If you are hunting for some interesting oil and gas companies, then today’s article is for you. But before that, we want to thank our community member for commenting and sharing about this company, Ring Energy stock. Upon further research, indeed we think it is of good value.
With that, let’s dive into a quick review about this company.
Ring Energy Stock Business Overview
First thing first, understand that Ring Energy is primarily an oil and gas exploration and production company. Other than exploring and developing oil themselves, the company is also actively pursuing accretive acquisitions. The latter aims to improve margin and returns on their investment portfolio, i.e. the oil reserves that they own.
Now, let’s take a look at how its share price has performanced over the past few years.
Ring Energy Stock Events And Price Trend
Source: Yahoo Finance / Ring Energy Inc Share Price Trend 5-Year
You can observe that during the second half of 2018, Ring Energy’s share price had fallen sharply. It dropped from the $12-$15 range to the $5 range.
Since then, it has been declining lower.
Well, I would sum up this trend attributing mainly to 3 things.
Underperformance of New Oil Wells
First, in October 2018, Seaport Global, an investment bank, through digging into some data provided by Drillinginfo, an industry data provider, concluded that Ring Energy’s most recent well completions, at that point in time, were underperforming older ones by 25%.
And this caused substantial market reaction to its share price back then.
Increased Debt Levels
Secondly, in April 2019, Ring Energy closed its transaction with Wishbone Energy Partners, LLC, Wishbone Texas Operating Company LLC and WB WaterWorks, LLC to acquire their Northwest Shelf assets.
This is in fact a decent and accretive acquisition. But, the problem is that historically, the company has minimal debt, at less than US$ 50 million generally.
Well, as part of the acquisition, Ring Energy took up a substantial amount of debt to finance the transaction. This brought its debt levels to all-time high of more than US$350 million since the closing of the acquisition.
Source: Stockrow / Ring Energy Inc Debt vs Assets
Since then, the market became wary of the company’s debt level, which brought further decline to its share price.
Coronavirus Pandemic Impact on Ring Energy Stock
And thirdly, the coronavirus pandemic outbreak in early 2020 wrecked the whole oil and gas industry due to demand destruction. This changed the outlook of the lending industry.
This is closely linked to the second point on its increased debt levels. The depressed oil prices and demand in 2020 has impacted Ring Energy’s business adversely.
Understand that companies like Ring Energy are in the early stages of acquiring leases and producing oil. Generally they do not have much cash flow and that will cause financial problems.
With the coronavirus demand destruction, lending is now focused more on cash flow.
Hence, the increased debt level from the previous year’s acquisition of Northwest Shelf assets have exposed the company to financial trouble in an unfortunate time. The unforeseen pandemic destroyed the whole market that resulted in the company facing lending constraints.
Source: Stockrow / Ring Energy Inc Number of shares outstanding
As such, management had to raise cash through issuing stock and warrants.
This caused dilution in its shares. As a result, we saw its share price hitting an all-time low of less than US$1 in 2020.
From the time when Ring Energy’s share price started to decline in mid 2018 till now, the number of outstanding shares has increased by about 50%. Hence, a corresponding dilution effect.
So these series of events are what contributed to decline of the company’s shares. But since then, it has climbed back up to pre-Covid levels of more than US$2 a share.
But as we saw earlier, the market has punished its shares heavily since mid 2018. It shed more than 80% of its value from US$12 a share to about US$2 a share.
Now that you understand what’s going, let’s take a look at why Ring Energy is still undervalued currently.
Ring Energy Stock Potential Upside
If you are not familiar with examining oil companies, there might be some jargons that can deter you from researching this opportunity.
So, here we will just highlight 3 metrics and areas to show why we think Ring Energy is undervalued. And try to make it as simple as possible.
Ring Energy Stock Low P/E
We will start off with what most of us understand first, which is the P/E ratio.
Well, P/E can be misleading as they don’t capture a lot of important elements per se. But over here i think it forms a good starting point to discuss further.
Source: Ring Energy Annual Report 2020 / Condensed Statements of Operations
First, understand that the company reported a net loss of US$253.4 million for the full year of 2020, compared to a net income of US$29.5 million recorded in FY2019.
This drastic difference was due to a non-cash ceiling test impairment charge on its oil and gas properties. It is primarily due to the substantially lower oil prices in 2020 caused by the pandemic situation.
