Laredo Petroleum: Reviewing Its Prospects With Lower Oil Prices

Laredo Petroleum (LPI) has run into some recent challenges with its wells becoming gassier than expected and higher-density development resulting in oil production tracking a decent amount below type curve in 2018. Laredo is switching to lower-density development in 2019, which should alleviate those issues, although it may still end up with a modest amount of cash burn in 2019 at current strip prices.

2019 Outlook

At $53 WTI oil and $3.15 Henry Hub gas in 2019 (close to current strip prices) along with current differentials, Laredo may generate around $730 million in oil and gas revenue during 2019 after hedges. There is another $6 million in net midstream service revenues.

I’ve used 70,500 BOEPD total production (40% oil) in these calculations, which would be similar to Laredo’s expected Q4 2018 production. This would also result in around +3% total production growth and +1% oil production growth compared to its projected full-year 2018 results.

Laredo’s 2019 hedges are primarily basis hedges (for both oil and gas) that currently have positive value, especially with the WAHA natural gas differentials becoming quite wide (around negative $1.75 to Henry Hub in 2019). Other than its basis hedges, Laredo’s oil hedges are mostly puts that kick in at $47.45 per barrel.

Barrels/Mcf $ Per Barrel/Mcf (Realized) $ Million
Oil 10,293,000 $49.00 $504
NGLs 7,719,750 $18.50 $143
Natural Gas 46,318,500 $1.40 $65
Hedge Value $18
Net Midstream Service $6
Total Revenue $736

Laredo had mentioned before that a small outspend would result in oil production growth similar to 2018 (+7.5%). However, that was when 2019 oil futures were around $10 higher than they are now.

Thus, I have modeled a lower $520 million capital expenditure budget for Laredo here, along with slight (+1%) oil production growth. Since Laredo is mostly exposed to changes in WTI oil prices in 2019, the lower oil prices still result in around $59 million in outspend.

$ Million
Lease Operating Expense $94
Production and Ad Valorem Taxes $44
Marketing and Transportation $21
Cash G&A $64
Interest $52
Capital Expenditures $520
Total Expenses $795

If Laredo wants to match operational cash flow to capital expenditures at low $50s oil, it will probably end up with a low-single-digits decline in oil production compared to 2018.

Performance Notes

Laredo’s well performance versus type curve has been fairly weak in 2018, with total production averaging around 5% below type curve, a significant change from previous years when total production tracked well above type curve.

Source: Laredo Petroleum

Oil performance has been below type curve by 12% in 2018, while the oil outperformance versus type curve in previous years has diminished as the wells trended towards a lower oil cut.

Source: Laredo Petroleum

Laredo believes the relatively weak well performance in 2018 has been partly driven by high density development. Laredo is planning on bringing lower density package to production in mid-2019, which should help increase its oil cut as well as bring performance back to type curve levels.

It noted that the strong performance with 2016 wells was due to a very low amount of infill wells then, so it doesn’t expect its newer wells to be able to get to that level of outperformance versus type curve.

The lower density development should help Laredo’s capital efficiency though.

Source: Laredo Petroleum

Notes On Valuation

Laredo’s enterprise value is currently around $2 billion, which appears fairly cheap at around 4x estimated 2019 EBITDA (without hedges) at low $50s oil. As well, if Laredo’s current production was valued at $25,000 per flowing BOE (reflecting the relatively low oil percentage), its acreage would be valued at under $2,000 per net acre.

While Parsley Energy (NYSE:PE) considers Laredo’s acreage to be Tier 1 instead of core, this still appears to be a low price for Laredo’s assets. The below image shows Parsley’s leasehold in yellow and its 2016 acquisitions in red. I have posted a map of Laredo’s acreage further down so that one can see how its acreage matches up with Parsley’s views on the area.

Source: Parsley Energy

Laredo’s leasehold is in yellow in the below image, and when comparing with the above image, one can see that pretty much all of Laredo’s acreage is in what Parsley considers a Tier 1 (not core) area.

Source: Laredo Petroleum

Laredo’s share price has been hit pretty hard since it is burning cash in 2018 and will probably burn a bit of cash in 2019 as well if it wants to maintain production levels. Companies that are burning cash and have non top-tier acreage have been hit pretty hard in the last couple months. However, I think there is a good case based on both asset value and projected EBITDA that Laredo should be worth a significantly higher amount such as $8 per share.

To get to that value though, the oil market would probably need to stabilize and then improve a bit, while Laredo’s lower-density development would need to show type curve or better results.

Conclusion

Laredo’s stock looks pretty cheap now as it is trading at around 4x estimated 2019 EBITDA and only a modest amount of value is attributed to its acreage. It is in okay shape at low $50s oil, but would probably want oil prices to rebound a bit higher to gain more credit for its acreage. The acreage value has been challenged a bit by the downturn in oil prices (which affects non-core acreage values more) as well as the switch to lower density development (resulting in lower inventory). Laredo could still be worth $8 per share with a modest rebound in oil prices, plus solid results with lower-density drilling though.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in LPI over the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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