Investment Thesis
Unit Corporation (OTCQX:UNTC) recently delivered its quarterly dividend, which implied 20% TTM dividend yield. The company also expects to report capex of about $10-$20 million besides participating in 1 to 2 net wells per year, which may bring additional free cash flow growth. It is also worth mentioning that new potential developments in new locations were announced in 2024. With repurchase of shares by UNTC at $32-$36 and trading at less than 4x-5x TTM EBITDA, in my view, UNTC does look quite undervalued.
Price target: My discounted cash flow with very conservative FCF growth assumptions resulted in a valuation of $74.24 per share. A review of precedent transactions revealed a fair price of $42; however, I do think that the correct valuation is higher than this value. The company has no debt at all. Previous transactions reported usually included targets with a significant amount of debt.
Business Review
Unit Corporation intends to acquire oil and natural gas properties, and signs contract drilling of onshore oil and natural gas wells. Revenue from contract drilling comes from contracts signed with upstream companies.
In the last quarter, the company obtained more revenue from contract drilling than from production of oil and natural gas.
- Revenues:
- Oil and natural gas: $26.572 million
- Contract drilling $40.632 million
- Total revenues $67.204 million
According to the most recent presentation, the company reports reserves of ~147,500 net developed acres in Anadarko Basin. The company noted PV-10 value of $249 million and net debt of -$60 million, which would imply a valuation of $309 million and an implied price of $31 per share. The current stock price is not far from this value. If we buy today, I think that we are buying at an attractive valuation. We are mainly buying for the reserves, so we are obtaining the valuation of the contract drilling segment for a small price.
Sale Of Assets, Repurchase Of Stock, And 20% Dividend Yield
The company emerged from bankruptcy a few years ago, and appears to be bringing new value to shareholders. In 2014, UNTC did not report cash in hand at all. In 2024, the total amount of cash stood at close to $65 million. In my view, the sale of business interests, cash flow from operations, and FCF growth are helping UNTC in accumulating cash. It is also worth noting that the total amount of debt is right now negative. Total amount of long-term debt decreased from $812 million in 2014 to zero in 2014.
Since 2019, I also could observe an increase in the book value per share, from $15 per share to $26 in 2024. Given the current stock price, we are mainly paying close to 1.3x the book value per share, and we are also going to receive a significant amount of dividends. According to Seeking Alpha, the current TTM dividend yield stands at about 20%.
The company has executed a significant number of divestures, including SCR rigs in 2023 and non-core contract drilling assets. In return, UNTC receives a significant amount of cash. The following lines were obtained from the most recent quarterly report.
On May 18, 2023, the Company closed on the sale of two older generation SCR rigs and certain related equipment for total proceeds of $5.8 million. Cash proceeds of $5.0 million were received at closing and deferred cash proceeds of $0.8 million were received on January 25, 2024. Source: 10-Q
Proceeds for the sale of other non-core contract drilling assets totaled $0.5 million and $4.2 million during the three months ended March 31, 2024 and 2023, respectively. These proceeds resulted in net gains of $0.1 million and net gains of $3.7 million during the three months ended March 31, 2024 and 2023, respectively Source: 10-Q
The company appears to be using the cash received from cash flow from operations and the sale of assets to acquire the company’s own shares, as well as to distribute large dividends. In the first quarter of 2024, the company acquired shares at $36.03 per share. If we buy shares today, we are buying at close to the price mark at which the company buys shares. UNTC knows well the real valuation of the company. In my view, if the company is buying shares at $36, the real fair value may be above this level.
During the first quarter of 2024, we repurchased 14,240 shares under the repurchase program at an average share price of $36.03. Source: 10-Q
It is worth noting that the company bought shares at an average price of $32 per share for a total of $79 million. The total amount of shares outstanding decreased substantially from 2018 to 2024. In my financial models, I assumed that new stock repurchases will most likely lead to demand for the stock.
As of March 31, 2024, we had repurchased a total of 2,486,632 shares of common stock at an average share price of $32.11 (unadjusted for dividends paid) for an aggregate purchase cost of $79.9 million through private and open market transactions made under the repurchase program authorized by the Board of Directors in June 2021, and other privately negotiated transactions. Source: 10-Q
My Ultra-Conservative DCF Model: $74
Considering the most recent increase in net income since 2021, I thought that conducting a DCF model would make a lot of sense. From 2021, the net income increased from $48 million to about $248 million in 2023.
I would also expect new potential development in new locations, which were described in the most recent presentation to investors. It is worth noting that the company continues to deliver capex of $10-$20 million, and expects drilling or participating in 1 to 2 net wells per year. In my view, new developments may enhance the total amount of proven reserves, which may lead to higher FCF growth. I also expect that new opportunities to sell minor interests may arise.
