News

Sep 12, 2023

Vital Energy Stock: Lowering The Breakeven More (NYSE:VTLE)

bjdlzx Vital Energy, Inc. (NYSE:VTLE) had legacy acreage in an area with a

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Vital Energy, Inc. (NYSE:VTLE) had legacy acreage in an area with a fairly high breakeven because not enough oil was produced from the wells and the production became gassier over time. The new management continues to move West when acquiring more acreage to pick up a greater oil percentage of production and lower the company breakeven point. This will increase the free cash flow even if commodity prices are a bit lower in the future than they were in the past.

Similarly, management is using shares of stock to keep the debt ratio down while at the same time making sure each deal is immediately accretive to current shareholders. This lowers the risk that high leverage levels incur. Meanwhile, acquiring acreage in "the company backyard" is acquiring acreage that the company is familiar with. New positions may be a distance from the current operations. But the distance is not so great that management is unfamiliar with the acreage characteristics.

The result of this careful strategy is the ability to drill wells with a greater oil percentage of production than is the case with established production so that the percentage of oil keeps increasing. Over time, this increasing oil percentage of production will also increase free cash flow even if management makes no more accretive deals. Shareholders will benefit from more free cash flow in the future as returns to shareholders steadily increase.

Because there is not nearly as much oil rich acreage as there was legacy acreage, any interference from neighboring operations is significant. This will likely lead to good and bad quarters in terms of expected production. The first quarter had less-than-expected interference and, therefore, exceeded expectations.

Vital Energy Production Summary For The First Quarter 2023 (Vital Energy First Quarter 2023, Update Press Release April 10, 2023)

Management completed a small acquisition that will add to production as well. However, investors can expect that interference from neighboring operations will vary with commodity prices. Therefore, the latest update is likely to be revised throughout the fiscal year.

Management also announced an acquisition in the Delaware Basin in an attempt to accelerate the move to more oil production while lessening the future dependence upon the results of Howard County.

More importantly, the pullback in commodity prices appears to have decreased seller expectations so that more oily acreage can be acquired. This will hasten the transition to higher levels of free cash flow.

The acreage that pays back the fastest is also the acreage with the highest oil percentage of production. That is the Howard County acreage.

Vital Energy Summary Of Howard County Well Production Characteristics (Vital Energy Fourth Quarter 2022, Earnings Conference Call Slides)

Any well that produces as much oil as shown above will likely pay back in about one year in the current environment. Commodity prices could drop materially from current levels and these wells would still payback in less than 2 years (that the industry uses as a standard when deciding to drill).

The oil production from these wells offsets the declining oil production from the legacy acreage. Because the payback on these wells is faster, the corporation free cash flow climbs with every well drilled (unless there is a disappointment).

That climbing free cash flow should lead to more debt rating upgrades in the future as management proceeds with the long-term strategy of increasing the percentage of oil produced (and hence corporate profitability as well). This strategy should offset fears that free cash flow will disappear as oil prices drop.

The latest acquisition of Driftwood accelerates the transition to more free cash flow in an absolute sense because the percentage of oil produced is greater than the corporate average. This management has emphasized the need for a free cash flow strategy to match the latest market demands. Rather than solely wait for enough wells to produce the desired level of free cash flow, this management is augmenting the transition to free cash flow with accretive acquisitions.

Vital Energy Comparison Of Driftwood Performance Characteristics To Other Acquisition Performance Characteristics (Vital Energy Fourth Quarter 2022, Earnings Conference Call Slides)

Management compared the prior wells drilled by the seller to the wells on the more profitable acreage (all of which was previously acquired). Note that this acreage is going to compete for capital very well compared to the other acquired acreage. It is also possible that management knows some things that could increase the performance of these wells in the future.

Vital Energy Additional Acquisition (Vital Energy Delaware Basin Acquisition Presentation)

The company used the recent commodity price pullback to make another deal. Like the previous ones, this acreage has a higher oil production percentage. This deal opens up still another area to piece together subpar holdings into something more marketable and more profitable. More to the point, management has needed to diversify away from very busy Howard County. This acreage does that. Notice also that it performs better than Central Howard County. That means that this acreage will immediately compete for capital.

These acquisitions allow for production growth while management claims to not be increasing production. But this acreage also allows for profitability increase by raising the oil percentage of production. This gives shareholders another way to win.

One of the things about the unconventional and even the conventional business is that technology is currently moving forward so rapidly that many of these acquisitions become bargains within a few years of purchase.

Long-term readers will remember that most of us were showing graphs that rarely showed oil production reaching 100,000 barrels of oil in the first year (let alone still more natural gas and liquids). Now that production is exceeded "all over the place."

So, the challenge has now moved to producing 200,000 barrels of oil in the first year. That is very likely to be commonplace in more and more basins as technology continues to advance. It also points to a continual lowering of industry costs over time. If costs continue to decline as they have the last few years (even considering recent service cost inflation), then we are likely to have a period of cheap oil and natural gas prices in the future.

The recent pullback in commodity prices benefitted this company in at least two ways. First of all, Howard County neighboring interference with company production was less than expected (probably due to lower industry activity levels). Secondly, management was able to make accretive acquisitions.

Even though the current acquisitions did not improve the debt ratio, each well drilled is likely to have a higher oil percentage than the current corporate product mix. That means that future wells drilled are likely to increase free cash flow. Therefore, management will continue to increase free cash flow with each well drilled on any of the recently acquired acreage.

While acquisitions can accelerate the transition to more free cash flow, management appears to have the company positioned to increase free cash flow without the need for acquisitions in the future. The market will see more cash flow at various commodity prices. This should lead to debt rating increases and a lower corporate breakeven point in the future.

The latest acquisition points to the fact that Howard County is not the only place for management to acquire oil rich production. This should reduce some market fears about the company having a relatively low amount of oil rich prospects to drill in the future. Management is proving there are a number of geographic areas that the company can expand into without being very far away from the legacy acreage.

The last consideration is that this management often makes acquisitions of small subpar acreage and then pieces those small positions into one larger more valuable holding. Management will further sell small acreage positions or swap those positions for "bolt-on" acreage. These actions likewise increase the company value.

The current Vital Energy, Inc. management has been in place for less than five years. Yet the transition to market-demanded free cash flow has been substantial in that time period. This management is likely to continue transitioning the company to greater profitability in the future. Vital Energy, Inc. stock is therefore a strong buy for those willing to bet on the continued outperformance of this management.

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