BUY (UNT, $33.67)
Diversified E&P Firm Offers Exposure to Both Upstream and Midstream Assets
May 20, 2015
Glenn Williams Jr.
We are initiating coverage on Unit Corporation with a BUY rating and $40 price target. With a 45% year over year decline in prices, we argue that UNT’s base of proved reserves, and production profile warrant a higher valuation. Moreover, with 3 separate business units (upstream drilling, midstream processing, third party drilling), Unit offers a level of diversification not common in small cap E&P’s.
Unit’s wells boast solid economics, despite the company’s use of (what we consider) a “conservative” price deck. While “conservative” is subjective, we note that Unit’s wells in its primary drilling regions, boast projected return rates of greater than 44% (Medrano), 90% (Marchand Sand) and 110% (Wilcox trend) respectively. More important to us however is Unit’s use of a price deck that sits approximately 16% below the current market for oil, holding that price constant for 2 years (before reverting to the futures strip for subsequent years). As such, we contend that Unit’s return rates are understated in any environment where oil exceeds $50 per barrel.
Unit’s “conservative” nature extends to its balance sheet, with a 30% net debt to total capital ratio. And given the prolonged decline in oil prices, we expect that many E&P firms with over leveraged balance sheets will potentially need to either shed assets, or file for outright bankruptcy in 2015. We contend that Unit can be opportunistic should this occur, acquiring assets at a discount along with additional production. At a minimum, we contend that Unit’s balance sheet will allow them to weather the storm of future declines in oil prices.
We base our valuation on a sum of the parts valuation, giving credit to each of the 3 business units. Our sum of the parts valuation assigns $29 per share to Unit’s upstream operations, while its contract drilling and midstream operations are assigned $9 and $2 per share respectively (exhibit 8). Thus, given the 19% implied upside to current prices, we initiate coverage on Unit with a BUY rating.
Source: Capital IQ; National Securities Corporation
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