The Prognosis For Pedevco Corp. (NYSE:PED)

Oil pump, oil industry equipment — bjdlzx

Blessed is he who expects nothing, for he shall never be disappointed.”― Alexander Pope.

Today, we turn the spotlight on a small production concern. The shares have been cut in half since early 2021 even as the company has a pristine balance sheet. The pullback in the equity has attracted insider buying. An analysis follows in the paragraphs below.

Company Overview:

PEDEVCO Corp. (NYSE:PED) is a Houston-based oil and gas concern focused on acquiring mature assets with slow-decline and long-life production profiles, the output of which are further enhanced by field management techniques. The company possesses 31,482 net acres in the San Andres formation of the Permian Basin in West Texas and eastern New Mexico, as well as 11,747 net acres in the Denver-Julesburg (D-J) Basin of Colorado. PEDEVCO was originally formed as Rocker & Spike Entertainment in 2000, and went public in 2003, raising net proceeds of $22,825 (not a misprint) at $336 per share (also not a misprint) after giving effect to one forward and three reverse stock splits. Shares of PED trade just under a $1.25 a share, equating to a market cap of approximately $100 million.

History

Shortly after going public as an accident reconstruction business, the company pivoted towards oil and gas services with the acquisition of exclusive rights to a proprietary lateral drilling process (known as applied fluid jetting (AFJ) for oil and gas production. After a poorly timed purchase of five rigs led to a bankruptcy filing in 2007, the company (then named Blast) reemerged later that same year, maintaining its AFJ technology and pivoting to its current mission statement in 2010. It then reverse-merged into Pacific Energy Development in 2012 and changed to its current moniker. Since that time, PEDEVCO has employed modern field management techniques to enhance production of mature conventional oil fields. Its first large property acquisition was in the D-J Basin during 2014 and 2015 – also ill-timed, as energy prices were heading into a severe bear market from 2014-2017.

The company’s transformation occurred in 2018, when, after accumulating debt of $73.4 million, SK Energy was onboarded as a strategic investor. Through a series of restructuring transactions, debt was initially cut down to $7.7 million with SK owning 47% of the company. Convertible debt financing was then provided by SK to facilitate the purchase of the company’s Permian Basin properties in 2018 and 2019. All debt was retired through conversion in 2019, leaving PEDEVCO with no debt and SK, as in CEO Simon Kukes, owning ~67% of PEDEVCO.

Initial news of the balance sheet restructuring and SK Energy’s involvement sent shares of PED rocketing 660% in the subsequent trading session (June 27, 2018) to $2.37. Although it returned to that price briefly in March 2022, when oil prices first crested $100 a barrel post-pandemic, its stock is off by more than half since.

Reserves & Wells

As of YE21, the company held estimated net proved crude oil and natural gas reserves of 14.7 million barrels of oil equivalent (MMBoe) with a PV-10 value of $196.6 million, of which $149.8 million were proved undeveloped reserves. The dollar values are based on $66.56 per barrel oil and $3.60 per thousand cubic feet (Mcf) natural gas. The proved reserves are 82% oil, 15% natural gas, and 3% natural gas liquids. Approximately 72% of the PV-10 value is derived from the Permian Basin with the balance from the D-J Basin.

As of June 30, 2022, the company held interests in 382 gross (303 net) wells in the Permian Basin, of which 38 are actively producing, supported by 16 active injectors and two saltwater disposal wells – all of which it operates. PEDEVCO also held interests in 86 gross (22.1 net) wells in the D-J Basin, of which it operates 18 gross (16.2 net) wells that are currently producing.

Approach

The company looks to acquire underdeveloped and underexploited properties and apply modern advances in horizontal drilling, completion design, and frac intensity to increase production from mature slow-declining fields. In its more important Permian asset, PEDEVCO looks to be the operator with a significant working interest so it can dictate the pace of development. In the D-J Basin, management just pursues highly economic opportunities, either on an operated or non-operated basis.

Furthermore, the company intends to leverage its presently pristine balance sheet to acquire additional assets in the San Andres play of the Permian to achieve economies of scale. It has bid on several packages, but the bid-ask spread is currently very wide. Management is in no hurry as it sees supply coming online from two main sources. First, there are several private equity backed companies that will require an exit to close out their funds. Second, there are big producers in the play that have significant base production but have not developed their fields horizontally.

