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Gold/Mining/Energy : Oil & Gas Exploration & Production Co.'s

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To: Ed Ajootian who wrote (46)4/14/2003 1:35:08 PM
From: Ed Ajootian  Read Replies (2) of 112
 
KCS Energy Inc. (KCS/NYSE): Fourth Quarter 2002 Results
Irene O. Haas (713) 250-4235; Irene.haas@smhhou.com
Stephanie Joe (713) 220-5139; Stephanie.joe@smhhou.com April 2, 2003
Industry: Energy Industries Recommendation: Buy
___________________________________________________________________________________________
Price: $2.58 Price Target: $5.00 Type: Quarterly Earnings/Price Target Change
___________________________________________________________________________________________
Estimates (Dec.) 2002 2003E 2004E
Curr Prior Curr Prior Curr Prior Investment Profile Q402
EPS (Diluted) ($0.31) ($0.15) $0.85 $0.68 $0.91 Share Base (mm) 36.4
P/E NM 3.0x 2.8x Market Value ($mm) $94
CFPS (Diluted) $0.60 $0.57 $1.41 $1.26 $1.70 Cash ($mm) $7
P/CF 4.3x 1.8x 1.5x Long Term Debt ($mm) $187
EBITDA ($mm) $34 $35 $71 $64 $82 Preferred $13
EV/EBITDA 8.4x 4.0x 3.5x Enterprise Value ($mm) $287
Dividend Rate Nil % Leverage 119%
Dividend Yield Nil Inst’l Ownership 23%
Daily Trading Vol. 290,200
Price Range (52-week) $4.01 -
$1.14
Erngs. Per Share 2002 Prior 2003E Prior 2004E
Q1 (0.15) (0.03) 0.30 NE
Q2 (0.36) (0.38) 0.17 NE
Q3 0.09 0.09 0.18 NE
Q4 0.08 0.14 0.19 NE
Cash Flow 2002 Prior 2003E Prior 2004E
Q1 0.07 0.07 0.42 NE
Q2 0.13 0.13 0.29 NE
Q3 0.17 0.17 0.33 NE
Q4 0.19 0.19 0.37 NE
___________________________________________________________________________________________
Please refer to smhhou.com, smhhou.com for important SMH
disclosures. The valuation methods used by SMH to determine the price target for this security, along with the
risks, are detailed within this report. If any hyperlink is inaccessible, please call 800-423-9656 and ask for the
Research Editor.
KEY POINTS
• We are revising our estimates for KCS. Our 2003E EPS/CFPS is $0.85/$1.41, up from our prior estimate of $0.68/$1.26.
Although we dialed down our production estimate for 2003 from 35 bcfe to 33 bcfe, the higher-than-expected commodity
outlook for 2003 compensated for the lower volume and higher costs.
• 2003 could be a real turning point for KCS. With strong commodity prices, we expect the company to fund its $50 million
capex internally, and generate excess cash flow of at least $10 million, which could be used to pay down debt, or for
drilling. We reiterate our Buy Recommendation on KCS. We raised our 12-month price target to $5.00 from $4.00, which
is based on 3.5 times our 2003E CFPS estimate of $1.41.
Sanders Morris Harris: KCS 2
Company Profile
KCS’s primary focus areas are the Mid-Continent region and onshore Gulf Coast. The company has key operations in the
Anadarko and Arkoma basins, North Louisiana, West Texas and Michigan. Along the Gulf Coast, the focus properties are in
South Texas, Coastal Louisiana and the Mississippi Salt Basin. KCS Energy devoted most of 2002 toward the redemption of
the $61.274 million Senior Notes that were due January 15, 2003. The company sold assets and slashed its budget to conserve
cash in order to meet this obligation. KCS was able to negotiate the financing to pay off the notes. Now that the financing is
over, we believe that KCS should be able to ramp up its drilling program this year.
Fourth Quarter Performance
KCS reported fourth-quarter 2002 EPS/CFPS of $0.08/$0.19. This compares to our estimate of $0.14/$0.19. The variance in
our EPS estimate versus the actual was a result of a one-time deferred financing charge of $1.1 million. Interest expense was
stronger in Q402 due to this charge, resulting in a 13% increase in all-in costs, to $3.19/mcfe. As a result of the asset sales and
limited spending, production was down 25% versus Q401, to 8.17 bcfe. Despite the drop-off in production, higher commodity
prices helped the company post revenue of $29.25 million, which was only a 5% decline. Cash flow increased over last year
and was in line with our expectations of $0.19/share.
