{"id":1092243,"date":"2018-12-31T16:52:56","date_gmt":"2018-12-31T16:52:56","guid":{"rendered":"https:\/\/oilandgas-investments.com\/?p=31019"},"modified":"2018-12-31T16:52:56","modified_gmt":"2018-12-31T16:52:56","slug":"why-do-og-producers-do-share-buybacks","status":"publish","type":"post","link":"https:\/\/juniorminingnews.com\/?p=1092243","title":{"rendered":"Why Do O&G Producers Do Share Buybacks?"},"content":{"rendered":"

On December 13, 2018 Pioneer Resources (PXD:NYSE)<\/strong><\/span> announced<\/a> a whopper of a share buyback program \u2013 $2 billion, up from the existing program that covered re-purchases of up to only $100 million.<\/p>\n

Great news for shareholders right?<\/p>\n

I\u2019m not so sure.<\/p>\n

I\u2019m feeling feisty this Christmas.\u00a0In fact I\u2019m going to play a little bit of Devil\u2019s Advocate and make a bit of a bold blanket statement\u2026.<\/p>\n

I think oil producers repurchasing stock is a bad idea!<\/p>\n

\"1\"<\/p>\n

Before You Call Me Names \u2013 Hear Me Out<\/span>\u00a0 <\/strong><\/p>\n

Don\u2019t shoot before you hear the reasoning behind my message.<\/p>\n

I understand perfectly well the value of share repurchases and how effective they can be \u2013 when done buying back shares that are trading for less than intrinsic value.<\/p>\n

In fact I love the idea of a smart Board of Directors taking advantage of an opportunity presented by a depressed stock market use repurchases to \u201cgoose\u201d earnings per share.<\/p>\n

I just happen to think this industry is different.\u00a0This industry is tough.<\/p>\n

My suggestion is that for oil producers (or any commodity producer really) there is a smarter place to put excess cash than into share repurchases. That place is the balance sheet.<\/p>\n

I suggest that these companies should keep reducing debt until they don\u2019t have any. Seriously \u2013 none.<\/p>\n

And after that I wouldn\u2019t minds seeing them build a bit of a cash hoard.<\/p>\n

These are the things I think (with a dose of Devil\u2019s Advocate)\u2026\u00a0now let me tell you why.<\/p>\n

Reason #1 \u2013 In The Commodity Business Low Cost Wins Always<\/strong><\/span><\/p>\n

This is a painfully cyclical business.\u00a0It never fails to amaze me is how extreme the high and low points are\u2026\u00a0and how frequent.<\/p>\n

But this (gut-wrenching) cyclicality is what creates such great opportunities.<\/p>\n

For the producers however it must be a nightmare.<\/p>\n

From 2010 through mid-2014 the price of WTI crude ranged from $73 to $107 per barrel.\u00a0If you had told the CEO of any oil producer at that time that in 2016 WTI would hit $26 per barrel they all would have laughed at you.<\/p>\n

But that is exactly what happened and it happened without a recession<\/em>!<\/p>\n

That cyclicality isn\u2019t going away and nobody knows where commodity prices are going.\u00a0Recent history shows that prices can go to absurdly low levels. Companies can hedge their commodity price risk for a period of time, but they can\u2019t hedge it forever.\u00a0Plus that hedging is expensive.<\/p>\n

The best way for companies to make sure that they always stay profitable is to have the lowest cost operations possible\u2026\u00a0and that includes interest expense.<\/p>\n

Having as little debt as possible is a certain way to have an \u201call-in\u201d operation cost per barrel advantage over the competition.\u00a0Remember this is a commodity business\u2026\u00a0you can\u2019t differentiate yourself on the quality of your product.<\/p>\n

You have to gain your advantage by being a low cost producer.<\/p>\n

When commodity prices dip to unfathomably low levels (which happens with surprising frequency) that cost advantage can mean the difference between life and death.<\/p>\n

