(Note: This article was originally published in the Market Newsletter on October 19, 2022 and has been updated as needed.)
Permian Resources (New York Stock Exchange:PR) is a company that was recently born with the merger of a private company, Colgate Energy, and a public company, Centennial Resource Development (CDEV). The company’s new CEOs will come from the private side of this merger. Therefore, a public history is not really available. However, it appears that compensation will go a long way in favor of management building the company successfully.
Management seems to want to be a consolidator in an area that has some fragmented and less than optimally sized operators. That’s a pretty good strategy for shareholders, as this type of consolidation often occurs with properties that limit market attractiveness and thus sell at a discount.
against that, the management team He seems to have a lot of investment and consulting experience. That can be a disadvantage if management doesn’t conform to the “hands-on” that is often necessary with the management and take-up of acquisitions.
Compensation packages presented to shareholders appear attractive for several reasons. The big reason is that management is unlikely to get much money if management doesn’t produce for shareholders. We will have to see how the board executes this type of strategy to confirm this. But at least at first it looks good.
These CEOs are going to get paid only in stock. There is no cash salary or bonus. This is comparable to Kinder Morgan (KMI), whose chairman of the board has long worked for $1 per year. Executed correctly, it will be a powerful incentive for shareholders to produce.
The management team’s background seems to favor a strategy of building a business that is attractive to potential buyers at the right price. The fact that a private company decided to go public in this way is another vote from experts who want to “get in on the action” rather than a group of experts being sold. Therefore, this does not seem to be the time to sell companies in this industry.
Private company registration
Private registration revealed to shareholders and the public appears to be attractive.
The fact that investors recovered their entire investment within a four-year period is impressive when you consider that one of those years was fiscal year 2020. That cash return supports the superior return claim in the chart below. Similarly, the claimed IRR also has some validity when cash is available to return to private shareholders. The full picture points to good management.
Location Location Location
In many ways, this industry resembles the real estate industry in that location and often results in a competitive moat that offers lasting competitive advantage. Both companies have that location advantage.
The combined company has leases in essentially the same locations. Management has delivered the corresponding drilling and production results. The only thing that is needed in the future is how this translates into recovery and cash flow. Of course, that’s strongly hinted at shareholder returns in the past.
The other thing about these companies is that each was financially very strong independently. Therefore, the combined company will begin its existence with very conservative balance sheet ratios. That means the acquisitions are likely to be cumulative by using a mix of equity and debt design to keep the debt ratio very low. That keeps future opportunities to take advantage of offers on the table.
Just based on the location of current leases, this administration is likely to be very picky about the location of future acquisitions. That would keep the growing company’s profitability high in addition to low debt levels.
The unusually profitable location of the leases allows for decent returns for shareholders, as well as the reinvestment of some cash flow to grow the company.
Shareholder returns are based on a combination of a base dividend, a variable dividend and share buybacks that should equal 50% of free cash flow. This balances the market demands for return on capital with the needs of growing a business that is likely to sell for the right price in the future.
Some of these companies will emphasize the return shown above in cash, while here there is likely to be a little more emphasis on share buybacks at the expense of cash returns.
The reason for this is that it is essentially a new company in the eyes of the market and therefore likely to be discounted until it is experienced. In my opinion, it appears that management intends to take advantage of that discount by buying back shares. Some companies like Pioneer Resources (PXD) don’t really have a discounted stock price. Therefore, it makes little or no sense to do a lot of share buybacks when that is the case.
Permian Resources is a new company run primarily by the co-CEOs of the private company. The first job is to optimize the operations of the combined company of the former Centennial Resource Development (CDEV) and Colgate Energy.
The CEO’s compensation package looks very favorable to shareholders at first glance. Likewise, the return to shareholders of a fixed and variable dividend combined with share buybacks seems to strike a better balance than many programs out there at the moment.
Many managements are touting big returns for shareholders. But the market also values growth along with dividends. Some of the companies that emphasize dividends over future growth may find their companies valued lower than companies that manage to generate revenue, share buybacks, and decent growth.
The combined plan also targets the profitability of the business location. The location of the leases is likely to provide a long-term competitive moat for this company compared to much of the industry.
Management gives itself an additional growth avenue by pursuing cumulative acquisitions that will most likely keep debt low through the use of equity and debt.
Overall, this startup has enough experience and a decent size to offer an above-average chance of success. Still, the company is new and the new management has not been tested. Shareholders and investors should not be surprised to see a valuation discount until there is a public record. At this point, however, this company appears to be off to a good start and is worth considering by a variety of investors who don’t care about the risks of the new company.
Next quarterly report
This first report is likely to have a lot of “noise” because the two companies completed their combination very recently. This first quarterly report is likely to be next to useless for many, but it’s worth a read to make sure no serious issues arose.
But even the next quarterly report could have a fair amount of non-recurring optimization charges. Quarterly reports may take some time to “clean up”.
An investment at this point would be some faith in the management and previous track record of the public company. That has something going for it. Also, the location is great. So that could provide some downside protection. Still, conservative investors may want a record of the combined company’s management for a year or so.