Potential locations in Red Fork, Cherokee Shale, Marchand, Medrano, Meramec, Woodford and Granite Wash. Source: 10-Q
Will continue to look for opportunities to sell minor interests in outlying areas and concentrate remaining properties in core fields and plays. Source: Presentation To Investors
Anticipate drilling or participating in 1 to 2 net wells per year, with development capital expenditures of approximately $10 to $20 million per year consistent with recent historical practice and dependent upon future market conditions. Source: 10-Q
It is also worth noting that the company expects to optimize existing reserves, and may convert non-producing reserves to deliver positive cash flow generation. In my financial model, I assumed that successful optimization may lead to FCF growth.
In our oil and natural gas segment, we are optimizing production and converting non-producing reserves to producing with selective drilling activities. Source: 10-Q
In order to design my DCF model, I took a look at the recent generation of FCF. FCF increased from close to $12 million in 2020 to $60 million in 2022 and $59 million in 2023.
My expectations include very conservative FCF of about $55 and $56 million, a WACC of 4%, and EV/2029 FCF of 9x. Total implied value would be close to $674 million, with implied equity of $734 million and a target price of $74 per share.
- NPV: $284.64 million
- NPV of TV (@Ev/FCF 9x, WACC of 4%): $390.19 million
- Total Value: $674.83 million
- Net Debt: -$60.10 million
- Equity: $734.93 million
- Shares: 9.90 million
- Target Price: $74.24
Precedent Transactions: $42
Given the previous transactions and their EV/EBITDA valuations, I applied a multiple range of 3.2x to UNTC’s 2024E EBITDA, which I assumed to be close to $111 million. The following is a list of precedent transactions.
- 10/04/23 Selected Assets of Vencer Energy, LLC-Civitas Resources, Inc.
- 08/21/23 Earthstone Energy, Inc.-Permian Resources Corp.
- 06/20/23 Selected Assets of Tap Rock Resources-Civitas Resources, Inc.
- 06/15/23 Novo Oil & Gas – Northern Oil and Gas, Inc.
- 01/24/23 Advance Energy Partners Holdings-Matador Resources Company
- 05/19/22 Colgate Energy Partners-Centennial Resource Development, Inc.
The implied enterprise value would be $355 million. I think that the company should be trading at more than 3.2x because UNTC does not report debt. Targets included in the list of transactions did include debt. In my view, the DCF model offers better information about UNTC’s fair value.
If we assume a total value of $355 million with net debt of -$60 million, the implied target price would be close to $42 per share, which is above the current market price.
- Total Value: $355 million
- Net Debt: -$60.10 million
- Equity: $415.10 million
- Shares: 9.90 million
- Target Price: $41.93
Risks
In my view, changes in the price of petroleum or natural gas may have a detrimental effect on the company’s future free cash flow growth. If expectations around the future price of petroleum decline, the value of the company’s proven reserves would decline, which may lead to a decline in the stock price.
The company recently conducted a large transformation and sold a number of assets. If the company sells valuable assets, production may be lower than expected by market participants. As a result, the company’s future net sales could decline significantly, and cash flow growth may also decline. The stock price would most likely decline.
The company recently delivered a larger amount of dividends. I think that many shareholders out there are buying shares because of the company’s total amount of dividends. In my view, in the future, as soon as the sale of assets declines, the total amount of dividends distributed could decline. Shareholders may dump their shares, which could lead to a decrease in the stock price.
Reservoir engineers could fail to assess the company’s total proven reserves. If they have overestimated the total amount of petroleum or natural gas, I think that future production could be lower than expected. Hence, future FCF growth may be lower than expected, and the fair value may be lower than my target price of $74.24.
In my view, the company may also suffer significantly from changes in the environmental regulations or increases in the taxes applicable to the petroleum industry. If UNTC needs to invest more money due to regulators to obtain the same amount of oil and gas, future FCF margins would be lower. In the worst case scenario, shareholders may sell shares.
Conclusion: I Think That UNTC Is A Buy
UNTC recently delivered information about new potential developments in new locations, and delivered TTM dividend yield of 20%. Besides, the company expects to report capex of $10-$20 million, and announced drilling or participating in 1 to 2 net wells per year. In addition, we could expect further sale of business interests, which may bring even more cash in hand.
The company is buying its own shares at a price between $32 and $36 per share. In my opinion, the company appears quite undervalued at less than 4x-5x EBITDA because UNTC does not report any debt like other peers in the industry. According to my discounted cash flow model, UNTC could be worth close to $74 per share.
Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.
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