In better times less debt means that you still have a profitability advantage over your completion.<\/p>\n

Reason #2 \u2013 Debt Means That Someone Else Is Ultimately In Control Of Your Destiny<\/strong><\/span><\/p>\n

I love people but I\u2019ve taught all of my kids that they don\u2019t ever want to put themselves in a position where they need to rely on the kindness of strangers for their basic necessities of life.<\/p>\n

At the core of what I teach my kids is to respect the dangers of debt.<\/p>\n

When oil crashed in 2014 and stayed down (nobody saw that coming)\u2026 there was a long line of oil producers that were forced to rely on the consortium of banks that were on the other end of their credit lines.<\/p>\n

Many of the producers found that those strangers weren\u2019t so kind.\u00a0And who can blame them?\u00a0The banks forced the producers to sell progressively better assets at progressively worse prices as oil prices stayed low.<\/p>\n

With oil in the $30s\/b there were only a few oil producers generating any positive cash flow from operations\u2026\u00a0they were incapable of making their debt and interest payments.<\/p>\n

As long as you have debt, you aren\u2019t necessarily in control.\u00a0Especially when your cash flows are determined by the movements of a volatile commodity.<\/p>\n

The more debt you have the more likely you are to eventually be begging for help.<\/p>\n

Reason #3 \u2013 Low Debt Equals Premium Valuation<\/strong><\/span><\/p>\n

The idea of share repurchases is to return capital to shareholders\u2026 to reward them.<\/p>\n

Here is a thought though.\u00a0How about doing everything possible to attract even more investors to want to own shares and eventually reward everyone with a higher share price?<\/p>\n

There is no more sure fire way to make sure of a premium stock market valuation than having a best in class balance sheet.<\/p>\n

Low-debt companies routinely trade at valuation multiples that are 2 or 3 turns above where companies with more leveraged balance sheets trade.\u00a0It almost doesn\u2019t matter what the more leveraged names do operationally \u2013 the stock market just doesn\u2019t reward companies with lots of debt.<\/p>\n

You know the overleveraged zombie stocks of which I speak \u2013 whose shareholders suffer from a permanently discounted share price.<\/p>\n

Reason #4 \u2013 That Premium Valuation Can Be A Weapon<\/strong><\/span><\/p>\n

I\u2019ve always loved companies with expensive looking stocks\u2026\u00a0ALWAYS.<\/p>\n

That might seem counter-intuitive because I am very aware of value when I invest. What I have always appreciated is that having a stock with a premium valuation can be a powerful weapon in the public markets.<\/p>\n

The entire idea behind share repurchases is to do something accretive for shareholders\u2026\u00a0by buying shares at a discount and increasing value per share for remaining shareholders (giving them a better piece of the pie).<\/p>\n

An expensive stock can be used to do exactly the same thing.\u00a0A company trading at a premium 9 times cash flow can issue shares at that valuation to purchase another company at 6 times cash flow\u2026\u00a0an immediately accretive transaction.<\/p>\n

Reason #5 \u2013 Being Cash Rich And Debt Free Lets You Love The Crashes<\/strong><\/span><\/p>\n

Do you know who had a heck of a good time during the Financial Crisis in 2008?<\/p>\n

That smart old Warren Buffett who was sitting with a bucket load of cash ready to buy when almost everyone else was desperate to sell.<\/p>\n

Not surprisingly by being the only buyer in this market allowed Buffett to make a bundle.\u00a0Buffett made a bunch of investments at the darkest hour of 2008 as Lehman Brothers was collapsing.\u00a0All of those investments worked out incredibly well\u2026\u00a0some spectacularly so.<\/p>\n

Take for example the $5 billion in preferred shares of Bank of America that Buffett bought.\u00a0Those preferreds paid a 6 percent annual dividend and came with warrant to purchase 700 million Bank of America (BAC:NYSE) <\/strong><\/span>shares at $7.14.<\/p>\n

