Diversified, to The Joke Bloke?

Commenting on the DEC chattersphere commentary

Dear reader,

One part of the DEC chattersphere is here

Should you give oxygen to your detractors? I expect the answer is no. The problem is I rather liked the nickname I’ve apparently been given. The Joke Bloke. How witty! How original! Very Gotham City. Come on! Why so serious? Poor Malcy of Malcy’s blog will be feeling very left out though - shouldn’t you extend the same courtesy and give him a nickname too? If I’m the Joker should he be the Penguin? Not sure what else you could use, but use your apparently advanced power of rhyming and you will eventually find something I’m sure. Oak…. Joke. What a leap of the imagination. I occasionally visit in case there’s anything useful and insightful. Unfortunately for me the LSE filter malfunctioned today and there it was. The howling in the void….

I’m pleased to report the filter is operational once more in the event I bother to return.

Sometimes, perhaps often, I’ll read something and think fair play you’ve got a point. For example one reader said I failed to mention that the hedging is not a management option. Fair play, I didn’t and it’s a good point. Hadn’t occurred to me. I revised my article based on that insight. Very useful to look at it that way. Does anyone/everyone who doesn’t agree with me get defined “misunderstood”? Not sure that’s true and I can’t think of a single instance I’ve ever said that until now. In fact if I’m amending what I write, I (and most) would call that conceding the point, surely?

Or have you misunderstood? I did say until now. Ha!

And maybe I am Wooden headed. English Oak to the core. Proud of it too. Stuff of Warships. Or maybe you should join GG in the playground and your name calling.

The comparison to Tony Blair was greatly appreciated too. For all his faults and failings (which I’m not at all interested in discussing) I actually think Tony Blair is a brilliant and clever man. One of my favourite reads is the TBI insights. I would love to one day have an Oak Bloke Think Tank, though I doubt it shall ever happen. I’m not an Ex-Prime Minister. But I would’ve been greatly offended if I’d been compared to any one of the politicians since Tony Blair. Although I do do an extremely good Boris Johnson impression, especially whilst on a zipwire, and I’ll admit I’m partial to a wheatfield when I’m feeling naughty. And, yes, I genuinely do aspire to somehow do 49 days work and get a £100,000 pension for life in return. Who wouldn’t? Lettuce have a chance.

That won’t be the first time I’ve conceded either. Notrex called me out for saying the shorts (on DEC) were melting. They weren’t. I expected they would, and still expect they shall. But fair play they weren’t. It prompted me to try to see if GG and his grisly gang of shorters (or wannabe shorters) had a point. In my article “DEC-sent” my calculations showed it did not made financial sense to continue shorting DEC. But there they are, still, burning their money. More fool them it would seem.

And here we are post 31st July with DEC down about £2.75 a share on no negative actual newsflow at or around that date. But where presumably shorters began leaning in again and weak hands and traders who’d bought at £10 sold at £13. I note the technical signals show at £13 as overbought and at £10.25 the RSI shows oversold (19), not that I am a fan of technical signals, as readers will know. They interpret what’s already happening or what’s already happened as far as I’m concerned.

Do I think a PV17 and PV20 deal is a great purchase? Yes of course I do. I’ve seen no decent argument to ever think otherwise. It’s like asking will a Large Meal fill me up more than a Small Meal. I guess the easy counter to that to ask what about the indigestion? Could a PV17 and PV20 deal be too good to be true? Or you could over extend? But when has that happened at DEC? They’ve steered their cash management expertly for years. Their last update said $120m of headroom. That’s a lot of headroom before you over extend.

A high NPV discount rate is like a high rate of return. Especially if you consider the weighted cost of capital where significant amounts of leverage super charges the equity returns. That’s just smart business. The line of thinking that Crescent Pass will sell at the earliest opportunity is fanciful too. Crescent Pass is a relatively small operator who are looking to expand outside of Texas and Louisiana. Being privately listed there is no “companies house” in the USA to examine their accounts but based on newsflow this $106m buys up most or probably all of their assets which they appear to have paid $100m for back in 2021. Unless they bought other assets and no news source reported on that. They walk away with $71m cash and DEC shares, but deploying that cash elsewhere will take time. It sometimes feels people who write these assumptions are teenagers or at least naive to what happens in business. In the real world.

Another commentator spoke to my thinking every acquisition was “great”:

“His comments on what another great buy Rusty has made should be considered against every other buy (and disposal) - all ranked in the "great" category. Yet we are where we are. Where is this business headed? Impossible to compare any periods performance against any other period - as has already been noted.”

