Reiterated Strong Buy: Unit Corporation's Leaner Operations Still Look Bullish

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Unit Corporation remains a "Strong Buy" due to its leaner operations and sustainable dividend strategy despite recent revenue declines and market challenges.UNTC's strategic divestitures and focus on ...

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Sean Hannon Unit Corporation (OTCQX:UNTC) has focused on stabilizing its financials and continues to be centered on delivering reliable dividends for its investors. Naturally, the recent dividend cut wasn’t welcomed, but after analyzing the company, I still believe there’s a viable long-term bull case for UNTC. Management seems to be on track as of Q2 2024 despite fluctuating market conditions, reduced revenues, and lower production volumes. However, this was mostly due to the company's ongoing divestitures since 2022. On top of that, the contract drilling segment saw reduced demand and pricing rates, which compounded its challenges. Nevertheless, I think UNTC now has a leaner operation, and as long as revenues stabilize, its dividends seem much more sustainable. Thus, I feel it’s fair to reiterate my “Strong Buy” on UNTC for investors who understand its inherent turnaround risks. Still an Income Play: Business Overview Unit Corporation (UNTC) is an energy company with a diversified Oil and Gas portfolio. UNTC extracts oil and natural gas from its properties, acquires properties already in production, and provides contract drilling services to other firms in the sector. UNTC employs specialized rigs and crews to manage its services onshore. Since my February 2023 article, UNTC has remained focused on being an income investment. Even though unfortunately, it had to cut its dividend by half, and its revenues continued declining due to lower production levels.   Source: UNTC’s website. More recently, UNTC’s oil and natural gas subsidiary reported an increase in average oil prices. Management noted that they saw a 38% rise in Q2 to $79.23 per barrel compared to $57.34 per barrel in the same period in 2023. However, these increments were not enough to compensate for its production volume decrease. You see, oil production dropped by a whopping 49%, and natural gas production fell by 43% YoY in Q2 2024. Nevertheless, I think it’s worth highlighting that UNTC’s declining production volumes are mostly due to its strategic asset divestitures. These divestitures have been ongoing since 2022, and in 2023, the company shed even more non-core assets. Those core assets were valued at approximately $107 million. UNTC then used those proceeds to bolster its cash reserves and double down on its strategy of focusing on core investments and reducing liabilities. Another positive from this downsizing was that plugging and abandonment costs associated with decommissioning old wells also decreased. Properties and Financials: Sustainable Dividend Strategy Furthermore, UNTC’s contract drilling subsidiary reduced its contract pricing and had a lower demand for these services. Despite maintaining the number of available rigs to 14, the average use rate decreased from 15.6 rigs in Q2 2023 to 11.9 rigs in use in Q2 2024. This reduction could be due to competition or external market conditions. Nevertheless, the key factor that affected UNTC’s revenues was the average rig price rates, which declined by 3%, from $31,764 to $30,786.   Source: Unit Corporation Website. Currently, UNTC’s main operating area is the Permian Basin in Texas, one of the US’s most oil-productive regions. The company also operates in Oklahoma, including the Anadarko Basin, where its oil and natural gas wells are located. Additionally, UNTC’s Louisiana infrastructure exposes it to another rich oil and gas region. New Mexico is also part of the Permian Basin. Overall, I think UNTC’s remaining assets are located in areas with high production potential that align with the company’s strategy to concentrate on core, abundant regions. Simultaneously, UNTC decided to keep its quarterly dividend payments at $1.25 per share in Q2 2024. This is key because most of its investor base is undoubtedly looking for a consistent dividend regardless of fluctuating income. The company paid $12.9 million in dividends this quarter, funded by available cash. Moreover, on September 16, the company announced that the quarterly cash dividend for Q3 2024 would also be $1.25 per share.   Source: UNTC’s website. So, this dividend seems to be the new normal payout going forward. But more importantly, it does corroborate that management remains committed to consistently returning value to its shareholders through regular cash dividends. Additionally, I believe the company seems financially stable and debt-free, so the recent pullback might be a good opportunity for long-term investors. Relatively Cheap: Valuation Analysis You see, from a valuation perspective, UNTC now trades at a $318.3 million market cap, making it essentially a microcap now. Its balance sheet holds $80.8 million in cash and equivalents against no long-term debt. However, the company does have about $55.6 million of regular liabilities and a book value of $257.1 million as of Q2 2024. This also indicates a P/B of 1.2. For comparison, its sector’s median P/B is 1.4, so UNTC seems slightly undervalued.   