HK 4Q08 Note With Conference Call Highlights

 

HK Reports 4Q08; Top Line Beat, Bottom Line Miss; Raising Production Guidance, Costs Remain Low.

• The 4Q Numbers:
  • Production: 361 MMcfepd was previously announced, up 15% sequentially and 52% YoY, 92% natural gas
  • Revenues of $270.7 vs $226 mm expected. Much of this beat was due to higher than expected marketing revenues (lower margin than oil and gas revenues)
  • Lease Operating Expense (LOE): $0.45 (very low)
  • EPS of ($0.04) vs $0.03 expected (quarter was clouded by the previously announced ceiling test writedown)
  • CFPS of $0.48 vs $0.54 expected
• Guidance:
  • 1Q09: 400 to 410 MMcfepd (HK had previously stated a 2008 exit rate of 400 MMcfepd).
  • 2009: 422 to 432 MMcfepd, up 40% from 2008’s average production of 305 MMcfepd. The last target range given for production was 25 to 35% growth so this is an increase to guidance.
  • LOE seen falling further in 2009; targetting a range of $0.36 to $0.44.
  • Average EUR for a Haynesville shale horizontal now seen at 7.5 Bcfe, up from a prior 6.5 Bcfe.
• Balance Sheet: 41% debt to cap
• Hedges: About 60% hedged with floors in the mid $7s.

Conference Call Notes:

Borrowing base was reconfirmed at same level under same terms.

Haynesville development will allow them to guide to the lower LOE range referred to above.

Target goes from mid point 30% to 40% growth, they are doing this with the same capital budget.

Says the EURs are remarkably consistent which is what gave them the confidence to go to 7.5 Bcfe.

Comment on the high yield deal:

• Used $535mm to pay off all of the borrowings on the revolver.
• They have $950 mm available.
• Net debt to total cap was 38% at YE08

 

Q&A

On The Upward Revision of the Recoverable Reserves from 6.5 to 7.5 Bcfe per well:

• There is of course variability,
• this is the answer so far,
• it comes from the small set of publicly released wells they’ve drilled
• stretched over a broad area over many miles both in the Elm Grove area and outside of it.
• Reserve growth seen as very consistent with production growth and they think it will be that way again this year … so that implies 40% boost in proved reserves.
• Lateral length: 4,500 foot lateral with 15 frac stages is still the current design. The laterals in the included set of wells were not all that long. So as they go forward think bigger.

Capex Thoughts:

• When do you reduce capex:? Not until they see a three year gas strip around $4.
• How much of the budget is designed to hold acreage in the Haynesville?  Answer: A good percentage is to hold acreage, probably 75% … Their planned spending in the H.S. this year is ~ $700 mm
• They will drill 70 to 80 wells out of 1,000s of potential locations (so they are cherry picking their Haynesville targets in this low $ gas price environment).

At $4 gas they make money in the Haynesville wells.

THEY WILL PUT OUT AN OPERATIONAL UPDATE SHORTLY AFTER THE END OF THE QUARTER (SO EARLY APRIL)

Service Costs:

 

• mud, pumping, tubulars 15 to 30% down in price from 2 to 3 months ago.
• See costs down by a “significant” amount but don’t want to throw out a number yet. Translation, lower F&D.
• Second iteration of translation. If we don’t have much lower gas prices we won’t have a second set of ceiling test writedowns that cloud the F&D, especially with the new, kinder, gentler SEC reserve calc rules.

Other Notes:

Current Well Costs: $10 mm or a little more (little more science in these wells, that’s a little higher than I thought)

Boardwalk pipeline not flowing fully to its ultimate destination…could be a little cloud for SWN’s 1Q before that gets cleared up.

Haynesville differentials - see slight premium to Nymex (1 to 3%) as they plan to move all their H.S. volumes to the east.

Off-structure wells from Elm Grove doing very well, good rock, good completions. That 28 MMcfepd well several weeks back  was off Elm Grove.

Timberlands well - further south. Taking a look at the Bossier there but just perf the Haynesville. Could be a good chance to commingle here.

Haynesville - core acreage - all of their 300,000 acres are what you’d call core. I’ve discounted their acreage by a third to a half in my previous acreage X EUR calcs. As they have drilled along a long mileage line of the play they reducing the need to discount the acreage so much.

 

SEC Rule Change question: don’t yet know how it will be implied. (Nothing final yet, hey look, someone else waiting on the government to get its ….. together)

Eagle Ford Shale: fracced 3rd well, ver encouraged, drilling 4th well now, bringing in second rig late 1Q. This is a change, adding the rig. There will be an IP for this third well in the April operations update. 

 

So what of the chokeback pilot announced in the last update? Abandoned. No reason to restrict the wells and flow them back slower to see if you get a higher ultimate recovery. This is probably a good piece of the ability to increase guidance without capex if you think about it.

Question From Choices Regarding My Sense About A Secondary From The Call:

The short answer is NO, didn't feel like a secondary is in the offing right now.

The long answer is:

1) they did the $600 mm senior ($535 mm net proceeds) a few weeks back to pay off the revolver.

2) the revolver was $1.1 billion prior to the deal and was set at $950 post deal. Adding the senior debt reduces what people will let you borrow on a credit line. Note that it was not a dollar for dollar reduction. They added $600 mm senior but only saw the revolver shrink by $150.

3) the revolver was up for redetermination in April but they went ahead and asked it be redetermined now, at the $950 level and it was approved at that level. That speaks to their claims on reserves.

4) So, as far as we know, right now, they have $950 mm of borrowing capacity on the revolver.

5) So with nothing to pay down on a credit line and no ability to swap high cost debt for lower cost debt due to the markets there is little need for more debt issuance just now.

6) They plan to drill more wells for less $ as service costs come down but will stick to the overall previously released budget with about $700 mm going to the Haynesville.

7) On the stock side, that could be another story. They NEVER hint about a stock deal because you do one after running the stock up on good news and doing so will preclude that run up.

8) My sense is that they put out the very openly disclosed and a little bit hyped by management operations update in early April and then we get a secondary, or not, but not before.

9) It’s going to depend a lot on where the stock is in early April. If its above $25 I’d say you have above a 50% chance of them floating 20 mm shares out the door. Note that its not impossible to get equity done as WLL proved the other day.