When Stock Issuance Isn’t A Bad Thing
By Martin Tillier - Mar 20, 2015, 3:01 PM CDT
In general, when a company announces plans to issue more stock, it has a rapid negative effect of the share price. That is understandable, each share is obviously worth less when there are more of them issued. Conventional wisdom says that the underlying value of the company hasn’t changed much, nor have projected earnings, but the number of shares has increased; each share must therefore fall in value. There are exceptions, however, and many of them have been seen recently in the oil exploration and production (E&P) sector.
The latest company to jump on the equity issuance bandwagon is PDC Energy (PDCE), and it is an example of why, in the current situation, issuing shares and diluting the investment of current shareholders can sometimes be seen as a positive for a stock.
When a company needs to generate cash there are two options. They can borrow money or issue stock. At a time when we have been told by the Fed that rates will rise at some point in the not too distant future and further volatility in the price of both oil and natural gas is a distinct possibility, loading up on debt would be at best a risky strategy. Far better to take the short term hit implied by stock issuance and, if anything, use part of the proceeds to pay down debt and improve cash flow in the future. That is what PDCE is doing, planning to use some of the cash to pay off their revolving credit facility.
That has two advantages. Firstly, when pressure on unconventional…
In general, when a company announces plans to issue more stock, it has a rapid negative effect of the share price. That is understandable, each share is obviously worth less when there are more of them issued. Conventional wisdom says that the underlying value of the company hasn’t changed much, nor have projected earnings, but the number of shares has increased; each share must therefore fall in value. There are exceptions, however, and many of them have been seen recently in the oil exploration and production (E&P) sector.
The latest company to jump on the equity issuance bandwagon is PDC Energy (PDCE), and it is an example of why, in the current situation, issuing shares and diluting the investment of current shareholders can sometimes be seen as a positive for a stock.
When a company needs to generate cash there are two options. They can borrow money or issue stock. At a time when we have been told by the Fed that rates will rise at some point in the not too distant future and further volatility in the price of both oil and natural gas is a distinct possibility, loading up on debt would be at best a risky strategy. Far better to take the short term hit implied by stock issuance and, if anything, use part of the proceeds to pay down debt and improve cash flow in the future. That is what PDCE is doing, planning to use some of the cash to pay off their revolving credit facility.
That has two advantages. Firstly, when pressure on unconventional producers’ stock is largely about their very survival, it buys time. Secondly it raises the possibility of even a small company like PDC using the oil price fall as an opportunity to expand through acquisition as other companies dispose of assets at fire sale prices. It should be said that PDC has not stated any intention of doing that, but improved cash flow makes it at least a possibility, albeit a remote one.
As I said, stock issuance usually results in a stock losing ground for obvious reasons, but the market reaction to PDC’s announcement on Wednesday tells a different story.
The stock fell at the opening on Thursday, but only by about 0.31 percent. Given that oil prices also opened lower, that is effectively no reaction to the issuance of close to 4 million shares once the underwriter option.
If the base assumption that I have repeated many times, that oil may track a little lower, but a bottom has been found at just above $40 for WTI, simply surviving as the inevitable cutbacks in capex begin to take effect over the next few months would make PDCE, with a 39 percent earnings growth rate, a good long term investment. After this issuance they will have a more solid balance sheet than most and should be able to survive even an extended period of depressed commodity pricing.
It is rare that “at least they won’t go under in a hurry” is a good reason to buy stock in a company, but with the panic that there has been in the energy market, companies such as PDC Energy that have taken steps to ensure that that is the case are worth consideration. Four million more shares looks, on the surface, to be bad news for stockholders, but dig a little deeper and the opposite could well be the case.