Therefore, if we exclude this impairment charge and some other minor items, adjusted net income will come in at US$20.7 million for FY2020 instead.
Since there is a series of share issues recently, and a time lag in the earnings per share reported, we will use the current market capitalization of around US$240 million at US$2.40 a share, and the adjusted net income of US$20.7 million, to derive a P/E of around 11.6
Again, understand that 2020 was a disastrous year for the oil and gas industry. So being able to have its trailing year P/E of 11.6, I will say it’s not too bad.
Since then oil price has recovered to pre-covid levels. Although demand for oil may not recover fully due to restrictions still being imposed in many countries, we can expect 2021 or 2022 projected earnings to be close to 2019 figures.
So just for reference, 2019 net income and adjusted net income were US$29.5 million and US$34.3 million respectively.
So, assume earnings recover to 2019 levels. We can expect the forward P/E or adjusted P/E to be 8.1 and 7.0 respectively.
I think this forward P/E in the 7 – 8 range looks pretty good to me.
PV-10 and Standardized Measure for Ring Energy Stock
Now the second metric. We will need to use a bit of the jargons used in evaluating oil and gas companies.
Specifically, we are looking at metrics PV-10 and Standardized Measure.
So what is PV-10?
It’s basically the present value of estimated future revenues net of estimated direct expenses, and discounted at an annual discount rate of 10% for the oil and gas company.
On the other hand, Standardized Measure is the after-tax estimate of future net cash flows from the oil and gas reserves, net of future production and development costs.
So basically these 2 figures are pretty similar. Just that one account for the taxes in the future, while the other does not.
Ring Energy’s Oil Reserves
The next thing we need to understand is how oil and gas companies classify their reserves. We can categorise them into 3 segments:
- Proved (1P): There should be at least 90% probability that the quantities actually recovered will equal or exceed the estimate.
- Probable (2P): There should be at least 50% probability that the quantities actually recovered will equal or exceed the 2P estimate.
- Possible (3P): There should be at least 10% probability that the quantities actually recovered will equal or exceed the estimate.
So this PV-10 and Standardized Measure only accounts for Proved reserves. Not the Probable or Possible ones.
As of Dec 31, 2020 Ring Energy’s Proved reserves were approximately 76.5 million BOE (barrel of oil equivalent).
Source: Ring Energy January 2021 Corporate Presentation
On the other hand, Dec 31, 2019 the company recorded a 81 million BOE of Proved reserves.
Also, you can see the reported PV-10 value in 2019 was about US$1.1 billion. However, understand that this is based on an average oil price of US$52/bbl.
Source: Ring Energy Annual Report 2020 / Standardized Measure of Discounted Future Net Cash Flows
On the other hand, you can see that Ring Energy stock Standardized Measure of discounted future net cash flows to be quite different between 2020 and 2019 figures.
The different SEC average price assumptions of oil and gas for the different years are what caused the variations.
In 2019, the calculation was based on an SEC average price of US$52.10/Bbl of WTI oil and US$2.58 per MMBtu Henry Hub natural gas.
Whereas in 2020, due to Covid-19 pandemic, oil and gas prices were depressed. Hence, the average price of US$36.04/Bbl of oil and US$1.90/MMBtu of natural gas were used instead.
Adjustment of Ring Energy’s Oil Reserves
Source: Macrotrends / Crude Oil Prices 20 Year Chart
So here we want to do some slight adjustments.
Based on the long term trend, an estimate of the oil price closer to the US$52/Bbl is more reasonable. Observe the trend for the past 20 years. Oil prices had been hovering above US$40/Bbl, except during major market selloff and recession.
About 6% of Proved reserves was reduced from 2020’s 81 million BOE to 76.5 million BOE in 2019. For a quick back on the envelope estimate, we will deduct 6% from the Standardized Measure of 2019 to derive a more reasonable estimate of US$868 million Standard Measure of Discounted Future Net Cash Flows as of end 2020, instead of using the reported value of US$556 million.
Remember this US$868 million estimate as of end 2020.
Source: Yahoo Finance / Statistics
Given the current market cap of around US$240 million, a debt level of around US$313 million and deducting about US$3 million cash on hand, Ring Energy’s enterprise value works out to be about US$550 million.
