Summary
- Talos Energy has declined over the past year in line with oil and gas prices.
- The company's EV/EBITDA and P/FB put the company squarely in the bargain category.
- Long-term, we'd like to own this company and think present pricing presents a good opportunity for risk tolerant investors.
- We rate Talos a Buy.
CHBD/E+ via Getty Images
Oh man, buy? Don't buy. It's so confusing.
Introduction
Talos Energy (NYSE:TALO) has been hit hard by the downturn in the market, with TALO stock declining from a peak of $19.36 at the time of our last article, to the Monday's $11.90 per share. It popped higher with the rest of the market in Tuesday, perhaps in anticipation of calming commentary coming from the Fed meeting on Wednesday, and seems to be dithering as the market sorts itself out. The actual commentary from the Jerry, "rate cuts are not our base case," and Janet, Here's a nice blanky, one day, and then, I'm gonna need that blanky back, yeah that one, the next, tag team didn't help stabilize the markets either. While the price declines are disappointing, they are proportional to declines we have seen in other oil-related equities in that time, with most of the down-draft occurring in early Feb, 23. We all pretty much understand the reasons for this implosion, so I am not going to belabor this reality herein.
Talos Energy Price chart(Talos Energy Price chart (Seeking Alpha))
The fact is there is nothing structurally wrong with the company. They have done a lot of things right over the past year, and that is where we will place our focus. There is an old saying that, "You can't fight City Hall." No further proof of that truth is needed than that. When there is fear and loathing in the market, good assets go on sale. That is exactly the time to buy. The question is, are they on sale even at these reduced prices?
Talos' prior TTM financials and flowing barrel calculation put the company in the buy column. On the sticky note bulletin board are concerns about realizations for Q-1, which will be at least 5-10% below Q-4, may compress earnings and put a drag on the stock price.
The thesis for Talos
Billions of dollars of infrastructure have been left behind by the major oil companies as they have departed the GoM. Talos under its own banner have assembled an impressive catalogue of these castoffs, which enables the development of satellite fields also left behind by the original owners. The combination with EnVen is immediately accretive and pays out in a year and a half at $75 per barrel WTI. Along with the potential for new oil and gas production, Talos has moved aggressively into the carbon capture and storage business, that will be propelled forward by Federal tax incentives and sustained with CO2 emissions from the huge inventory of Gulf Coast refineries and chemical plants.
Talos Asset base(Talos Asset base (Talos))
The EnVen deal
Since our last report on Talos, the company has merged with EnVen, a competing GoM player, with a substantial footprint in this key basin. EnVen fills in a lot of gaps in the Talos infrastructure base beginning with the old Shell (SHEL) bottom supported Cognac platform in relatively shallow waters to the floaters-Brutus/Glider, and Neptune in 3,000-4,250' of water.
Footprint of EnVen Deal(Footprint of EnVen Deal (Talos))
Key facilities bought with EnVen(Key facilities bought with EnVen (Talos))
This footprint acreage-wise and the attendant multi-billion topsides gear that follows the Miocene/Wilcox trends that first drew operators into deep water in the 1990s. It also brings into reach a number of satellite fields left behind by the Super Majors. To Shell, BP (BP), or Chevron (CVX) a 50-100 mm bbl reservoir just doesn't move the needle or compete for capital with their daily output of 2-3 mm bbl.
These "pockets" of oil left behind in the Super Major exodus from shallow-deep to mid-deep water, plus the new fields that are identified in today's ultra high tech seismic imaging make a veritable feast for an operator like Talos Energy. Q-4, 2022's Lime Rock and Venice discoveries are examples quick turnaround adds of oil weighted production, facilitated by the Ram Powell TLP-Tension Leg Platform. The two wells are expected to contribute up to 20K BOEPD of mostly oil.
Lime Rock and Venice discoveries(Lime Rock and Venice discoveries (Talos))
The Talos/EnVen 2022 drilling program also yielded positive results with up to 24K BOEPD to be added as the wells come on line, including the Mount Hunter well. The A-26 Lobster well tested multiple zones and will be put on line this year. Non-operated Gunflint and Spruance will add another 5-8K BOEPD gross barrels.
Talos drilling program (Talos)
The Rigolets and Sunspear exploration wells could add another combined 20K BOEPD, if they are successful. The Puma West appraisal well was the only disappointment with further delineation needed. A side track out of the main wellbore is planned once targets are set.
A possible catalyst for TALO
Pancheron, operated by Occidental (OXY), is what the operators class as aHigh Impact Well-HIW, and brings with the expectation of recoverable reserves of at least 100 mm BOIP, or 1-TCF of gas. Talos CEO, Tim Duncan was a little understated in his initial commentary regarding Pancheron:
Another project we are very excited about is Pancheron. Pancheron is a high-impact project, we own with Oxy following the completion of a 46,000-acre continuous track, we were able to combine with them. Oxy is the operator of the project and we expect to spud the well in the first half of 2023. Talos owns a 30% working interest.
Pancheron Well(Pancheron Well (Talos))
A question from an analyst spurred Duncan on to a little more effusivity in the Q&A section of the call, inquiring about the possible size of the field.
We have worked with the partners on what kind of feel like think it's appropriate to disclose before we drill it and in this case, I think what I would tell you, it's certainly high impact, it's got large geological structures, it's underneath salt and so you can kind of imagine what type of project that would look like to be of interest certainly Oxy and us as well.
There is ample infrastructure in the area Heidelberg for example, in the area. So what makes us interesting is you're in a large geological fairway, subsalt, oil-weighted around near facilities in a big acreage position. So again not every project is something that we've got out specifically what that range will be, obviously, we have one internally but I think we put this one on the kind of a high-impact ledger if it works.
