Civitas Resources: Potential Future Dividend Increases (NYSE:CIVI)

Investment thesis

Civitas Resources, Inc. (NYSE:CIVI) is heading for a great 2022 with guidance that the company will grow its production by 2-9% and grow the oil production by double digits. All of the external factors are in their favor such as the longer-than-expected elevated WTI and natural gas prices, the energy consumption growth until 2050, and the Russian oil embargo. All of this combined with a recent oil and gas acquisition that will help to grow the production by 9,000 barrels per day will very likely mean a bright 2022 for CIVI.

Business Model

Civitas Resources, an exploration and production company, focuses on the acquisition, development, and production of oil and natural gas in Colorado. Civitas is Colorado’s largest pure-play oil and natural gas producer. Their current capacity is 153.5 MBoe/day. It is almost evenly distributed between oil (40%), Natural gas (33%), and NGL (26%). In addition, CIVI owns approximately $300 million worth of midstream infrastructure. The majority of this infrastructure is gas pipelines and the company is currently expanding its oil pipelines in the Southern region.

Q4 results and 2022 expectations

I think there is no surprise for anyone that the company well exceeded daily sales volumes and production on a year-on-year basis. As the U.S. economy returned to pre-pandemic growth and the COVID-19 restrictions were eased, energy consumption and oil production went back to pre-pandemic levels. CIVI reported a better-than-expected GAAP EPS of $2.46, almost double the expected EPS of $1.32. The management could also keep the expenditures within its previous guidance of $220-260 million. In February 2022 the company also agreed to acquire Bison Oil & Gas II for $346M in cash and stock. This acquisition will increase CIVI’s production by approximately 9,000 barrels per day from the second half of 2022.

The management expects a total production growth between 1.6%-8.8% for 2022. In 2021 the company could produce 61.4 MBbl/d and the management’s guidance is 69-75 MBbl/d for this year, this would mean a whopping 12.4%-22.1% capacity growth. Even with their current -$6/barrel difference to WTI CIVI would realize fantastic profits with WTI being around $100 per barrel and there are no signs of it coming back to pre-war levels.

External positive factors

We can say that almost all of the external factors are in CIVI’s favor for the upcoming years. Let’s start with the basic one: energy consumption. The U.S. energy consumption will increase until 2050 and the renewables will increase their share in the total energy mix, but on a net basis, we will need more natural gas. The power demand of Colorado is a bit more complicated due to regulations but one thing is crystal clear: Colorado has a growing population, especially in the urban areas and those people will need electricity and heat. This means that despite regulations the energy consumption in Colorado will also increase in the upcoming years. In terms of the oil price, WTI prices increased by approximately 38% YTD. This is mainly due to the Ukrainian war and as it seems we are facing a longer-than-expected war and that will cause oil prices to remain at these elevated levels. In addition, there are new Russian sanctions on the oil and gas sector. The latest one is that Germany will no longer buy oil from Russia and stop oil imports by the end of the year. (I do not think it is 100% possible but within a couple of years it can become a reality.) This will also support the elevated oil prices as cheap Russian oil will no longer be on the western markets.

Valuation

The current price seems fairly valued however due to all of these external factors and with the elevated gas and oil prices, a longer-term $73-75 per share is not impossible. This is because calculating with a long-term $70 WTI and $3.5 NYMEX gas would mean an estimated value of CIVI around $62 per share but the long-term WTI is very likely to be around $80 while NYMEX gas is $4+. (I calculated with 9.7x EV/EBITDA, 2.5 EPS TTM, and 4% growth rate). Although the company increased its net debt due to the Bison Oil & Gas acquisition these liabilities will diminish over time as the increased production grows the net sales.

Company-specific Risks

The decline of oil, natural gas, and NGL prices will adversely affect CIVI’s business, financial condition, and ability to meet its capital expenditure obligations and financial commitments. This is not a major threat at the moment but it is worth mentioning because, in recent years, the markets for oil and natural gas have been volatile. When inflation pressure eases and the Ukrainian war will be over, the oil prices will return to “normal” levels. According to forecasts they expect the normal price to be around $70-80 per barrel.

As a sector risk, we have to mention the substantial capital expenditures of exploration, development, exploitation, and production projects. This is not a new risk factor but an ongoing sector risk. At the moment CIVI is well covered with enough dwells and production capacity but this can turn within years if they cannot cope with the elevated oil and gas demand.

The largest risk factor I see at the moment is the accident risk. I am sure we all remember what happened to BP in 2010 in the Gulf of Mexico. The company had to pay tens of millions for legal settlement fees, cleaning costs, and not to even mention the reputational damage. (BP had to completely rebrand itself to appear as a “green” company and emphasize its ESG initiatives.) Of course, on this scale it is not going to happen to CIVI however, the potential accident risk factor is real.

My take on CIVI’s dividend

Current dividend

CIVI pays a regular quarterly dividend and a special dividend based on the available free cash flow. The management calculated the first special dividend by payout out 50% of the average quarterly free cash flow after the base dividend. CIVI is paying a $0.4625 per share quarterly dividend and is yielding at 2.82% without the special dividend. Taking into consideration a special dividend of $0.75 per share CIVI has a dividend yield of 3.97%.

Future sustainability

The company has a very well sustained and secure dividend. It has a very low payout ratio and even in case of the oil price would decline by 30-40% the regular quarterly dividend would still be sustainable. And as it seems we can expect the currently elevated oil prices to continue in 2022 which means I expect a special dividend in Q1 2023. According to analysts’ estimates, the regular dividend would remain at the current level.

Final thoughts

CIVI is a stable oil and gas production company with serious upside potential due to external factors. The positive external factors are also supported by the management’s recent acquisition which will help increase the production in 2022. I expect a large number of special dividends in the first quarter of 2023 and I see a possibility that the management will increase its quarterly dividend as well.