Berry Stock: The Singularity Approaches (NASDAQ:BRY)

Introduction

A good bit of water has passed under the bridge since we discussed Berry Corp, (NASDAQ:BRY). It ramped up from $5.8 to $10.50 shortly after that bullish article in September of last year. Over the short haul, we didn’t see a reason to revisit afterwards. There were a lot of other things to discuss, and we really couldn’t think of a catalyst for the company. Now we might have one. Energy Security is a catch-phrase that’s starting to make the rounds these days.

BRY had been stuck in the $8-10.00 range for about 6-months now, but recently spiked through $11.00. There are a lot of reasons it could have broken out of that range before now, but there was one reason in particular that weighed them down. They are primarily a California operator and has suffered from that association. That’s it really.

But this location could turn into an advantage as the year rolls on. Hear me out. (Get ready, the catalyst pitch is coming.) Oil supplies are tight, and California imports most of what they need.

California is heavily dependent upon foreign sources for their oil as the graphic above indicates. Below we see the sources of their imports, and there are some problem areas. Primarily Saudi Arabia, which as I noted, in recent articles, is aligning itself much closer with Russia these days. That could spell trouble.

The world is dividing itself into new “camps” and spheres of influence. Even with the dramatic impact we know that sanctions are having on the Russian economy, it is far too early to say how lasting they will be. But, Russia, China, The Saudis, and quixotically, Iran all have something in common. They either don’t like America, or want to replace her on the world stage. Long term that could spell trouble for California and make the state rethink its antipathy toward its domestic oil industry. I think better times are coming for Berry.

Note- this article was published in the Daily Drilling Report a few weeks ago.

The thesis for Berry

The term ‘Singularity’ has several definitions. The one upon which I drew for this article’s title is best described in an article carried in Gizmodo–

The term singularity describes the moment when a civilization changes so much that its rules and technologies are incomprehensible to previous generations. Think of it as a point-of-no-return in history.

I will admit to taking a teensy bit of license here and stretching this definition just a hair. But not much more. In my view, which I’ve stated in numerous articles and commentary is that we are fast approaching an inflection point, where when we look back we will be astounded at the degree to which the world was hoodwinked by the green energy crowd. I suppose the best recent example of this contention was my January article on BP, where I chided them for throwing oil money down the windfarm rabbit-hole. (They are still doing it.)

“BP: Investors Have Questions About the Energy Transition“

I now think that perhaps California may be on the precipice of rethinking it’s anti-oil stance, at least in some degree. Maybe just a little at first. If the oil shortages I’ve been postulating come to pass as are now widely forecast, there’s a sea change coming. It’s going to be a torrent. Chris Wright of Liberty Oilfield Services, (LBRT) wrote a piece carried in David Ramsden-Wood’s blog. Hot Take of The Day, that summarizes this coming predicament fairly well-

The energy transition isn’t failing for lack of earnest effort. It is failing because energy is hard, and 3 billion people living in energy poverty are desperate for reliable and scalable energy sources. Meanwhile, 1 billion energy-rich people are resistant to diminishing their standard of living with higher cost and an increasingly unreliable energy diet.

Some sunny day, Gavin Newsom is going to pick up the phone and call Trem Smith CEO of Berry, and say something like, “Can you help a brother out?” On that day the Singularity will have arrived. It’s not the purpose of this article to discuss how far behind the curve of energy security, the government of California is at this point. Or how difficult it will be for the industry to respond in the way the governor will hope can be achieved. There will be time for that discussion soon.

Once I got over being grumpy about them changing their name to Berry Corporation from Berry Petroleum – a disease that’s going around currently with oil companies – I saw a company with tremendous potential. Except, for that one little thing discussed above. None-the-less, there is something else that might have the politicos in Cali, ripping through their Filofax (what business people used before cell phones), and dialing up Trem Smith, CEO of Berry.

Berry is an operator with long-life, low decline reserves-13% annually, mostly in the State of California, with a heavy concentration in Kern country. The Kern Valley is the steam-flood capital of America. At ambient temperatures you can ball it up and throw it at… whoever comes to mind. (Not a good idea.)

The point here, as I’ve pointed out in recent articles, is that we need this sub-30 gravity stuff and Cali has a lot of it. It turns out that not all heavy oil has to come from a foreign source! Imagine that!