That person doesn’t actually explain which deal(s) they feel weren’t great? Why not set out your thinking properly - i.e. in more than just a sentence? It would help to set out an actual line of thinking. Some facts and figures to back up the thinking (assuming there is thinking) wouldn’t hurt. To make it easier, below is a list of all the deals, their cost, the PDP resources acquired, the PV10 value, the cost per barrel of production, the supposed or suggested value of undeveloped acreage, so take your pick. Substantiate why one or more deals were not “great” for DEC.

The same person asks “Where is the business headed?”. The business strategy is pursuing - and delivering - four goals. It’s on Page 4 of the latest presentation, it’s not difficult to find.

And why are period to period comparisons for that person impossible? I seem to manage to do it? What prevents them? You look at cash, you look at profit, you look at liquidity. You look at the numbers surely? They were able to spot a $621m overall loss on settled hedges over 6 years which I didn’t - so is it “impossible”? Come on!

Someone else meanwhile called out the bespoke metrics (of DEC Interim Report page 42)

“Adjusted EBITDA - about 20% down on 6 months to Jun 23 - ie worse

Debt up - ie worse

Pro forma adjusted TTM EBITDA down - ie worse

Leverage up - ie worse

Adjusted EBITDA margin up - ie worse

Free cash flow up on Jun 23 but down on Dec 23 - ie worse

Operating costs per Mcfe better than Dec 23 but worse than Jun 23”

It’s actually very interesting to examine each of these, and why they are worse. There’s a lot of use of the word “worse”!:

Adjusted EBITDA: Worse. $65m of difference.

The realised price including hedges in 1H23 was $19.87/boe and 1H24 was $18.33/boe. That explains $40m of the $65 difference. Is the price of natural gas DEC’s responsibility or fault? The environment is “worse” (for all NG producers) but I would disagree it’s a worse performance by management.

A second reality is that production in 1H24 was 22,627MBoe and in 1H23 was 25,697 MBoe. The difference is 3,070MBoe. Using the 1H23 $18.30/BOE price that’s a $56.2m difference.

Why is 1H24 production lower? Is that DEC incompetence? We know that DP Lion was 2/3 of that decrease (which generated funds for DEC). 1/3 was due to natural declines. Eagle-eyed readers will spot that a 1,023MBoe decline on 25,697 is a 4% (not 5%) decline. I consider that DEC COMPETENCE.

So is it a “worse” number. Of course. But is it actually worse in terms of performance? I find that: UNTRUE

Debt up = Worse

Is debt being up actually worse? Do you understand leverage?

If you’ve invested into DEC and not understood leverage then you shouldn’t be here. It’s as simple as that.

Leverage is the idea that if I can earn say 17% IRR on buying some O&G resources, and if I have £548.30 of equity and £1,654.56 of debt costing me an average 7.3% a year, and £1,613.60 of other liabilities (with no cost). With all of that I can own £3,816.46 of assets.

Those assets at 17% return can generate £648.80 per year. I pay creditors £120.78 so leaves me £528.02 profit, and money to pay for that £1,654.56 of debt.

If I had no debt because I believe debt is worse and had £548.30 of assets also generating a 17% return, I’d make a £93.21 profit.

£434.81 less profit because of the mistaken belief that more debt is worse.

Is more debt per se “worse” for DEC in 1H24? I find that naive and UNTRUE

PS if you change the above numbers to $m I’ve more or less just described the DEC balance sheet and business model. Appreciate I’m oversimplifying but I am trying to explain the principle of leverage.

Pro forma adjusted TTM EBITDA down - ie worse

This is a repetition of adjusted EBITDA and the explanations are the same.

The TTM EBITDA is $49.6m “worse”

But considering the differences of $40m due to price and $56m due to production means it’s actually a $46.4m “better” performance, not worse. So true or untrue I’ll leave you to decide.

Leverage Up - worse

Leverage is the use of debt. So again this is just repetition. Not sure why the person doesn’t understand that. Possibly it goes back to understanding how leverage works in business. I am going to disagree and say leverage up being “worse” is UNTRUE.

Adjusted EBITDA margin up - ie worse

I’m baffled how a higher EBITDA margin could be worse. A lack of understanding of business or just a typo. Either way I have to conclude UNTRUE

Free cash flow up on Jun 23 but down on Dec 23 - ie worse

Now we are getting selective about which period is chosen for the “worse” comparison. Shall we do a best of five also?

It’s probably more useful to look at net cash provided by operating activities. DEC spent less in 1H24 than 1H23 on capex. If the reader had noticed this, he wouldn’t have had to fudge his period of comparison. $172.5m of net cash provided by operating activities in 1H23 dropped to $160.8m in 1H24. Aka Worse.

But when we know that there’s $40m of difference due to lower prices (including settled hedges) comparatively at a steady price of O&G the net cash would have been around $200m. It’s worse due to lower prices.

But let’s also consider December 2023. $237.6m vs $160.8m. A vast $76.8m difference.

Why?

