corporation (SGY): Here Is Why I Don’t Put This Offshore Player on My Buy List

One of the main energy producers in the U.S. Gulf of Mexico (GOM) is EPL Oil & Gas Inc (NYSE:EPL). EPL Oil & Gas Inc (NYSE:EPL)‘s operations are concentrated in the untapped reservoirs of the GOM shelf, focusing on the waters of offshore Louisiana. The stock has almost doubled over the last twelve months, making any prudent investor wonder whether
there is any upside left or the stock has run its course. To answer this, let’s check out the company’s strengths, weaknesses, opportunities and threats.

Strengths

Oil Production and Reserves Growth: Q1 2013 oil production rose 85% versus Q1 2012 to 17,327 barrels of oil per day (bopd), impacted by organic growth from ongoing operational activities and the first full quarter of production from the Hilcorp acquisition that closed late last year.

Last fall was transformational for EPL Oil & Gas Inc (NYSE:EPL) (NYSE:EPL) when it acquired GOM assets from privately held Hilcorp Energy for $550 million. The acquired assets included 36.3 million barrels of oil equivalent (MMboe) in proved reserves (54% oil and liquids), and over 10,000 barrels of oil equivalent per day (boepd) of production (50% oil and liquids). Overall, the deal doubled EPL Oil & Gas Inc (NYSE:EPL)’s proved reserves and added 149,000 net acres. This boosted EPL Oil & Gas Inc (NYSE:EPL)’s total net GOM acres to 331,000.

Cash Flow Growth: EPL Oil & Gas Inc (NYSE:EPL)’s shift from natural gas to oil has paid off. Since 2009, the company’s oil and liquids production has grown to ~80% of overall production, up from 36% in 2009, driven by the company’s focus on oil-weighted acquisitions and organic expansion.

As a result, cash flow from operating activities in the first quarter of 2013 was $78.2 million, a 37% increase compared to cash flow from operating activities for the same quarter a year ago. EPL Oil & Gas Inc (NYSE:EPL) also estimates that it will generate approximately $400 million in cash flow from operating activities in 2013.

Active Hedging Program: Most of the company’s operating cash flow for 2013 is protected because EPL has hedged ~60% of its total production.

Consistent Profitability and Satisfactory Profit Margin: The company’s crude oil is advantaged by receiving Heavy Louisiana Sweet and Light Louisiana Sweet crude oil basis differentials. This premium pricing has helped EPL remain profitable for several quarters in a row, with estimated 2013 EBITDAX to be in the range between $475 million to $525 million.

Strong liquidity: In April 2013, EPL sold certain interests in the non-operated Bay Marchand field to the property operator for total consideration of $62.8 million.

After giving effect to this sale, EPL’s current liquidity is $290 million. By year end, the company can increase its liquidity further thanks to its free cash flow, which is estimated to be $125 million for 2013.

Weaknesses

Key metrics compared to peers: In Q1 2013, the company produced ~ 22,700 boepd (77% oil and liquids), holding 75.8 MMboe (~60% oil and liquids) after the latest asset sale mentioned above (Bay Marchand field).

Operating within cash flow and allocating $300 million for its 2013 capital budget, EPL estimates that 2013 annual production will remain at ~22,500 boepd (80% oil and liquids) by year end. After all, let the numbers speak for themselves:

Company	EV (Billion $)	Production (boepd)	Proved Reserves(MMboe)	$/boepd	$/boe
EPL	1,85	22,700(77% oil/liquids)	75.8(60% oil/liquids)	81,500	24.4
Energy XXI (NASDAQ:EXXI)	3,18	50,000(60% oil/liquids)	120(71% oil/liquids)	63,600	26.5
Stone  Energy	1,8	40,100(52% oil/liquids)	129(49% oil/liquids)	44,900	13.95
W&T Offshore (NYSE:WTI)	2,2	50,000(53% oil/liquids)	117.5(60% oil/liquids)	44,000	18.72

Based on these key metrics, EPL isn’t undervalued in comparison to Stone Energy Corporation (NYSE:SGY), W&T Offshore, Inc. (NYSE:WTI) and

Energy XXI (Bermuda) Limited (NASDAQ:EXXI) that also operate in GOM. Actually, EPL trades at a satisfactory premium due primarily to the fact that it is more oil-weighted than its peers.

Increasing Debt: The company’s long term debt was $700 million while equity was only $576 million equity as of March 2013. Furthermore, assuming the best case scenario materializes and the annual operating cash flow hits $400 million for 2013, the D/CF ratio will be close to 2x. Although this D/CF multiple isn’t alarming, it isn’t low either.

Overreliance on GOM: The company fully relies on GOM and doesn’t own any properties onshore North America or elsewhere. It is unknown to what extent the production will be affected if something goes wrong with EPL’s operations in GOM either due to external factors or due to some operational hiccups.

Opportunities

Acreage Expansion: During Q1 2013, EPL was the high bidder at $2.1 million on five leases comprising 13,892 acres in the shallow GOM shelf. Given the assets are near EPL’s existing acreage, there’s likely to be several synergies both in costs and in the company’s ability to quickly digest forthcoming seismic data.

Active Acquisition Program: Thanks to its liquidity and free cash flow generation, EPL will continue its “acquire and exploit” strategy, targeting additional acquisitions in order to accelerate its growth. The company’s plan consists of oil-dominated development and exploration activities, which are intended to drive production and revenue growth along with organic reserve replacement.

Natural Gas Potential: EPL is currently focused on oil, but it also has 10 gas projects ready to go as soon as pricing gets more favorable. This suggests additional opportunity for shareholders if natural gas prices continue higher, given nearly 40% of the company’s reserves are natural gas.

Threats

Commodity volatility: A significant part of EPL’s total production is unhedged, and the company’s cash flow is heavily impacted by oil prices. A sustained drop of the oil price during the remainder of 2013 will affect negatively both the operating and the free cash flow.

Gulf Coast costs and risks: As long as EPL produces all its hydrocarbon resources from the GOM, it incurs high seasonal maintenance costs for its platforms. Moreover, its production is exposed to unpredictable weather that can cause pricey damages. Remember how badly Hurricane Isaac and Katrina hurt the GOM players?

Foolish roundup

I believe that EPL has run its course for 2013 and has limited upside from the current levels. EPL can get cheaper before it gets more expensive due to the fact that it already trades at a significant premium and there aren’t any major positive catalysts ahead.

Nathan Kirykos has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Nathan is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.

The article Here Is Why I Don’t Put This Offshore Player on My Buy List originally appeared on Fool.com is written by Nathan Kirykos.

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