Riley Exploration Permian, Inc.

I bought shares of REPX, an oil and gas E&P; in 2023 they produced ~18.6mboe/d, generated ~$375mn of revs & ~$70mn of fcf. EV is ~$900mn (MC ~$575mn); trades for ~3.5x NTM EV/Ebitda & ~20% fcf yield.

Summary

Little different post today, focused on a new stock I just purchased. Riley Exploration Permian (~$27 a share). REPX 0.00%↑ is a small cap oil and gas E&P business; in 2023 they produced ~18.6mboe/d, generating ~$375mn of revenue and ~$70mn of free cash flow. The business has an EV of ~$900mn (market cap ~$575mn) and trades for ~3.5x EV/Ebitda. Why I bought:

• Assets — They focus on horizontal well development on conventional rock formations in Permian Basin. Their focus on conventional assets gives them a cost advantage as their avg. well depth is significantly shallower than a classic shale producer, leading to ~30% less cost per completed lateral length (CLL), with comparable lifetime oil production and a lower decline rate.

• Capital allocation — Management has a stated goal of investing ~50-60% of operating cash flow to moderately grow production, with the rest used for dividends (~5% yield) and debt paydown; goal of ~1x Net Debt/Ebitda (currently ~1.4x after ~$330mn New Mexico acquisition in 2023).

• Selective acquisitions — acquisitions at reasonable valuations have grown scale without significant dilution to shareholders. 2023 New Mexico acquisition was funded via debt and valued at ~15% free cash flow yield and ~3.5x EV/Ebitdax.

• Valuation — Trades at ~3.5x NTM EV/Ebitda and ~20% free cash flow, all while growing production. They also use hedges to reduce the impact of significant oil price movements.

Key risks:

• ~50% owned by 3 investment firms (Yorktown, Bluescape, and Balmon), with the 2 largest holders recently reducing their stakes by ~10%. Currently very low institutional interest but public float has increased from ~25% to ~45% of shares in last year.

• Their strategy (horizontal drilling on conventional reservoirs) is different than most other shale players. If their strategy doesn’t work, or they are unable to extract oil in line with their forecasts, losses will be significant.

• Issued ~1mn shares (~5% increase in share count) at ~$28 in Q2 24 to fund a small bolt on acquisition in New Mexico footprint (~$20.5mn).

• Only ~55% of proved reserves are developed, meaning there’s a higher risk of reserve impairments.

I’ve always been skeptical of exploration & production (E&P) companies, especially small caps. The risk is management is incentivized to chase dilutive acquisitions in an attempt to build scale or get acquired down the road (with management getting a payout and a board seat from the acquirer). I think I’ve found a situation that is priced with this in mind, but management has shown discipline by waiting for an accretive deal at a reasonable valuation.

Position is ~5% of my portfolio; don’t plan to increase significantly given inherent risk of a small cap E&P investment. This write-up won’t make any macro predictions about the price of oil.

The Situation

Riley Exploration Permian operates ~44,000 net acres and has ~400 producing wells (net) on the Northwest Shelf of the Permian Basin. Their acreage is concentrated in two locations, Yoakum County, Texas (~75% of production in 2023), and Eddy County, New Mexico.  The company went public through a reverse merger with Tengasco Inc. in 2021.

Their business model is focused on:

“Horizontal well development of conventional hydrocarbon formations on the Northwest Shelf of the Permian Basin.”

Simply put, they use modern techniques (horizontal drilling/fracking) to extract oil from shallower and easier to access deposits than a classic Permian shale player. This allows them to drill wells that are ~50% shallower and ~30% cheaper, with comparable lifetime production and a less steep decline rate.

In Q2 2023 they acquired ~12,000 acres in Eddy Country, New Mexico, for ~$330mn. The acquisition added ~7.2mboe/d (4.2mbo/d) and was valued at 3.4x EV/Ebitdax (“x” stands for exploration costs); the $330mn was paid by drawing on their revolver and issuing $200mn of 5-year senior unsecured notes (10.5% coupon). Management planned to paydown down debt post-acquisition and has reduced debt by ~$50mn since Q2 2023.

In Q2 2024 they made a small bolt on acquisition in their New Mexico footprint for ~$20.5mn. The acquisition added 20-25 net drilling locations and ~1.1mboe/d. This acquisition was paid for by issuing ~1mn shares (~5% of total share count), for ~$26mn (net of fees). As part of this share issuance, key shareholders also sold (mainly Bluescape & Yorktown) ~1.4mn shares.

In 2024, management plans to grow production by ~15% to ~21.8mboe/d (~14.5mbbls/d), drill ~22 wells, and spend ~$125mn on capex; free cash flow is expected to be >$100mn.

