Centennial Resource Development’s (CDEV) top shareholder bought more shares in May and early June. However, I’d consider its bonds (for those who are able to purchase them) a better risk/reward opportunity than its shares, though. Centennial’s stock needs the company to be worth over $1.4 billion to have upside, while its unsecured bonds have upside if the company is worth over $900 million.

Centennial may be forced to continue reducing production in order to maintain a decent amount of liquidity, but appears able to keep afloat (and continue to pay interest on its bonds) for a few more years if oil prices gradually improve. Centennial’s secured debt does add some risk to its unsecured bonds, but in an eventual low-$50s oil scenario, its unsecured bonds could see a full recovery.

Debt Exchange

Centennial did a debt exchange in May involving the company swapping some of its unsecured notes for second-lien notes at a 50% discount. Only 28% ($254 million) of Centennial’s unsecured notes were tendered, so it only issued $127 million in second-lien notes (compared to the $250 million maximum second-lien exchange amount that it was considering). The exchange reduces Centennial’s outstanding debt by $127 million and its interest costs by around $6 million per year.

Termination Of Water Infrastructure Sale

Centennial also announced in May that its $150 million water infrastructure sale was terminated. This keeps its credit facility debt higher than it would like, but also results in its lease operating expenses being kept lower than if it had sold its water infrastructure assets. A completed sale of its water infrastructure would have increased its oil breakeven point by a couple dollars.

2020 At Current Strip

Centennial reduced its 2020 capex budget further to around $265 million and also indicated that it expected to curtail May production by up to 40%. As a result, I am now estimating that Centennial will average 64,000 BOEPD in 2020 production.

At current strip of near $38 WTI oil, Centennial would end up with approximately $524 million in revenues after hedges in 2020. Centennial’s hedges are pretty weak, with it having swaps covering the majority of its April to September oil production at $26-27 per barrel.

Centennial also has some WAHA basis hedges that have negative value now that Permian natural gas prices have improved. Thus, Centennial is estimated to end up with negative $39 million in hedge value for 2020.

Type Barrels/Mcf $ Per Barrel/Mcf $ Million
Oil 12,410,000 $37.00 $459
NGLs 4,380,000 $12.50 $55
Gas 39,420,000 $1.25 $49
Hedge Value -$39
Total $524

Centennial’s lease operating costs should end up lower than previously expected due to the termination of the water infrastructure sale. I am now modeling its 2020 lease operating costs at $5.35 per BOE. The water infrastructure sale was expected to increase Centennial’s lease operating costs by a bit over $1 per BOE after the sale closed.

With its other cost-cutting measures and its reduced capex budget, Centennial is now expected to have $78 million in cash burn in 2020.

$ Million
Lease Operating $125
Production Taxes $39
Cash G&A $51
Gathering, Transportation and Processing $64
Cash Interest $58
Capex $265
Total $602

Debt Situation

Centennial started 2020 with $175 million in credit facility debt. Centennial also had a $157 million working capital deficit (excluding derivatives) at the end of 2019. Adding Centennial’s projected 2020 cash burn results in it potentially ending 2020 with as much as $410 million in credit facility debt (although this depends on how much its working capital deficit is reduced).

Type $ Million
Credit Facility $410
Second Lien $127
Unsecured $646
Total $1,183

After its debt exchange, Centennial has $127 million in second-lien debt and $646 million in unsecured debt. This results in a projection of $1.183 billion in total debt at the end of 2020 (including its working capital deficit).

Breakeven Point

Centennial may exit 2020 with around 60,000 BOEPD in average production. I estimate it can maintain that level of production in 2021 with around $400 million in capital expenditures.

This results in a scenario where Centennial will need roughly $51 WTI oil in 2021 in order to maintain production levels without cash burn. At that price, Centennial would generate around $731 million in revenues.

Type Barrels/Mcf $ Per Barrel/Mcf $ Million
Oil 11,607,000 $50.00 $592
NGLs 4,117,200 $17.50 $72
Gas 37,054,800 $1.80 $67
Total $731

Centennial expects to achieve the full benefit of its G&A cost-cutting in 2021, so its cash G&A may decrease to around $40 million then. This would result in $731 million in cash expenditures with a $400 million capex budget.

$ Million
Lease Operating $120
Production Taxes $51
Cash G&A $40
Gathering, Transportation and Processing $60
Cash Interest $60
Capex $400
Total $730

Centennial’s breakeven point is projected to decrease to the high-$40s for WTI oil in 2022 as its base decline rate moderates some more (assuming no production growth in 2021).

Valuation

At 60,000 BOEPD in annual production, Centennial can deliver around $370 million EBITDAX at $45 WTI oil and $430 million EBITDAX at $50 WTI oil. It traded at around 3.3x to 3.4x EBITDAX in late 2019 and early 2020, before the oil price crash.

At 3.3x EBITDAX, Centennial would be worth $1.221 billion at $45 WTI oil, which is slightly higher than its projected debt at the end of 2020. The risk with Centennial is that it needs roughly $51 WTI oil in order to maintain production without cash burn in 2021 and current strip is around $10 per barrel below that.

Thus I would knock a couple hundred million off Centennial’s value to account for potential cash burn and/or further production declines before oil got back to the $45-50 range.

At $1 billion in total value for the company, Centennial’s unsecured notes would still have decent value though at around 72 cents on the dollar, compared to the 50-55 cents (excluding accrued interest) that the bonds are currently trading at.

Centennial’s stock remains an option on higher oil prices. At its current price of $0.90 per share, Centennial’s total value would have to reach $1.43 billion for its stock to have upside, while its bonds are currently valuing the company at under $900 million.

Risks

Centennial’s credit facility debt does pose some risks to it. If its working capital deficit is eliminated, it would have $410 million in year-end borrowings versus a $700 million borrowing base. That does allow for sufficient liquidity, but Centennial would likely need to continue sacrificing production to minimize cash burn as long as oil remains below the high-$40s. Shrinking production means that its interest costs and G&A costs add up to a larger percentage of its total revenue. Centennial’s credit facility currently matures in May 2023, although that can probably get extended at least a year given that its next debt maturity isn’t until 2025 (the new second-lien bonds).

Centennial does appear to be a reasonable candidate to survive for a few more years as long as oil prices gradually improve. The lack of near-term debt maturities means that it is likely to try to ride things out for now, with top shareholder Riverstone pushing for Centennial to tread water until oil prices improve.

Conclusion

Centennial Resource Development has previously been burning a lot of cash to grow production, which has resulted in fairly high base decline rates. Its base decline rate should moderate significantly as its production falls, bringing its breakeven point to low-$50s WTI oil in 2021 and high-$40s WTI oil in 2022. It may burn a fair amount of cash or suffer further production declines in 2021, but it appears to have the ability to stay afloat for a few years to try to wait for higher oil prices.

Centennial’s unsecured bonds are an interesting play that could result in full recovery with low-$50s WTI oil. The risk/reward for its bonds appears better than its stock, with the main risk being how much additional added secured debt (or production declines) occurs before oil makes it back up to $45-50.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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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2020-06-30

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