Well the 2H23 average realised price per BOE was $20.10. Compared to $18.33 in 1H24 that’s a $1.77/BOE difference. So again a $40m difference.

But there’s still a remaining $36.8m difference.

Production in 2H23 was 24,241.7MBoe vs 22,627MBoe in 1H24. A 1,614.7MBoe difference. At $20.10 that’s a $32.5m difference.

But also comparing the Settled Hedges. In 2H23 the benefit was $120.3m whereas 1H24 it was $77.8m. So a $42.5m difference.

So depending on your view of whether DEC are “responsible” for sufficiently hedging production or obtaining an attractive enough price makes free cash flow $4.3m worse if you consider DEC are 100% responsible for the worse price/quantity of hedges.

Or if like me, you think the El Nino weather of the last few years probably made it hard to obtain options at as an attractive a rate as 2H23 for 1H24 then the underlying FCF is actually $38.2m BETTER comparatively.

TRUE/FALSE you decide.

Operating costs per Mcfe better than Dec 23 but worse than Jun 23

More selectivity of dates. More naivety. And let’s explain why. Let’s consider why it’s “worse”. For a start, elements of operating expense are fixed costs. In business if you spread your fixed costs over a smaller footprint of production then your cost per unit goes up. Not because the costs have gone up but because you have fixed costs. The difference of production comparatively is 11.94% lower (due to the DP Lion divestment, and due to natural decline)

This causes midstream to be up 18% per unit and people costs to be up 20%.

Yet if you look at the “total change” column costs are ACTUALLY DOWN 6% compared to June 2023. But there’s an 8% “per mcfe” change (upwards).

So are operating costs worse?

On a per Mcfe yes the number say that but actually if you compare the drivers for that “worse-ness” it’s actually better. 6% better.

6% better. Despite a period of inflation. Despite a supply chain crisis. Despite tight labour markets.

Personally I think it’s an impressive performance to have achieved that. Not that many businesses did achieve that in the past year, did they?

The Rub

And this brings me to the rub.

People say the deals aren’t great, they say the debt’s not great, rising costs aren’t great, lower profits aren’t great. But all of this is all interconnected.

It’s like complaining about it raining and then you get your wish and the rain stops, and then later you complain there’s no crops to eat because there’s been no rain.

There’s that saying isn’t there “Can you have your cake and eat it too?”

Leverage helps delivers production and replacement and growing production. Deals deliver production, at advantageous (“accretive”) rates. Managing the capital allocation strategy to balance dividends, buy backs, acquisitions and paying down debt and has to be finely balanced.

Rain (debt) boosts crop yields (O&G production). Perhaps some people just like having a moan.

You invest in businesses where you put trust in the management to manage the business with your (equity) money (and also with debt).

Or exit if you don’t trust them. I’m surprised people persist holding DEC despite proclaiming they don’t trust Rusty.

It was interesting to consider the APMs from Page 42 but can’t agree with the chorus of “worse”. Comparing two sets of numbers (sometimes selectively) doesn’t really lead to any understanding of what will drive this business to future success. There’s a certain melody to being to say worse, worse, worse, worse, worse. It reminds me of an article I wrote where the melody was “accretive, accretive, accretive”. But for me what mattered was the why, why, why.

Once I got into the why, I found a series of factors either beyond DEC’s control (price) or factors which are resolved post period by the “great” deals of Oaktree and Crescent pass (increasing production and spreading fixed costs more widely).

Hopefully readers find the “why” useful also. It certainly shines a light on the very things DEC can control and that in my opinion - and according to the numbers - they are controlling very well; and the things they can’t control like natural gas prices. But things which appear to be turning from headwind to tailwind as we head into 2H24 and beyond.

Ultimately, people were bumping their gums about DEC being doomed in the chattersphere back when it was at £8.80. Back when honorable Pallone was putting his enquiries in. When malicious and untrue snowy reports spooked things. The bumping hushed down as it headed to £13. The price is back down again, but I just don’t believe this will still be at only £10.25 in the months and years ahead.

The last time DEC fell to £10.25 was Jan 16th, whilst Honorable Pallome, and the dishonorable shorters Snowcap report were in full swing. After £10.25, DEC dipped briefly to £8.80.

Seven months later DEC is in a far stronger position than January, and has soundly answered those attempts to destabilise. Delivered two “great” deals or three including the Lion divestment, or four if you consider the $9.6m acreage divestments and gains in 1H24 results. Delivered a strong 1H24 result also. Delivered two dividends this year, buy backs, and debt repayments. It’s delivered on all four of its strategic goals.

I’ve set out very detailed reasons why I believe DEC will do well going forwards. In this and in prior articles. And that’s what separates being an Oak or a Joke. Clear headed or wooden headed.

Regards

The Oak Bloke

Disclaimers:

This is not advice

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