Source: Latest Corporate Presentation. March 2024. Additionally, over the trailing twelve-month [TTM] period, I estimate that UNTC has generated a positive cash flow of $79.3 million by adding its CFOs and CAPEX. This calculation excludes the $61.2 million it received by selling its PPE over that period, so it’s actually a relatively conservative assessment. Still, I do think it’s worth mentioning that back in Q1 2023, UNTC had accumulated depreciation worth 35.7% of its gross PPE. However, as of Q2 2024, it’s now 45.6% of gross PPE, which suggests that UNTC is investing less in maintenance CAPEX, which might have acted as a cash flow tailwind. Alternatively, it’s also possible that UNTC has sold its less depreciated assets. Furthermore, UNTC generated $12.1 million in operating income in Q2 2024, which annualized implies a $48.4 million run rate. This would price UNTC today at 6.6 times its operating income, which does seem relatively undervalued. Moreover, I think its high dividend yield seems safe for the foreseeable future as long as revenues stabilize. Therefore, I still lean bullish on UNTC, rating it a “Strong Buy” for long-term income investors who are willing to accept UNTC’s inherent turnaround risks. Investment Caveats: Risk Analysis However, the main drawback with UNTC is that its revenues are declining significantly. Since I last covered it back in February 2023, its quarterly revenues have decreased from $93.9 million in Q1 2023 to just $56.8 million in Q2 2024. This is a notable 39.7% decrease, which could very well persist going forward. Moreover, UNTC also cut its quarterly dividend from what used to be $2.50 per share to just $1.25 per share today. Yet, since its stock price is currently around $32.50 today, that’s still a respectable 15.4% annualized dividend yield. The only issue is that this compelling dividend yield holds some risks as long as UNTC’s revenues continue deteriorating.   Source: Seeking Alpha. Furthermore, in their Q1 2024 investor presentation, management mentioned that they were also reducing G&A expenses to reflect their smaller footprint. Thus, for all intents and purposes, UNTC is now adjusting to a much more downsized reality. The only question remains whether or not they’ll continue downsizing if revenues trend even lower or if they’ll stabilize and set a new potential base for future growth around these levels. Yet, last time I covered UNTC, their SG&A expenses reached $5.1 million in Q1 2023, but as of Q2 2024, they’re now slightly higher at $5.6 million. It’s not a huge increase, but it also raises some questions about their actual downsizing of expenses. Likewise, their gross margins have deteriorated from 53.1% in Q1 2023 to 37.4% in Q2 2024. The same applies to EBIT margins, which declined from 58.0% to 21.3% over the same period.   Source: Investor Presentation. March 2024. So, I’m skeptical about management actually reducing expenses to reflect their new, downsized reality. Naturally, it could be explained away by arguing that revenues have declined much faster than expected, outpacing UNTC’s cost-cutting efforts. Thus, as long as revenues stabilize, their cost-cutting strategy will start to reflect improved margins. But this remains speculative until we see that reflected in their actual financials.   Source: TradingView. Fortunately, the main positive I found about their latest Q2 2024 figures was that UNTC’s latest quarterly cash flow was roughly $18.0 million by adding its CFOs and CAPEX, excluding what it received by selling $3.2 million worth of PPE. Also, it spent $1.1 million on stock repurchases and $12.9 million on paying dividends. Thus, in total, it needs roughly $14.0 million per quarter to sustain this level of stock repurchases and dividend payments. Since it’s already generating $18.0 million in positive cash flow, I think UNTC’s current 15.4% dividend yield seems sustainable. However, this is still contingent on revenues stabilizing. Still a “Strong Buy”: Conclusion Overall, UNTC has indeed faced headwinds since I last covered it last year. The main issue is its rapidly declining revenues, which can be explained to some extent due to its downsizing. However, going forward, the main variable to monitor is whether or not revenues stabilize and margins start improving. Fortunately, I think that its current cash flow run rate does suggest its dividend is sustainable at this point. Moreover, the dividend itself somewhat de-risks UNTC as well. So, in total, I think it’s still fair to lean bullish on UNTC, especially now that it’s a more focused operation with an already positive cash flow. Hence, I reiterate my “Strong Buy” rating for income investors who understand its embedded turnaround risks.  Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. 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