Meaning that if you are buying the whole company, you will be paying US$550 million, or a 37% discount to its Proved oil and gas reserves, valued at US$868 million.
This Standardized Measure of discounted future net cash flows may not be a perfect measure, as it carries many assumptions. But it serves as a good reference to evaluate oil and gas companies.
Also, I want to highlight that we shouldn’t assume that companies should trade at a price that will equal the full PV-10 or Standardized Measure value.
Therefore, one way to get a better valuation will be to look at recent acquisition activities.
Reference From Recent Acquisition
Source: Diamondback Energy / Diamondback Energy, Inc. to Acquire QEP Resources in All-Stock Transaction
Take the recent acquisition of QEP Resources by Diamondback Energy for a value of US$2.2 billion, including QEP’s net debt of US$1.6 billion.
Meaning Diamondback is paying the equity shareholders of QEP the remaining US$600 million. Or basically for a total enterprise value of US$2.2 billion.
So what is QEP’s Proved reserves worth as of 2020?
Source: QEP Resources Annual Report 2020 / Standardized Measure of Discounted Future Net Cash Flows to Proved Reserves
Again, you can observe the substantial differences between the Standardized Measure of 2020 and 2019. This is due to the different average oil and gas prices assumptions used in the computation.
Similarly, there was about 5% reduction in the total Proved reserves from 382.3 MMboe in 2019 to 363.4 MMboe in 2020. Hence, we will reduce 2019’s Standardized Measure of US$2.676 billion by 5% to become US$2.542 billion as an estimate for 2020’s Standardized Measure of discounted future net cash flows, instead of the reported US$1.535 billion.
What this means is that, while Diamondback is paying US$2.2 billion for QEP, it is paying at a 13% discount to QEP’s estimated Proved reserves Standardized Measure of US$2.542 billion.
Doing this study of Diamondback Energy’s acquisition of QEP Resources is important. Because it represents the actual market value of the Proved resources, and how much companies are actually paying for it.
Ring Energy’s Valuation Estimate
So, assume a similar valuation for Ring Energy stock. Say another company acquires it at a 13% discount to our estimate of its Standardized Measure of US$868 million as of end 2020. It will be transacted at a value of US$ 755 million.
Then deduct the net debt of around US$ 310 million from this figure. The amount that Ring Energy’s equity shareholders will get is US$ 445 million.
Therefore, at the current market cap of US$240 million at around US$2.40 a share, this will translate to a discount of 46%.
Put it in another perspective, it represents an 85% upside potential for investors entering now.
Finally, I want to highlight quickly regarding management’s capabilities and track record.
Proven Track Record
Source: Ring Energy Inc
Understand that Ring Energy’s Co-Founder and Chairman Tim Rochford along with Co-Founder Stan McCabe took their previous venture, Arena Resources, from US$0.13 a share in 2001 to US$43 a share in 2010, when it was acquired by SandRidge Energy.
Source: Chron / SandRidge Energy buying Arena Resources in move to oil
This represents a 330 times return in less than 10 years.
Thus, this proven track record shows that the leaders and management have the capabilities to help Ring Energy to navigate through the tough periods. Investors should have confidence that they will be able to unlock value for its shareholders eventually.
Also, given the company’s relatively high debt levels, we saw management recognize that as well.
Instead of continuing to expand and acquire other properties, management is focused on deleveraging and creating a healthier balance sheet.
Source: Ring Energy / Announcement of Fourth Quarter and Full Year 2020 Results
As such, it is good to see that the company has been generating positive Free Cash Flow for the fifth consecutive quarter.
And that management is using it to pay down debt. In fact we saw that the company managed to pay down US$ 75 million worth of debt in 2020 itself.
To wrap it up, we believe that Ring Energy stock is undervalued, trading at a 46% discount. And for investors thinking of getting in now, it still represents a potential 85% upside in terms of capital gain.
However, given that Ring Energy is a small cap company and very much linked to the fluctuations in commodity prices of oil, as well as the fact that we are still not entirely out of the pandemic situations yet, do expect some strong volatility in the short term.
And do monitor the company to look out for any potential liquidity risk due to the current debt levels.
Then again, I’m pretty positive that substantial value can be uncovered eventually. Definitely adding this to my portfolio. And adding more when the share price goes south.
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