In the meantime, PEDEVCO FY22 plans include capex spending of $33 million to $38 million to drill five wells and complete seven in the San Andres (although two completions may slip into FY23), as well as drill and complete 14 wells in the D-J Basin, where it has a non-operating working interest.

Q2 2022 Earnings

With that as the backdrop, PEDEVCO reported 2Q22 financials on August 15, 2022, posting $0.04 a share (GAAP) and Adj. EBITDA of $6.0 million on revenue of $9.5 million versus breakeven earnings (GAAP) and Adj. EBITDA of $1.6 million on revenue of $3.7 million in the prior year period, registering a 155% gain at the top line. Approximately $2.7 million of the surge in revenue was related to 32% higher commodity prices ($96.77 per Boe versus $73.36 in 2Q21), while $3.1 million was the result of a 51% production increase from 718 Boe per day (84% oil) in 2Q21 to 1,085 Boe per day (80% oil) in 2Q22.

Potentially Troubling Development

That performance seemed well and good; however, placed in the Subsequent Events section of its 10-Q, PEDEVCO mentioned that on August 2, 2022 it received notice from the New Mexico Energy, Minerals and Natural Resources Department (EMNRD) that it was in non-compliance with agreed-upon protocols for having failed to provide reports and proof that it was conducting certain well tests at its properties by deadlines specified in the said protocols. As such, it was being fined $850,500 and would have to promptly commence the plugging of 333 legacy vertical wells at an approximate cost to the company of $45,000 per.

Management believes that it has fulfilled (or even exceeded) the previously agreed upon compliance orders and to that end is providing documentation to EMNRD. However, if a commercially amenable resolution cannot be reached, this would put the company at risk. Very surprisingly, no press release or 8-K was issued regarding this matter. It was not mentioned in the company’s 2Q22 press release, and management did not conduct a conference call. As such, the market did not react in any way to his seemingly newsworthy event.

Third Quarter Results:

On November 15th, the company posted GAAP earnings of one cent a share for the third quarter. Revenues rose 82% on a year-over-year basis to nearly $7.5 million. During the quarter, PEDEVCO produced an average of 960 barrels of oil equivalent per day and operating income came in at $1.02 million, a 390% increase from 3Q2021. During the quarter, the company realized an average crude oil sales price of $91.04 per barrel, average realized natural gas price was $7.72 per Mcf, and average realized NGL sales price was $30.57 per barrel

Balance Sheet & Analyst Commentary:

That development notwithstanding, PEDEVCO’s debt-free balance sheet reflected cash of $30.9 million on September 30th, 2022, against no long-term debt.

As a microcap in the oil patch, the company receives little attention from the Street. However, EF Hutton and Roth Capital are both bullish on its prospects, sporting buy ratings, as well as $2.00 and $1.95 price targets, respectively. On average, they expect PEDEVCO to earn $0.17 a share (GAAP) on revenue of $54.6 million in FY22, followed by $0.13 a share on revenue of $64.0 million in FY23. Neither has commented on the EMNRD correspondence embedded in the company’s 10-Q.

That said, CEO and majority stakeholder Simon Kukes seems unconcerned about the development, purchasing 509,718 shares at an average price of $1.15 a share between September 19th-30th.

Verdict:

Assuming the alleged non-compliance is a non-event, the company has PV-10 reserves valued at $196.6 million at $66.36 per barrel of oil. At $80 oil that PV-10 figure approaches $240 million. However, it costs PEDEVCO $41.54 per barrel to get the oil out of the ground in 2Q22, essentially cutting that figure down to $120 million. Net of cash on the balance sheet, the company’s market cap is $71.9 million, which at first blush would suggest ~67% of upside. However, that upside does not take into consideration cap ex, and PEDEVCO was cash flow negative in 1H22.

This exercise is simply to say that PEDEVCO has to realize greater economies of scale to be considered undervalued at this stage. Factor in the non-compliance issue and the impending (or ongoing) worldwide recession and there is just not enough meat on the bone to get excited about this oil and gas production company right now.