Buffett exercised those warrants<\/span> in 2017 and now holds Bank of America shares worth $26 billion\u2026\u00a0with dividends included his profit is over $20 billion on a $5 billion investment.<\/p>\n

Buffett made penny-stock-type-returns while investing in one of the biggest banks in the world.<\/p>\n

At the bottom of every oil crash there are countless leveraged companies ready to be bought for pennies on the dollar\u2026 the alternative is bankruptcy.<\/p>\n

All that is required is a Fort Knox balance sheet and then using it during low prices…like NOW.\u00a0 The only problem is, most management teams don’t have PATIENCE.<\/p>\n

Let Me Be Clear On What I\u2019m Not Saying<\/strong><\/span><\/p>\n

As I noted at the start \u2013 I am playing a bit of Devil\u2019s Advocate here.<\/p>\n

Like with almost everything in life the best answer to this discussion likely lies somewhere in the middle\u2026\u00a0imagine if our politicians thought that way!<\/p>\n

For me to say that oil producers should never repurchase shares would be going too far\u2026\u00a0there are obviously times that share repurchases make sense.<\/p>\n

Take Parex Resources (PXT:TSX, PARXF:PINK)<\/strong><\/span> for example.\u00a0I spoke with Parex\u2019s Chief Operating Officer Mike Kruchten about the concept that oil producers shouldn\u2019t repurchase shares and he said:<\/p>\n

I think the difference for Parex is that we are debt free AND accumulating too much cash. Too much cash isn\u2019t an efficient capital structure.\u00a0Buying back shares still gives us future flexibility<\/em>.<\/p>\n

It is hard to argue with that logic.<\/p>\n

For Parex, share buybacks make perfect sense.\u00a0I would point out however that with the company sitting on $140 million in net cash and set to generate $300 million in free cash flow\u2026\u00a0Parex already has the Fort Knox balance sheet with which I\u2019ve been suggesting oil producers should operate.<\/p>\n

Which brings up another issue that Gluskin Sheff\u2019s Leon Knight also mentioned to me on this subject\u2026\u00a0that we don\u2019t need all of the cash that companies are putting into share repurchases instead being used to drive industry production growth even faster\u2026.<\/p>\n

As per Leon:<\/p>\n

“This is the dilemma, if industry just piles all of the cash back into the ground, too much growth keeps prices depressed and returns are marginalized.\u00a0 <\/em>
\n\u00a0<\/em>
\nSo in this environment, industry as a whole can either ramp up with a lower corporate margin \u2013 either lower cash margin from lower oil prices, or lower profit margin because of cost inflation) \u2013 or pull back on (capex<\/span>)spend, increase your margin and return cash to shareholders (or pay down debt, or both).<\/em><\/i><\/p>\n

If there is no real free cash flow generated within the business, this can be considered another avenue to destroy shareholder value (betting on commodity prices to increase asset value).”\u00a0 <\/em><\/p>\n

A valid point to be sure, but again I wasn\u2019t advocating plowing cash into the ground drilling wells instead of share repurchases\u2026 I was saying that priority number one should be creating a Rock of Gibraltar balance sheet.<\/p>\n

Too few oil producers have that today.\u00a0 Much improved from 2014 yes\u2026\u00a0but there is plenty of room to improve balance sheets in this industry.<\/p>\n

In conclusion then\u2026<\/p>\n

While I wouldn\u2019t say NEVER to share repurchases I also think that I\u2019m making a very valid argument.<\/p>\n

I would be willing to say that oil producers should only by utilizing the repurchase tool until they have built a balance sheet that positions them to enjoy, rather than fear the next great crash\u2026 which appears to already have arrived.<\/p>\n