Source
I think the key point here in the quote above is the "geological fairway." It lies just west of theChevron Big Footwhich targeted 200 mm bbl, and nearby CVX, Shell and BP projects (Tahiti, Holstein, and Mad Dog that have collectively produced a couple of billion barrels over the last two decades. It's a fair point this is a target-rich environment, and Talos is justified in having high expectations. Pancheron is scheduled to be drilled in the first half of 2023.
If it comes in with a 100 mm bbl of recoverable reserves at $75 per barrel, Pancheron could add ~$98 mm of EBITDA annually to Talos balance sheet. Equating to a 10% bump from 2022. Fun with numbers!
CCUS
I will just document Talos CCUS footprint without much of any other commentary on the topic itself. Thus far this effort is in its fairly nascent stages and just sucking up capex. Shane Young, CFO noted the following on CCS capex:
Upstream capital expenditures for the year are expected to be $650 million to $675 million while plugging and abandonment expenses are expected to be $75 million to $85 million. Total CCS investments are expected to be an additional $70 million to $90 million and will be a mix of capital, G&A, and other income statement expenses.
Source
CCUS footprint(CCUS footprint (Talos))
Down the road the plan is for this to be a revenue generator, and Rystad notes that it could be a $55 bn annual industry globally by 2030. Using Rystad's numbers per ton and applying them to projected injection rates in the Talos slide above, CCS could generate $2 bn in gross billings annually.
It also worth noting that all this CCS stuff is fairly new andjust a few projectsare in operation. Time will tell about how all this pans out. Problems can pop up as theChevron Gorgon projecthas experienced. But, in the success case, you probably would spend a few hundred mm a year to generate $2 bn in revenue, so Talos is not being profligate.
Q-4, Full year 2022, and guidance
Revenues of $342 million for the quarter from solid realizations for liquids and gas, but down from Q-3 at $376 mm. Realized prices before hedging during the fourth quarter were $80.87 per barrel of oil. NGLs were at 30% the realized oil price and $6.10 per 1,000 cubic feet of natural gas.
Net income for the fourth quarter was $2.8 million or $0.3 per diluted share. Adjusted net income was approximately $17 million or $0.20 per diluted share. They generated adjusted EBITDA of $185 million during the quarter. On a per barrel of oil equivalent basis, this translated to an adjusted EBITDA margin of about $36.
Adjusted EBITDA, excluding realized hedge losses, was $242 million and a margin of approximately $47 per barrel of oil equivalent. This represents 65% and 71% margins, respectively. For 2023 Talos has half their production hedged using swaps with a $70 strike and with strike prices slightly higher at lower volumes for the rest of the year into 2024. Gas is hedged at about half daily production using 3-way collars for Q-1 and with fixed swaps between $5.25- 8.50 per mmbtu.
Capital expenditures and plugging and abandonment were approximately $156 million for the quarter and were below the previously provided guidance range. Long term debt stood at $585 mm and liquidity was $850 mm, including cash of $44 mm and the
In 2022 total production was 59.5K BOEPD and management is guiding toward total output of 72-76K per day. They are also increasing the oil output. As you can see from the slide below, Talos has shifted their production targets to substantially increase oil output. This is after a bruising 2022 where over half their total was gas weighted.
Talos Guidance(Talos Guidance (Talos))
Risks
Two risks I want to high light are the Q-1, 2023 risk. Realizations were in the $80s for Q-4, 2022. Great. Those have been slip-sliding down this quarter and will impact net realizations for the quarter. A swag is an average in the upper $70s for crude, and something in the $3s for gas, to the extent they are exposed to the market.
Another risk for the company long term is Asset Retirement Obligations (AROs), for the massive infrastructure they hold. A lot of it is reaching the 20-year level, meaning that as production declines it may become uneconomic to continue to operate, which will necessitate its removal.
Not worth discussing to any extent, but notable is the Zama project which just reached aMarch, 2023 Unit Development Plan deadlinewith the Mexican regulator. Zama is a huge discovery on the Mexican/American line, and originally operated by Talos, as the discover. The Mexican regulator didn't like this and, "shockingly" since 60% of the reserves were on their side, decided thatPEMEX should operate. Duncan's commentary in the call suggests that getting PEMEX up to speed has been a chore. Again, I amshocked.
The risk of course is PEMEX, which is notorious for project delays, turns it all into a dog's breakfast, and costs increase. Not an inconsiderable risk. The learning curve for new projects of the complexity of Zama, can be brutal and costly. We'll leave that there for now.
Finally private equity has been putting a drag on shares selling out of their positions over the last few months. PE firms own 25% of the stock so this kind of pressure could continue for a while.
Your takeaway
With the decline in the shares in light of the new $70ish oil price reality, shares are trading at about ~2.5X forward EBITDA, using a margin of about $35 per barrel, and giving them the benefit of their projected production rate. On a flowing barrel basis they are selling at about $33K per barrel. A fair margin of safety there. Fun with numbers!
On the balance, Talos represents a good value at today's prices and we will give Talos a buy rating. Higher oil prices would boost this thesis still further. The CCUS stuff is too far out to really use in valuing the shares.
Analysts view the company as abuy with target prices between $18-40, all of which represent a good opportunity at present prices.
Long term I think TALO is a company to own and today's pricing represents a solid entry point. Success on the Percheron well could also move the stock higher. The counter to that is risk coming in Q-1 earnings from lower oil prices, putting a drag on shares. Investors should monitor the stock at this point for any weakness, and consider their risk profile prior to taking a position.
Follow me to learn more about analysis!!
Comments