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Oil prices continue to stay above the $100 mark due to the energy crisis sparked by the Russia-Ukraine war. Small producers in the US are moving swiftly to capitalize on the opportunity to add capacity and boost profitability. HighPeak Energy (NASDAQ:HPK) has swiftly captured this opportunity posting impressive gains in its share price. However, based on the projection of oil price of $61/bbl in 2025, HighPeak Energy, Inc. has a 20 – 65% downside in terms of its share price. With a sustained high price of oil above $100 in 2025, HighPeak Energy has about a 34% upside. This makes HighPeak Energy, Inc. an unattractive investment.
The main strategy of growth used by HighPeak Energy is to maximize the value of its current holdings in Midland and Howard County, Texas. This region ranks #17 in terms of oil and gas production activity in the US, according to Mineral Answers. Among its peers operating in this region, HighPeak Energy Inc. is the lowest cost producer in Howard County and Midland, Texas, with a cost of production of $52.88/barrel of equivalent oil and an EBITDA margin of around $50/bbl of equivalent oil, as shown below.
HighPeak Energy has steadily ramped up its production capacity from 1.9 Mboe/day in 2020 to over 40 Mboe/day in 2021. It acquired Hannathon Petroleum, LLC in April 2022 and plans to expand production to more than 50 Mboe/day. With higher anticipated production, we can anticipate higher revenues for HighPeak Energy in the short-term. However, it is interesting to note that the permits issued in Howard County, Texas have steadily declined in 2022. Peaking in 2019 to over 2797, dropping to 632 in 2021, and only 108 thus far in 2022. Using permits as a leading indicator, we can anticipate that the only factors that can boost profitability for HighPeak Energy Inc. in the future is the increase in the price of oil beyond current levels or more acquisitions of nearby reserves.
Howard County Drilling Permits (Mineral Answers)
As discussed above, an investment into HPK involves having an overall view of the price of oil. According to analysts, the price of oil is projected to drop below $100/bbl by 2025. For example, EIA anticipates the price of oil to be $61/bbl by 2025. Investors in HPK have to balance the current market and the geopolitical climate around the Russia-Ukraine war with the potential for new production coming online. With an increased focus on growing renewable fuels and meeting stringent climate goals, some analysts even predict the price of oil dropping below $40/bbl by 2030.
It is clear from the previous discussion that the revenues and profitability of HighPeak Energy, Inc. is relatively sensitive to the price of oil. In this section we analyze the company fundamentals vs. historic price of oil shown below.
5 Year Historical Price of Oil Benchmark
When the price of oil was around $60/barrel, the value of the assets of HPK was only around $498 million in 2019. During the time when the oil price dropped below $50/barrel, HPK halted drilling operation. Not having any long-term debt, the company was able to come out of the oil market downturn unscathed. In 2021, when the price of oil started to recover to around $80/barrel, not only did the value of reserves increase, but HPK was able to improve its financing position even further by securing $195 million in revolving credit. Prior to 2021, the company had no long-term debt on its balance sheet. With an increase in available credit, the company became ever better financed than before.
Based on the past 3 years of fundamental data shown below, HPK has maintained a relatively steady cash position between $20 to $35 million.
3 year company balance sheet
With the price of oil hovering around $60/barrel in 2019, HPK was only able to generate around $8 million in revenue. However as the price of oil started to increase and approached $80 in 2021, we see a significant increase in HighPeak Energy, Inc. revenue to $220 million, which is an increase of more than 27 times. During the same period, gross profits have increased from $5 million to $195 million, due to the low costs of production. The company had its first profitable year in 2021 – net profits after tax were $56 million. The company does not invest in research in development. It simply owns and operates the assets.
3 Year Company Income Statements
With a strong revenue generating potential,
In order to model the future revenue, we use a price of oil of $105 for 2022, consistent with the HPK management guidance. We gradually decrease the price of oil from $105 to $61 by 2025 and scale back the revenues proportionally at negative 16% per year. Using the multi-stage dividend discount model, we observe that this stock has a 65% downside. In performing this analysis, we assumed the terminal value to be the three year average from 2024 to 2026. This value is likely very conservative because with only $11/barrel of oil equivalent margin, we would expect the operations to cease in the terminal year. We also assume a conservative dividend payout ratio ramping up from the current 23% in 2023 to 90% in the terminal year to reward long term investors.
Dividend Discount Model – Oil Price $61/bbl by 2025
HPK Fair Value Prediction Based on Oil at $61 per barrel by 2025
Finally, we perform a sensitivity analysis, varying the long-term dividend growth rate between 3 to 5% and the cost of equity between 7.1% and 10.5%. We observe that the fair value price of HPK is between $6.69 and $23.46.
HPK Price Sensitivity Analysis Based on Different Payout Ratios and Costs of Equity
In this section we analyze scenarios where the oil price remains above $100/barrel 2025 and beyond. With the current operating strategy, it is clear that HPK will continue to post impressive quarterly and annual returns in this scenario. We will assume an annual exit rate of production increase 32% per year, consistent with the Hannathon Petroleum, LLC acquisition, and apply the increases in revenue proportionally. Keeping the remaining assumptions the same, we observe that this represents a fair price valuation of $39.6. With the current stock price if around $29.7, this is approximately a 33.6% upside relative to the current price.
HPK Price Analysis for Oil Price Above $100 per barrel by 2025
HighPeak Energy is a low-cost producer of oil and gas with impressive financial results. However, with the future projections for the price of oil ranging between $61 to $100, we see that HighPeak Energy, Inc has a 2:1 downside to upside risk. If the price of oil drops below $61 by 2025, we anticipate the fair value price to be $10.4 per share, a 65.4% decrease from the current price of around $29.7. However, if the price of oil stays elevated above, we anticipate that HPK share price will be around $39.6, which is a 33.6% upside. Therefore HPK does not offer an attractive risk to reward ratio for prospective investors.
This article was written by
Disclosure: I/we have a beneficial long position in the shares of HPK either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.