This is a Z4 Research quick update note.
Please note that we had thoughts on the 2Q20 report here. In short the quarter was solid highlighted by an EBITDA beat on strong prices and good cost control with guidance trending towards where we wanted it. However, we were taken off guard (and we believe the Street was as well) by the lack of Q&A session with the 2Q20 report. We sold our position as noted under that article at $1.21 at the close of the call as management reiterated and expanded upon a more cautious outlook for the coming fall credit facility redetermination. We have since re-entered the position for a high risk but potentially high reward trade as the name fell sharply in the wake of our punt. For reference:
- 1Q20’s conference call comment: “We recently completed our spring borrowing base redetermination and while we have seen an uptick in 2021 gas strip prices, unfortunately the bank price decks were not reflective of this upward momentum. Overall, the banks remain very cautious and conservative and that is reflected in our $700 million borrowing base.“
- 2Q20’s call comment: ” We continue to explore a wide range of alternatives to best position Gulfport for the future. As part of that effort, we recently received an amendment from our bank group that allows us to issue up to $750 million of second lien debt to facilitate our ongoing liability management initiatives. However, given the historical low pricing environment we are seeing, banks remain extremely conservative and many are looking to reduce their exposure to our industry. Accordingly, we remain very focused on improving our balance sheet and cost structure as we face a borrowing base redetermination and the necessary extension of our revolver this fall.”
We also note that the 2Q20 call saw the addition of standard “going concern language” to the 10Q due to the increased difficulty in refinancing existing debts and concern that commodity prices could retreat further yielding a further reduction (note 1) in their borrowing base in November 2020 and this could ultimately lead to a chain of unfortunate events resulting in reorganization.
- (1) Note that the Spring 2020 redetermination already saw the borrowing base fall from $1.2 B to $700 mm and the commitment level retreat from $1.0 B to $700 mm as well.
Management reiterated they are working with their advisors (not new that they were) to improve the balance sheet.
The stock started falling at the close of the 2Q20 call (again, we sold it) and ultimately fell to a low of $0.56 in the days following the call.
Fall 2020 Bank Redetermination – the danger for the shareholder comes from a liquidity event in which the borrowing base could be redetermined below the currently outstanding balance. The current borrowing base is $700 mm and at last report (2Q20 numbers) they had:
- $123 mm outstanding on the facility,
- and another $324 mm in letters of credit.
That is $447 mm of bank “borrowings” that go against the $700 mm. The borrowing base could be cut if the banking group does not see enough movement in the natural gas futures strip or on the cost front. Again, this happens in November. While the banks approved an amendment allowing the company to issue a second lien note of up to $750 mm there is no guarantee that this offering will be successful, or even if successful, it will be enough to repay the banks. If they are successful in issuing 2nd lien notes the first use would be to pay down the revolver balance. Then we would think they would sit on the remaining funds to bolster their liquidity profile. In this event the senior notes, which have been drifting higher in recent days (see cheat sheet, debt section), would likely improve further signaling less fear to equity investors.
In the interim:
- We expect Gulfport to show positive free cash flow in 3Q and 4Q20. This is supported by stronger production into year end, an improvement in natural gas prices since the time of the call (they’re only 45% hedged in the back half), realizations that were trending towards the lower end of expected differentials, and costs that were expected to trend lower. 2H20 free cash could amount to over $30 mm which could be used to further reduce the outstanding revolver balance.
- We expect management to bolster their 2021 hedge position. We note the Strip is up markedly from the end of July and the calendar strip at $2.91 has moved just above their targeted range for adding to hedges of $2.60 to $2.90.
Nutshell: This is a risking trading position that we currently hold, again. It’s less than 3% of our assets in the ZLT. For now this is a Trading Only vs a Core position and we could sell it at any time. We don’t know if Gulfport will be successful in marketing the second lien and/or convincing the banking group to reaffirm the current borrowing base.
- We do see modest free cash generation in 2H20 as they spend less capital on drilling and turn more wells to sales in this recently higher natural gas price environment. This thought of higher gas prices has worked well in terms of management’s plan for 2020.
- We suspect they are bolstering the 2021 hedge book as the calendar strip has risen above the upper end of their recent thoughts on pricing (they remarked $2.60 to $2.90 and we’re at $2.91 calendar today). More of their 2021 expected production hedged would also help their case with the banking group. As of the 2Q report they had significant room to hedge should prices move into their targeted range (which they have).
- We suspect investors will hear something about the 2nd lien prior to or with the third quarter call that generally occurs in late October but of course don’t know that for sure either.
- Given the overall debt metrics here and our $2.50 and $3.00 natural gas cases (see $2, $2.50, and $3.00 cases near the bottom of the cheat sheet) we expect alleviation of concern regarding the borrowing base to result in substantial upside for the name. Each $0.40 increment in the share price would represent only a 0.1x increase in our $3.00 cash 2021 TEV/EBITDA multiple (so $1.15, 53% above current levels would only nudge the multiple to 3.65x on that case).
- Anyway, there is not a good mechanism within Seeking Alpha for me to make you aware of our trades and given that this is a trading idea and potentially not a longer term hold that seems problematic. If we add or sell the position it will be noted at Z4 Research and subsequently here in the comments below in as timely a manner as possible.
Disclosure: I am/we are long GPOR. 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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