Keith Schaefer<\/p>\n

\n



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On December 13, 2018 Pioneer Resources (PXD:NYSE) announced a whopper of a share buyback program – $2 billion, up from the existing program that covered re-purchases of up to only $100 million. Great news for shareholders right? I’m not so sure. I’m feeling feisty this Christmas. In fact I’m going to play a little bit of […]<\/p>\n","protected":false},"author":19,"featured_media":0,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"site-sidebar-layout":"default","site-content-layout":"","ast-site-content-layout":"","site-content-style":"default","site-sidebar-style":"default","ast-global-header-display":"","ast-banner-title-visibility":"","ast-main-header-display":"","ast-hfb-above-header-display":"","ast-hfb-below-header-display":"","ast-hfb-mobile-header-display":"","site-post-title":"","ast-breadcrumbs-content":"","ast-featured-img":"","footer-sml-layout":"","theme-transparent-header-meta":"","adv-header-id-meta":"","stick-header-meta":"","header-above-stick-meta":"","header-main-stick-meta":"","header-below-stick-meta":"","astra-migrate-meta-layouts":"default","ast-page-background-enabled":"default","ast-page-background-meta":{"desktop":{"background-color":"","background-image":"","background-repeat":"repeat","background-position":"center center","background-size":"auto","background-attachment":"scroll","background-type":"","background-media":"","overlay-type":"","overlay-color":"","overlay-gradient":""},"tablet":{"background-color":"","background-image":"","background-repeat":"repeat","background-position":"center center","background-size":"auto","background-attachment":"scroll","background-type":"","background-media":"","overlay-type":"","overlay-color":"","overlay-gradient":""},"mobile":{"background-color":"","background-image":"","background-repeat":"repeat","background-position":"center center","background-size":"auto","background-attachment":"scroll","background-type":"","background-media":"","overlay-type":"","overlay-color":"","overlay-gradient":""}},"ast-content-background-meta":{"desktop":{"background-color":"var(--ast-global-color-5)","background-image":"","background-repeat":"repeat","background-position":"center center","background-size":"auto","background-attachment":"scroll","background-type":"","background-media":"","overlay-type":"","overlay-color":"","overlay-gradient":""},"tablet":{"background-color":"var(--ast-global-color-5)","background-image":"","background-repeat":"repeat","background-position":"center center","background-size":"auto","background-attachment":"scroll","background-type":"","background-media":"","overlay-type":"","overlay-color":"","overlay-gradient":""},"mobile":{"background-color":"var(--ast-global-color-5)","background-image":"","background-repeat":"repeat","background-position":"center center","background-size":"auto","background-attachment":"scroll","background-type":"","background-media":"","overlay-type":"","overlay-color":"","overlay-gradient":""}},"footnotes":""},"categories":[528],"tags":[],"_links":{"self":[{"href":"https:\/\/juniorminingnews.com\/index.php?rest_route=\/wp\/v2\/posts\/1092243"}],"collection":[{"href":"https:\/\/juniorminingnews.com\/index.php?rest_route=\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/juniorminingnews.com\/index.php?rest_route=\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/juniorminingnews.com\/index.php?rest_route=\/wp\/v2\/users\/19"}],"replies":[{"embeddable":true,"href":"https:\/\/juniorminingnews.com\/index.php?rest_route=%2Fwp%2Fv2%2Fcomments&post=1092243"}],"version-history":[{"count":45,"href":"https:\/\/juniorminingnews.com\/index.php?rest_route=\/wp\/v2\/posts\/1092243\/revisions"}],"predecessor-version":[{"id":1098629,"href":"https:\/\/juniorminingnews.com\/index.php?rest_route=\/wp\/v2\/posts\/1092243\/revisions\/1098629"}],"wp:attachment":[{"href":"https:\/\/juniorminingnews.com\/index.php?rest_route=%2Fwp%2Fv2%2Fmedia&parent=1092243"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/juniorminingnews.com\/index.php?rest_route=%2Fwp%2Fv2%2Fcategories&post=1092243"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/juniorminingnews.com\/index.php?rest_route=%2Fwp%2Fv2%2Ftags&post=1092243"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}