choness/iStock via Getty Images

choness/iStock via Getty Images

PDC Energy, Inc. (NASDAQ:PDCE ) did not only increase its proven reserves, the management also announced an acquisition. Besides, PDCE raised its FCF guidance with more than $1.1 billion in 2022, which would imply a future valuation of much more than the current mark. In my view, the Board Of Directors is aware of the current undervaluation of the stock, and reacted well by implementing a stock repurchase program. I will be buying shares as I see that PDCE intends to reduce its debt, and is operating most of its own wells.

PDCE is an exploration and production company with operations in the Wattenberg Field in Colorado and the Delaware Basin in west Texas.

The recent increase in the oil price is appealing. I believe that it is the right time to have a look at the company’s business model. In my view, with the recent increase in proved reserves delivered for the year ended December 31, 2021, PDCE will likely receive a lot of attention from investors.

Note that the PV-10, which is the NPV of the future net cash flows from proved reserves, increased from $3.2 billion in December 2020 to more than $7.9 billion in 2021:

After the acquisition of Great Western, I would expect significant FCF generation through inorganic growth. In my view, if the transaction closes successfully, the demand for the stock will increase as analysts will increase their sales and CFO expectations:

On February 26, 2022, we entered into a definitive purchase agreement under which we will acquire Great Western for approximately $1.3 billion, inclusive of Great Western’s net debt. We expect the Great Western Acquisition to be completed in the second quarter of 2022, subject to certain customary closing conditions. Source: 10-k

The company gave some guidance in the last presentation, which included more than $1.1 billion in FCF in 2022 and close to $1.4 billion in 2023. Besides, the Board of Directors also promised to maintain a base dividend of close to $100:

Year End Earnings and Core Wattenberg Acquisition

Year End Earnings and Core Wattenberg Acquisition

With the crude oil price increasing at a large pace, most investors may be looking for companies in the petroleum industry with existing inventory. PDCE does have an inventory of proven reserves in Colorado and Texas, which makes the stock an appealing pick. In my opinion, free cash flow will likely accelerate as drilling and production evolve in those areas:

We have a substantial multi-year inventory of high-quality horizontal drilling opportunities across two premier U.S. onshore basins: the Wattenberg Field in Weld County, Colorado and the Delaware Basin in Reeves County, Texas. Our portfolio has a proven record of delivering strong and repeatable economic returns and provides us the ability to allocate capital investments and manage risk as each basin has its own operating and competitive dynamic in terms of commodity price markets, service costs, takeaway capacity and regulatory and political considerations. Source: 10-k

It is also very relevant that PDCE does operate a substantial number of its own wells, which means that management has full visibility of what’s going on. With this in mind, I would be expecting better efficiency ratios and better FCF margins than other competitors in the American petroleum industry:

We currently operate approximately 78 percent of all the wells in which we have an interest. This operational control allows us to better manage our drilling, production, operating and administrative costs and to leverage our technical expertise in our core operating areas. Our leaseholds that are held by production further enhance our operational control by providing us with additional flexibility on the timing of drilling of those locations. Source: 10-k

I would also highlight that PDCE appears to offer the latest technology in the petroleum industry. In the last annual report, management reported the use of digital technologies, and the ability to operate longer length lateral wells, which make PDCE’s operations more efficient. In my view, if management continues to invest in technology and innovation, FCF will likely grow:

Efficiencies are also driven by digital technologies such as artificial intelligence, machine learning and process automation technologies, which are utilized in our field and corporate operations. Additionally, acreage consolidation in both of our operating areas increases our ability to drill longer length lateral wells. Longer laterals allow us to develop our properties with a smaller number of wells and less truck traffic, with resulting benefits for our operations, the environment, and the communities in which we operate. Source: 10-k

Finally, I am also optimistic about management's intention to reduce indebtedness. In my view, with less debt obligations, both the cost of debt and the WACC would decline, which would enhance PDCE’s stock valuation:

