HighPeak Energy: Hot Water Escape (NASDAQ:HPK)

HighPeak Energy (NASDAQ:HPK) got itself in a tight corner by waiting until the last minute to refinance its debt while retiring a troublesome covenant. Fortunately, management had the resources to be able to take care of the situation. Going forward, management may have learned something about the current debt market that should prevent a “second time around” for something like this. The next time around is likely to prove to be a whole lot more challenging if it occurs. Nonetheless, this management has considerable experience in building and selling companies. That experience puts them on much firmer ground than many competitors despite the recent experience with the debt market.

Sure enough, the third quarter earnings report begins with a statement about a new line of revolving credit along with responsible growth generating free cash flow and repaying debt. Management may have learned the hard way. But at least it learned.

Investors need to realize that a lot of smaller companies do not have access to the management depth and talent of larger companies. They often depend upon one or two key individuals far more than would be the case for a larger company. If something comes up that is not part of the experience of those few key individuals, the company is likely to struggle far more than a larger company would with those issues. That appears to have been the case here. Therefore, it is not enough in and of itself to define the management as poor. However, a repeat of the situation would be another matter entirely (you can put that down as a small company risk).

In The Meantime, Back To Business

This company has more than 50,000 BOED in production. Management stated during that same refinancing press release that they now intended production to produce enough cash flow to include a third operating rig while beginning to reduce debt.

The strategy of growing while repaying debt is viable because the location of the acreage is in Howard County. This was the focus of Vital Energy (VTLE) when new management first tried to increase profitability. There are a lot of large companies that have noticed the profitability of Howard County acreage. This company started off with some of the best acreage in Texas.

This is a very low visibility industry. Therefore, rapid debt reduction is a must and an immediately priority at that. So, the announcement is welcome. there was a recent stock offering as well that added some liquidity to the situation and probably allowed the refinancing to complete. But it also gave management options to grow production (which is a priority here).

The location of the acreage, in the Midland Basin, has the potential to both grow production while repaying debt. Right now, the debt ratio looks conservative enough to get the company through a cyclical downturn. That is a major debt market consideration even though there does not appear to be a downturn on the horizon for some time to come. But the low visibility can cause that view to literally change “overnight”.

CEO Stock Purchases

‘The CEO made the largest purchase at more than $8 million in September. After the debt issues, a message a purchase like that would send was probably necessary. The stock has been drifting downward with much of the industry in the current fiscal year.

But a likely message of a return to growth signaled by the addition of another rig and the effect on reported production (which will take a couple of months to become apparent) will likely help the stock price in the short run until the effects of the strategy become apparent in the long run.

The company has very good financial underpinnings so the message sent by the stock price purchases will be backed up with fundamental facts that come in the next report. That gets the messaging further away from the debt issue and back to operations (where the message has been very positive all along).

Another boost from the stock is likely to come from the repayment of debt. Mr. Market loves declining debt in this industry before the stock price can be significantly revalued. This means that the debt ratio is being worked on both the numerator and the denominator. So, debt ratio progress could be made at a good clip. The strategy is only risky if a severe and sustained commodity price decline shows up tomorrow. That appears to be highly unlikely.

Review Of Operations

This company has the advantage of being located in Howard County, Texas, a few years ahead of others trying to get acreage there now.

Management is clearly choosing to make production growth a high priority. Therefore, anyone looking for dividends can safely look elsewhere. The fact that management is adding a possible third rig now that commodity prices are fluctuating in a very comfortable range tells you that growth is a priority.

The net debt ratio is satisfactory in the current price environment. Generally, the debt market wants a ratio that is conservative using much lower than current prices. There is the risk that growing production to do that will be met with a period of weak pricing that cancels the strategy.

Right now, there does not appear to be that influx of speculative money that often financed the rapid growth of oil production prior to 2015. As long as that is the case, then the growth strategy has a decent change to succeed. However, a failure of the growth strategy to succeed could result in unacceptable debt ratios.

Conclusion

The company emerged from the debt refinancing with a little bit of stock dilution. But the job got done. Now management is again focused upon growing production.

The growth plans have slowed somewhat due to market demands for free cash flow to repay debt and debt market demands to use that free cash flow to reduce the debt ratio. But management will clearly persist with a growth plan.

This is a management that has built and sold companies before. That reduces a lot of the small company risks. However, this management is not afraid to use debt. That could make a proposed investment unacceptable to risk averse investors.

But those investors who do not mind a slightly higher debt ratio than normal will likely see a growth idea that will succeed due to the management experience. The risk is higher than normal for this situation. But the stock can still be considered a strong buy at the current price.