W&T Offshore: $1 Handle Is A Good Entry Zone But Capital Outflow Risks Remain

Note: This article should be seen as a continuation of my prior coverage of this ticker.

W&T Offshore investment thesis

W&T Offshore (NYSE:WTI) briefly touched $1.99 during Friday’s trading session, eventually closing slightly above $2. The last time W&T had a $1 handle was in November 2020, when the world was still under Covid lockdowns and the front-month oil futures (CL1:COM) traded in the $40s.

Besides oil prices being double than now, W&T’s fundamentals have also vastly improved. In 2020, the stock was a distressed debt play and the refinancing was a question mark. In 2024, the successful refinancing is already in the rearview mirror and the new 2026 maturities are trading above par. The valuation thesis – which is based on W&T’s net asset value – remains intact, and Wall Street’s sell-side retains its stubbornly high $10 price target.

All this points to deep undervaluation, but the market keeps selling, and the stock has now broken pretty much all support levels except the Covid lows of about $1.40 per share.

While in the past W&T selloffs have been connected to the rise in short interest, this time around the reason may be institutional rotation away from the small cap and commodity factors.

As W&T doesn’t have a buyback program and outside interest from “value hunters” is minimal, there is no obvious floor in sight until the macro flows reverse – and even when that happens, W&T’s recovery may still lag behind. On the other hand, the value proposition is indeed strong and if you don’t mind a further drawdown, picking up some shares now may also make sense.

Impressive asset value but no catalysts

The valuation thesis for W&T centers on its massive reserves value, and I have written about it before. In its most recent presentation from this May, the company touted a $1.3 billion PV-10:

Even deducting the projected asset retirement obligations, that leaves $1 billion which is double the current enterprise value.

Unfortunately, W&T’s current production is quite meager and in recent times has gotten more gassy – not great given the recent pressures on natural gas prices (NG1:COM).

Due to the lack of outside interest, “unlocking” the reserves value would require drilling capex to increase production and future cash flow. In particular, investors have put a lot of hope into W&T’s so-called “Holy Grail” prospect, namely block Garden Banks 783 A-4, which was part of the Entrada Field that Callon Petroleum (CPE) was planning to develop in 2008. Back then, the probable reserves were estimated at 56 million boe, so this could be a significant add for W&T as well.

However, W&T CEO and largest shareholder Tracy Krohn poured cold water on these hopes after the acquisition this past January of 6 fields from Cox Oil. W&T’s current capital constraint is that it can only accomplish 2 of the following 3 objectives:

• Maintain liquidity to repay the 2026 debt;
• Acquire producing assets, such as the Cox acquisition;
• Drill the Holy Grail.

Clearly, Mr. Krohn chose to push out the Holy Grail to 2025 or even beyond in favor of the Cox deal.

According to some reporting from the Oil & Gas Journal, Mr. Krohn has mulled putting the Holy Grail into a drilling JV with a third party which may allow lower cost development as the JV partner will assume some capex in exchange for some interest in the asset (my highlights):

Looking at 2024 and beyond, we are integrating our recent acquisitions and believe that we can materially increase production and reduce costs at the 14 additional fields that we now operate. We are deferring some of our drilling plans while we complete the integration of those assets and are exploring a drilling joint venture, similar to the Monza Energy LLC joint venture, which closed in 2018. The new drilling joint venture may include certain of the company’s 100% owned and operated deepwater wells, including the Holy Grail well.

This may be a good way out, but the May presentation doesn’t seem to offer anything more conclusive as far the Holy Grail is concerned.

Positive cash flow despite weak gas pricing

Despite the Holy Grail disappointment and weak natural gas prices, W&T remarkably eked out a $32.4 million positive free cash flow for Q1 2024 – apparently, the company’s 25th consecutive positive cash flow quarter. Q1 EBITDA was $49.9 million and sell-side analysts now forecast EBITDA of $197 million for the full-year; this implies a 3.0x EV/EBITDA multiple.

Natural gas has seemingly bottomed already, so this should be a tailwind:

As a Gulf Coast producer, W&T realized a small premium to Henry Hub for Q1:

Wall Street analysts – primarily Roth – remains bullish with a $10 PT:

My read through the Roth report (behind paywall) suggests they arrive at the $10 target using a net asset value approach, which makes sense. Supporting $10 in reference to EBITDA or cash flow at the current oil and gas pricing strip would be quite difficult.

So, who is buying and who is selling?

Let’s start by reviewing the short interest, which historically has been a driver of W&T’s price:

Short interest remains high but seems to have peaked back in March.

Looking at institutional investors that are required to file 13-Fs, institutions have unfortunately been sellers during Q1. At the end of Q1 2024, institutions reported a total of 56.4 million of WTI shares (compared to 146.9 million total shares outstanding), which was a decrease from 64.6 million at the end of Q4 2023. That is an -11.3% drop in institutional capital.

The largest decrease was reported by State Street, which as known manages a number of passive ETFs, which would be affected by broader sector rotation. Over the last months small caps have not done well:

The value factor has also been a laggard:

Energy stocks also peaked in April:

Outside interest in the stock at this point appears limited, so the lack of any buyback program leaves W&T without any backstop when a macro-driven selloff happens.

The only silver lining from my research is perhaps that Citadel, one of the best known hedge funds, has substantially added to its W&T holdings during Q1:

Based on this disclosure, Citadel now seems to own more than 2% of W&T, so that may be a good sign.

Takeaway

W&T Offshore remains a deeply undervalued stock. The recent deterioration in oil and gas pricing is less of a fundamental concern because the value thesis was always about the undeveloped assets and not about the current cash flow. Financial distress could theoretically be an issue but appears unlikely given the solid pricing of the company’s bonds.

Yet, the stock has lost another 37% year-to-date:

This may be related to the institutional capital that owns 1/3 of the shares (or really 50%, as Tracy Krohn owns 1/3 himself) has rotated out of small caps and value stocks – including energy.

In the absence of buybacks or sufficient interest from value investors, this stock may continue being a “falling knife” for longer, and I can’t predict when we will find a “floor.” Long term, I am bullish and have started accumulating some shares, but a further drawdown remains possible.