VANCOUVER, Dec. 4, 2012 /CNW/ - The Shareholders Group finds it unfortunate that the company has resorted to ad hominem attacks against its key shareholders in its latest press release dated December 3, 2012, rather than focusing solely on the crucial capital allocation decisions at hand. We believe this tactic is a reflection of the very weak case the company has made and is an attempt to distract shareholders from the truth. We will not engage in these tactics because we don't need to.
So-called "accretive" acquisitions
While the Shareholder Group is pleased to hear that Equal plans no major acquisition, that statement does not go far enough. Equal Energy shareholders do not want any acquisitions, tuck-in or otherwise, because it is clear to any competent financial analyst that the company's own shares are far and away the most accretive possible acquisition at this time. Why? For the very reason the company itself has acknowledged, and for the very same reason the strategic review was initiated in the first place: Equal Energy shares are extremely undervalued. Using the conservative NAV estimate of $6.49/share derived in our last press release, and taking into consideration that Equal is currently trading at $3.17/share, simple arithmetic dictates that every $1/share spent on a buyback increases NAV/share by $1.05/share. It is very telling that after management just finished raising $130M from asset sales, and after including several statements in their press release about future consideration of so-called accretive acquisitions given that so much cash was raised, there was not a single word regarding any consideration of what is obviously in the shareholders' best interests: a massively accretive buyback of the company's own shares.
Balance sheet strength
Apparently management's reasoning on why a buyback is impossible is that the balance sheet can't support it. The Shareholders Group strenuously disagrees. According to a TD Securities note published on November 8, 2012, the average 2012 Debt/CF ratio for dividend paying Canadian companies was 2.7x. In June 2012, prior to any asset sales closing due to the strategic review, Equal's 2012 Debt/CF ratio was 2.7x. We agree that it is appropriate for Equal to have a below average Debt/CF ratio due to the volatility and difficulty of hedging NGLs, and therefore we supported some amount of balance sheet deleveraging, but going all the way from 2.7x down to 0.7x is unnecessary and extreme. Management hides behind this notion that certain "advisors" say the Debt/CF ratio must remain below 1.0x. The shareholders demand to see objective evidence justifying this unnecessarily low debt ratio, particularly in light of how accretive a significant share buyback would be at this time. We believe that a far more reasonable maximum limit on Debt/CF would be 2.0x, which would leave the debt ratio well below average while allowing a substantial share buyback.
Excessive capital spending
Particularly given management's rather pessimistic view on propane pricing in 2013 and 2014 (i.e., $0.90/gallon in 2013 and $1.05/gallon in 2014 - oddly pessimistic given that Mont Belvieu propane varied between $1.30/gallon and $1.60/gallon in 2011 and that propane inventories are expected to normalize to 2011 levels by mid-2013), we believe the capital spending budget of $36M announced for 2013 is far too high. First of all, there is absolutely no justification for actually growing production in 2013 given management's view on NGL pricing, since new Hunton drilling is clearly uneconomic if commodity prices remain at current levels over an extended period . So why is management insisting on not only holding production flat but actually growing production in 2013, before it becomes clear that NGL pricing will recover soon? It is economically unjustifiable, and capital allocation decisions should not be based on "advisors" telling the company that they must show some growth due to the corporate "Model" (i.e., hybrid dividend/growth E&P) that has been chosen. Capital allocation decisions should be based on ROI and hurdle rates, nothing more.
Given management's commodity price assumptions, we believe Equal should be drilling at most 8 new wells in 2013 rather than 10, which should be enough to hold production approximately flat. Each Hunton well initially produces around 150 boe/d, so 8 wells is enough to replace 1200 boe/d of production, or around 15.4% of the current production of 7,800 boe/d. Management has recently indicated to us that the currently observed field decline rate is in the "14%-15%" range (which is consistent with the 14.7% derived using our own analysis), so we believe our drilling plan of 8 new wells in 2013 is reasonable. We estimate this reduced drilling plan would save around $6M from the drilling capex budget and $1.2M from the maintenance capex budget, resulting in a total 2013 capex budget of $28.8M.
We estimate DACF of around $45M per year based on 7,800 boe/d of production and long-term commodity prices of $1.20/gallon Conway propane, $4.25/mcf natural gas, and $87/bbl WTI oil. Management concurred with our long-term DACF estimate in a recent discussion. Interest expense will depend upon the buyback amount, but let's assume it's around $3.3M per year with a $30M buyback. That means cash flow should be $41.7M per year with a sustainable dividend of $0.44/share based on a $4 buyback price and 27.5M shares outstanding.
A couple of "bloggers"
Management is misleading the shareholders by characterizing our shareholder group as "a couple of bloggers". We would like to highlight that our group has received tremendous support from the shareholder base; the absolute majority of the company's 15 largest shareholders have indicated strong support for our actions and plans. Shareholders can learn more about us by visiting the website listed below.
SOURCE Nawar Alsaadi