Through successful execution of our business plan, as of December 31, 2021, we reduced our indebtedness to below $1.0 billion, had total liquidity of $1.5 billion, and had a leverage ratio, as defined in our revolving line of credit facility agreement, of 0.6x. Source: 10-k

Under my previous assumptions, I assumed sales growth close to 2% from 2025 to 2028, which implies 2028 sales of $5.4 billion. I also assumed an EBIT margin close to 51%-22% and capex/sales of 29%. My numbers are a bit optimistic, but they are in line with the figures reported by PDCE in the past:

My results included 2028 EBIT of $856 million, 2028 D&A close to $1.1 billion, and 2028 capital expenditures of $1.1 billion:

If we assume cost of debt of 6%, cost of equity of 4.57%, and a WACC of 9.7%, the NPV terminal value should stand at $14 billion, and the implied price would be $102:

Note that I used a conservative exit multiple of 6.7x EBITDA, which is close to the sector median EBITDA of 7.56x. Other financial advisors may use a different exit multiple, but I don’t expect their EV/EBITDA ratios to be far away from that of mine:

PDCE could suffer from a substantial number of risks that not only include a decline in the price of oil and gas, management may face from time to time lawsuits claiming that the company does not respect environmental regulations. It did happen in the past:

From time to time, we have been subject to sanctions and lawsuits relating to alleged noncompliance with regulatory requirements. For example, in October 2017, in order to settle a lawsuit brought against us by the U.S. Department of Justice, on behalf of the EPA and the State of Colorado, we entered into a consent decree pursuant to which we paid a fine and agreed to implement certain operational changes. Source: 10-k

Under this case scenario, among different drilling problems that PDCE may suffer, I would include the lack of water. As a result, management may not undertake hydraulic fracturing, which is necessary under some of the PDCE’s wells. I would also be very concerned if authorities decide to block the injection of water. As a result, both the production of crude oil and the identification of new reserves could diminish:

Drilling and development activities such as hydraulic fracturing require the use of water and result in the production of wastewater. Source: 10-k

For example, in November 2020, the COGCC adopted various new requirements on the underground injection of fluid waste. In December 2021, the Texas Railroad Commission suspended the deep injection of wastewater in the Gardendale Seismic Response Area. Source: 10-k

Under the previous traumatic events, I would say that net sales may decline between -5% and -10% from 2024 to 2028. The EBITDA margin may also decline from 55% in 2025 to 45% in 2028:

If we also assume a WACC of 10% and an exit multiple of 5x, I obtained a net present value of the terminal value close to $5 billion, and the implied share price should stand at $55:

As of December 31, 2021, PDCE does not only report an asset/liability ratio of 2x, but also $33 million in cash and properties worth $4 billion.

PDCE also reported $942 million in long-term debt. However, I could see that management is really working on reducing its debt obligations. Note that one year earlier, the company reported $1.4 billion in long-term debt:

I do believe that the current valuation fails to represent future free cash flow. The good news is that the Board of Directors seems to agree that there is some type of undervaluation in the stock price. In my view, the recent stock repurchase agreement announced in February may enhance PDCE’s valuation:

In February 2022, our board of directors has also approved an increase to our Stock Repurchase Program to acquire up to $1.25 billion of our outstanding common stock through December 31, 2023. Source: 10-k

With many organizations changing their petroleum industry outlook after the recent increase in the crude oil, PDCE may gain more and more attention in the market. The company did not only recently increase its proven reserves, management also announced an acquisition, and increased its free cash flow guidance for the years 2022 and 2023. In my view, if the company continues to operate most of its own wells, and keeps investing in technology, the FCF margin will likely remain solid. In any case, I believe that the current stock price fails to represent the future FCF. I am a buyer.

This article was written by

Disclosure: I/we have a beneficial long position in the shares of PDCE either through stock ownership, options, or other derivatives. 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.