Enerplus (NYSE:ERF) is a North American oil and gas exploration and production company focused on developing its light oil assets in the Bakken (North Dakota) and natural gas assets in the Marcellus shale region in Pennsylvania.
The firm has recorded TTM revenues of $2.20bn alongside a net income of $995.69mn, leading to a net margin of 33.27%.
Over the rest of the year, Enerplus is concentrating on a mix of meeting adequate production targets to the tune of >93,000 BOE/D, ensuring organic growth through capital spending of >$500mn, and returning a minimum of 60% of free cash flow to investors through dividends and share repurchases.
Breaking down the geographic production enabling these financial objectives, the Bakken region supports the bulk of Enerplus’ free cash flow, with $1.24bn of net operating income being generated versus Marcellus’ $300mn.
Valuation & Financials
I believe this is a dual product of Enerplus’ engagement with returning FCF to shareholders in addition to strong production metrics through both light oil and shale gas assets in Bakken and Marcellus.
As a mid-cap oil and gas exploration and production firm, Enerplus operates in a highly crowded field, wherein firms are largely operationally homogenous, differentiated only by the quality of their assets and their ability to efficiently extract value from said assets. Among similarly sized oil and gas exploration and production companies include SM Energy (SM), Black Stone Minerals (BSM), Kosmos Energy (KOS), and California Resources (CRC).
As demonstrated above, over the trailing twelve-month period, Enerplus has experienced the best price action among its peers, likely a product of best-in-class ROE and second-best ROA. This is alongside the second-best profitability among peers, superseded only by Black Stone Minerals.
However, my belief is that Black Stone Minerals maintains a poorer capital deployment strategy, with a 73.42% dividend payout ratio- much higher than the industry average- meaning the company has significantly lower capital for organic growth relative to Enerplus, which has a sustained capital allocation strategy for long-term benefit.
Despite a lower payout ratio, Enerplus retains an ‘A+’ from Seeking Alpha on relative dividend growth, demonstrating the firm’s ability to adequately return capital on a tangibly lower payout ratio of 5.87%.
According to my discounted cash flow analysis, the fair value of Enerplus, at its base case, is $17.70, meaning its current $14.61 price is undervalued by 17%.
My DCF model assumes a discount rate of 9%, reflecting the higher cost of debt and higher equity risk premium of a more volatile stock. I take this more conservative approach in spite of a relatively cheap financing structure as Enerplus maintains a lower debt/equity ratio of 0.17. Moreover, I expect a continuation of historic net margins, smoothed out for inconsistency from negative oil among other irregularities. I project net margins to grow at a conservative rate of 10%, lower than Enerplus’ income CAGR.
Alpha Spread’s multiples-based relative valuation tool refutes my thesis on Enerplus’ undervaluation, calculating that the firm is overvalued by 16% and would be fairly valued at $12.21.
However, Enerplus actually sustains superior valuation metrics to the industry barring enterprise value ratios. As such, Enerplus’ relatively poor EV skews the entire model to calculate an overvaluation.
As such, I maintain my thesis, that Enerplus is undervalued, even on a multiples basis.
Commitment to High-Quality Assets Enable Effective Capital Return
As I’ve discussed in the ‘Comparable Companies’ section of this article, the homogenous nature of oil and gas exploration and production means that the differentiating factor between company success lies in asset strength, operational capabilities (i.e. cost reduction), and capital deployment.
Through its Bakken position, Enerplus demonstrates its adherence to high-quality assets; Bakken Little Knife and Bakken FBIR- representing a majority of Enerplus’ Bakken drilling inventory- require a breakeven WTI price of $38-$40, one of the most cost-effective oil plays in North America.
Alongside lower breakeven prices, Enerplus has positioned itself for stable production through the coming three years, with excess pipeline capacity in addition to incremental production growth supporting sustained demand levels. This will additionally allow the firm to best leverage variable oil prices.
Beyond operational success, Enerplus’ capital allocation strategy supports both present stock price growth and ensures long-term cash flow generation. The fossil fuel producer has laid out a disciplined free cash flow priority plan; net debt reduction and return of capital take priority. In just Q1 2023, the firm has returned $67mn to shareholders via a combination of repurchases and dividends. Enerplus maintains this position while fostering company growth through 50% average reinvestment, enabling present-day 3-5% liquid production growth.
Wall Street Consensus
Analysts share my positive view on the company, projecting an average 1Y price increase of 41.95% to a price of $20.74.
Even at a minimum extrapolated price, analysts predict 17.15% growth, to a price of $17.12, likely a product of continued belief in Enerplus’ operational strengths and shareholder-oriented capital deployment strategy.
Risks & Challenges
Commodity Price Volatility
As a principally oil and gas firm, Enerplus obviously depends on sustained commodity prices, for example requiring >$38 WTI to break even on oil. In recent years, the COVID-19 pandemic, OPEC actions, the ongoing conflict in Ukraine, etc. have led to an increase in the price volatility of commodities, threatening the viability of Enerplus’ business.
Focus on Climate and Sustainability
Stakeholders are increasingly scrutinizing the ESG and sustainability practices of companies across every vertical and industry. Failure to meet this scrutiny may lead to a loss of stakeholder trust, increased regulatory pressures, and an inability to acquire capital. As such, climate action presents a risk to Enerplus’ ability to generate and effectively deploy capital.
Increased Cost of Capital and Operation
With higher interest rates expected to be sustained, Enerplus has shifted its capital deployment strategy to one focused on foremost decreasing net debt levels. This, however, comes at the cost of reduced reinvestment into organic growth or return to shareholders.
In the short term, I expect that Enerplus’ shareholder-oriented capital deployment strategy will put upward pressure on its stock price.
In the long term, Enerplus’ asset quality and incrementalist reinvestment strategy will enable the company to sustain high levels of shareholder return for years to come.