Callon Petroleum Company (CPE) is one of the smaller players in the big league considering global energy giant Chevron which governs a $160 billion market capitalization in contrast to Callon’s $450 million or so. However, CPE stock is fairly volatile and is quite an attraction for day traders. Callon Petroleum stock slumped to $0.42 at the height of the Covid-19 outbreak in March, and within 8 weeks the share rose to a high of $2.51 (which is a 498% gain). The stock currently trades at $1.29-$1.42 range and could still be disputed as a good pick for value investors.
Now, if you ask me whether I would bet my hard-earned money on going long CPE, I would not recommend it because of two major concerns.
A – Glut in the world oil market
B – Will Callon fade away?
A – Glut in the world oil market
Who can forget? Right!
Oil prices went subzero during the peak of Covid-19 when both supply and demand-side developments “shocked” the market simultaneously. Demand shock followed when countries went on lockdown and barred traveling as a measure to contain Covid-19 from taking over the reins. At the same time, while the world was living in a bubble, Russia and Saudi Arabia flooded the market with excess supply creating a glut of oil in the world market. On April 20, crude oil prices plummeted to historic lows with WTI Crude closing at -$37.63/ a barrel.
Domino effect at play
With economies gradually opening for business, the real reflection of destruction caused by Covid-19 came to light. In line with markets trying to stay open with the “new normal’ which in essence is to work around Covid-19 and to stay in business (also researching for a vaccine so to be rid of this torment), crude oil demand has risen and price per barrel has started to tick up and now floats at a price range of $41.26-$41.34, which is much more comforting considering the daunting prices when the market crashed.
However, despite crude oil prices recovering, the damage has already been done. To date, at least 24 oil companies have declared bankruptcy owing to the fact that most of these companies had taken on too much of debt during the good times (Callon is no exception to this) and with crude oil plunging to dirt cheap prices these companies couldn’t weather the storm.
Covid-19 is here to stay and test businesses’ strong point
Despite economies trying to stay afloat, demand and supply still have not converged, global and domestic travel is not the same as they once were, people are not yet confident about traveling so freely without a vaccine to combat Covid-19. Even cruise line businesses were given the red alert with the no sail order being extended to September 2020. According to a survey of GlobalData, a third (32%) of U.S. respondents have stated that they will reduce domestic and international travel, while also almost half (48%) revealed that they will also now dine at home, instead of at restaurants.
These significant changes in consumer preferences are alarming for the domestic tourism and hospitality industries in the U.S. America’s attempts to flatten the curve is not yet fruitful. Last week, the U.S. reported a daily record of more than 77,000 new infections, illustrating that the effects of the virus will continue to impact domestic tourism flows in the U.S. for months to come.
B – Will Callon fade away?
Callon started the year with a strong footing which was witnessed in the first-quarter earnings, yet, when things went all doom and gloom with Covid-19 taking over the world and bringing global industries to its knees, Callon acted out swiftly with a contingency plan without delay.
Ground Plan
| A material reduction in general and administrative costs | 35% compensation reduction for board members. 35% reduction in CEO target cash compensation.Minimum 25% reduction in target cash compensation by all other officers. |
| Credit Facility & Liquidity ($1.7 billion) | Suspension of the total leverage ratio test until March 31, 2022.Addition of a secured leverage ratio test of 3.0x.Temporary waiver of the current ratio test.Allowance for $400 million of junior secured debt without any reduction to the borrowing base. |
| Capital expenditure | Reduced 2020 capital program by >40% |
| Hedging advantages | Restructured hedges to protect cash flow with an MTM value of $245 million.Meaningful basis and “roll” hedge portfolio. |
| Oil Production | Planned curtailments since May 2020 (Down from 9 rigs to 2 rigs in 27 days, dropping to 1 rig as of mid-May) |
Expanded debt in December
Callon took on $1.7 billion of debt in December 2019, where Callon acquired E&P Carrizo Oil and Gas, another shale company. Currently, Callon’s financial debt/equity ratio is at 9.7 times but then most of Callon’s debt does not mature until 2023. However, the company is still cash-poor and its credit rating was lowered to B- with a negative outlook. This reflects the S&P Global Rating agency’s view that oil and gas prices will remain challenged in the next few years, oil and gas companies will have limited access to capital markets and liquidity may be constrained owing to lower bank price decks.
Peer comparison – debt profiles
| Company | Market Capitalization | Debt/Equity |
| Callon Petroleum | $450 million | 9.7 times |
| Centennial Resource Dev. | $230 million | 13.5 times |
| Oasis Petroleum | $230 million | 15.0 times |
The easing off of debt pressure on Callon is heavily dependent on the price gains in oil. The higher the oil price the greater the comfort for a highly leveraged company like Callon. Furthermore, Callon is heavily invested in shale production, which is one of the most expensive ways to extract oil. Deloitte accounting firm states a clear warning – “if oil prices remain around $35/bbl, more than half the companies in the shale business are either technically insolvent or financially stressed. The pace of change will depend on how long those weak players can continue making payroll and paying the bills.”
Takeaway
The outlook for the oil industry altered within one day in March 2020, and a number of oil companies filed for bankruptcy in the months that followed. The peak in bankruptcies after the 2014 oil price crash was in 2016, the lag this time could be shorter. During the first half of the year, 18 oil companies filed for bankruptcy protection, which is well behind the pace in 2016, when 70 cases were filed, according to the Oil Patch Bankruptcy Monitor compiled by Haynes and Boone. However, we believe it is better to offer a stern warning and put off any action driven by hopes that oil prices and improved management will fix things. For now, we recommend steering clear from a long term investment perspective on Callon as it is still unclear “who will remain and who will fade away.”
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