CEO Trem Smith comments on the Berry production advantage-

Our 2022 goal is to maintain our production, which means we plan to keep production flat year-on-year. Let me briefly summarize how we do this. Our low decline production accounts for 90% of our production needs. The remaining 10%, which requires new permits, is achieved by drilling new wells for 6% of the production, and by doing workovers in existing wells for the remaining 4%. Bottom line, 90% of our cash flows come from production out of existing producing wells.

I have no idea when or if the anti-oil mentality will be modified in the great State of California. Decades old opposition to E&P development is deep seated. Still, a few days of “out of gas” signs could change that narrative in short order. High prices or not, most of the 40 mm odd cars, trucks and buses that California hosts, run on petroleum products, and if they can’t get it there will be an uprising.

The company has recently reinstated and boosted its dividends, announced an aggressive shareholder return model, repurchased 7% of its shares for $52 mm, with another $48 mm of availability for future purchases, increased production by 5% YoY, made a strategic asset disposition, reduced debt, and entered a new business on the service side. In short in addition to this, with PV-10 reserves worth $1.5 bn at $69 Brent, which exceeds their current market cap by a factor of nearly 2, we think Berry presents an attractive entry point at current prices.

Berry’s Q4 2021

The company generated $212 mm of hedged EBITDA in 2021 and over $300 mm unhedged, with a quarter of that coming Q-4. Production, which is 92% oil was increased by 5% while holding capex of $128 mm firm. Capex will rise in 2022 to $138 adjusting for higher costs, increased production forecasts, and the activities of their well servicing division. The company has about 10% of its daily production hedged to the Brent strip starting at $70 and rising gradually through 2023/4. Some of this hedging is driven by covenants on their untapped RBL. Berry has $15 mm of cash on the books, and ~$397 mm of LT debt with a 2026 maturity.

Another Catalyst for BRY

Berry bought C&J Well Servicing for $94 mm last year. C&J has a good business with well abandonments forming a key base for their activity. Kern country has hundreds of thousands of stripper class wells making less that 25 BOPD in many cases. There are also about 35,000 orphan wells, administered by the state that need work. There is an ever-important ESG over tone in this business as capping these wells eliminates methane emissions and helps C&J and qualify for state largesse along these lines. Trem Smith comments–

C&J is also uniquely positioned to capture state and federal funds estimated to be $300 million to $400 million over the next two years, to help remediate orphan wells. These are wells for which the state is liable. California has a reported 35,000 orphan and idle wells, many of which are in densely populated LA County. A core competency of C&J is its ability to plug and abandon the complex orphan wells in highly populated, often distressed communities. This reduces GHG leakage into the atmosphere, and potentially reduces health risks to nearby communities.

Your takeaway

Berry generated $160 mm of OCF in Q-4 on annual basis at an average realized price for Brent in the upper $60’s. The EV/OCF multiple here is 7.5X, which without the impact of the catalysts we are thinking might kick in this year. This realizations spread should significantly improve for Q-1, with the run we have seen above $100 in Brent. I can easily see OCF rising to $250 mm on an annual basis. To keep this multiple the same the shares will have to rerate toward $20 per share. This doesn’t seem farfetched to me, and could take the current enhanced dividend from the $1.90 per share basis toward $2.25-2.50 per share.

I don’t see Berry being overpriced at a PFB basis either. BRY is selling for $44K PFB. With its unhedged exposure to the market price of Brent for the other 90% of its production, cash flow will be significantly enhanced. Most analysts rate BRY as a hold with a price target range of $10-16.00 per share. I am sure this is driven by the regulatory environment in the state.

Now a word of caution on this one. There are so many anti-oil initiatives in California that could adversely affect the company’s fortunes that I will rely on their disclosure below to enumerate.

There are approved permits for the first quarter of this year, but the regulatory environment in Cali is very extreme and could adversely affect the company’s ability to obtain permits for new wells. The market is not currently discounting the stock for this risk, so I am not going to either. Investors should be keenly aware of this mentality however.

That said, the whole thesis I’ve presented for the stock is under-pinned by a demand for energy security taking precedence to the climate oriented mentality that exists now. We will see if this actually occurs as the year progresses.