Thesis

Key thesis points:

• Unique assets

• Capital allocation

• Growth (organic)

• Valuation

Assets/acreage

The most important part of this thesis is the assets. REPX isn’t a classic shale producer extracting oil from unconventional (tight) rock formations. Instead, they’re focused on conventional wells that have a history of producing oil; their area of the shelf has “produced over 3 billion bbls of oil over the past century”, mostly from vertical drilling. REPX uses horizontal drilling methods and new completion techniques to access more of the reservoir than historical vertical wells.

The advantage is ~30-40% lower costs per lateral foot, driven by shallower avg. well depth. Additionally, their wells have a slower decline rate, ~30-40% in the first-year vs ~60-90% for an traditional shale player; this has created an opportunity as REPX is a small cap/under followed stock — anyone taking a quick look likely assumes it’s a shale producer that needs to aggressively drill to keep production flat. Their less aggressive decline rate means this isn’t the case.

Additionally, their niche focus/business model allows them to pick up similar assets for reasonable valuations. The New Mexico footprint was acquired for ~3.5x EV/Ebitdax, or ~15% free cash flow. It’s admittedly a little riskier than their Texas footprint due to more undeveloped inventory (Proven Undeveloped Reserves) and a higher cost per well due to more intensive fracking required, but at a very cheap valuation, not a lot has to go right to make this work.

Riley has a set of assets where they can grow production organically without massive capex investment; the market appears to have missed this due REPX being an overlooked small scale Permian E&P play (understandable...).

Capital allocation

Management has a clear capital allocation policy of investing 50-60% of their operating cash flow back into the business to produce moderate volume growth (HSD organic growth) while returning capital via dividends (~5% yield); they plan to do this while maintaining conservative leverage. The business is currently ~1.4x Net Debt/Ebitda (post New Mexico acquisition) but plans to return to ~1x within a year.

The recent share issuance is a slight concern, but it was relatively small (~5% dilution) and also allowed long-term investors to liquidate a portion of their investment; the benefit to these transactions is an increase in trading liquidity (public float is now ~43% of the equity, up from ~23% in Q2 2023), and it funded a small bolt on acquisition without adding debt. They also issued ~$50mn worth of shares in June 2021, but this was when the stock was trading ~$50 (~10x EV/Ebitda), and the funds were mainly used for an Enhanced Oil Recovery (EOR) project that was key to growing production; they eventually issued shares at ~$30 or ~6x EV/Ebitda after investors balked — I don’t consider this a value destroying issuance (the stock was pricey and they tried/took advantage).

Volume growth

Management has shown they can grow production with declining capex intensity. Organic volume growth in 2023 was ~10% with capex at ~35% of revenue; 2024 organic growth is forecast to be ~7%, with capex intensity dropping to ~30% (their slower decline rate helps here). The New Mexico acquisition created additional scale and their hedging strategy gives up some of the upside to protect the downside, but this helps give some certainty on price realization.

They do have some smaller projects that are adding value; in 2023, due to low natural gas prices, they entered into a JV (RPC Power) with Conduit Power to use Riley’s extracted natural gas to power their oilfield operations in Yoakum County, Texas. In Q2 2024, they expanded the scope of this JV to include “sales of energy and ancillary services to ERCOT, the Texas power grid operator.” This type of project won’t make or break this investment, but it gives Riley another option during a period of low natural gas prices.

Valuation

The stock is very cheap – trading at ~20% NTM free cash flow yield and ~3.5x Ebitda. If management can continue to grow production organically, this stock likely ends up a winner, not much more to it; this is admittedly simplistic but directionally correct. Oil prices are obviously key, but if we assume roughly flat WTI and flat price realization (~$53), we’re getting >$600mn of revenue in 2028 and ~$150mn in free cash flow.

Risks

I see 2 key risks (outside of the macro oil price environment), where if I’m wrong or something changes, this loses money:

1. Management does something to destroy shareholder value.

2. Key investors are liquidating due to something I have missed.

On management, I look at what they’ve done post-merger and I think they’ve made moves to try create long-term value. This might not be shown in the stock price performance, but they’ve avoided massive share issuances to fund overpriced acquisitions, focused on growing production while keeping expenses in check. I think they’ve earned some rope with a small share issuance to fund a bolt on acquisition.

The key investor selling is a risk but not one that worries me too much; they’ve been long-term holders (pre-2018) and a partial sale isn’t out of the ordinary for a private equity sponsor 6+ years after an investment has been made. Bobby Riley, CEO, has not sold a material amount of stock outside of shares withheld to settle tax liability from stock compensation.

Final Word

REPX stock is priced like an E&P that is going to find a way to destroy shareholder value, but reasonable management and unique assets create a very interesting opportunity. I’m keeping this position small due to the inherent risks of investing in an oil and gas E&P business, but I think this is a good risk adjusted bet.