For 2002, the company had two write-offs: one related to deferred tax assets of $15.9 million in mid-year, and another charge
of $6.2 million for the cumulative effect of an accounting change to the “unit of production” method of accounting for DD&A.
This amount was added to the Q102 results. After the accounting change, KCS reported a loss for the year of $0.31 per share
on revenue of $118.8 million. Netting out the impact of the $0.17 per share of accounting changes, KCS’s 2002 earnings
would have been a loss of $0.14 per share, diluted.
Table 1: KCS Fourth Quarter 2002 Performance
. 4Q01 4Q02 02 vs 01 % change
Production (bcfe) 10.95 8.17 -2.78 -25%
Gas Production (Bcf) 8.58 6.40 -2.18 -25%
Oil Production (mmbbl) 0.30 0.23 -0.07 -23%
NGL Production (mmbbl) 0.10 0.07 -0.03 -32%
Oil/Gas Revenue ($ million) 30.78 29.25 -1.53 -5%
EPS ($/diluted share) -0.11 0.08 0.18 176%
CFPS ($/diluted share) 0.07 0.19 0.12 181%
Gas Realization ($/mcf) 2.88 3.70 0.82 28%
Oil Realization ($/boe) 15.86 21.89 6.03 38%
NGL Realization ($/boe) 10.87 11.69 0.82 8%
Cash Cost ($/mcfe) 1.42 1.81 0.39 28%
DD&A ($/mcfe) 1.42 1.38 -0.03 -2%
All-in Cost ($/mcfe) 2.84 3.19 0.36 13%
Debt-to-Book Cap 113% 119% 0.06 5%
EBIT 0.28 8.55 8.27 2997%
Outlook for 2003
We recently raised our oil and gas commodity price deck and are now forecasting estimates for the company going forward. In
2003 and 2004, we believe that KCS can achieve earnings per share of $0.85 and $0.91 and generate $1.41 and $1.70 of cash
flow, respectively. The strong commodity environment and increased production forecasts by the company should allow it to
generate over $57 million of operating cash flow in 2003. This should be more than enough to cover the company’s planned
capital expenditure budget of $50 million for 2003.
The company guided production estimates for 2003 in the range of 31 bcfe to 35 bcfe. We have modeled 33 bcfe for the year,
a 12% production decline from 2002 levels of 37.4 bcfe. Going forward into the 2004-2005 time frame, we think KCS will
begin to show increases in production, with a more normal level of spending. With a capex budget of $50 million, we look for
an active drilling year in 2003.
Sanders Morris Harris: KCS 3
Table 2: Revised Estimates
Current Previous
2002 EPS ($0.31) ($0.15)
2002 CFPS $0.60 $0.57
2003E EPS $0.85 $0.68
2003E CFPS $1.41 $1.26
2004E EPS $0.91 NA
2004E EPS $1.70 NA
2003E Basic Share Base (million) 38.95 35.83
2003E WTI ($/bbl) $28.75 $26.00
2003E Henry Hub ($/mcf) $5.00 $3.75
2004E WTI ($/bbl) $26.00 $26.00
2004E Henry Hub ($/mcf) $4.50 $3.75
2003E Production (bcfe) 33.01 35.41
2004E Production (bcfe) 35.19 35.41
2003E Production Growth -12% (6%)
2004E Production Growth 7% NA
2003E All-in Cost ($/mcfe) $3.15 $2.88
2003E Cash Cost ($/mcfe) $1.77 $1.58
SMH estimates
Reserves
In 2002, KCS replaced 71% of its production at a finding and development cost of $2.57/mcfe. Proved reserves at year-end
2002 were down 15% to 196 bcfe versus 230 bcfe in 2001. The company sold 26.7 bcfe in reserves, as it divested properties in
2002. There was also a negative revision of 20.8 bcfe due to proved undeveloped (PUD) properties in Wyoming, and a
downward revision of some Michigan properties as well.
Operational Highlights
KCS drilled 53 wells in 2002 at a 74% success rate. Despite the lower budget during the year, the company was able to
participate in a few key wells during the fourth quarter.
At the Panola Field in Latimer County, Oklahoma, KCS has a 38.4% working interest (WI) in the Ozment Christian #1 well,
which was placed on-line at 3.3 mmcf/d, and a 31% WI in the Shelby 27#1 well, which began production in January 2003 at
5.6 mmcf/d.
At the La Reforma Field in Hidalgo County, Texas, KCS has a 25% WI in the Guerra C#1 well, which was drilled by Newfield
Exploration (NFX/NYSE-$34.26, Rated Buy). In the latter part of 2002, the well tested at 9.45 mmcf/d from two deeper
zones; recently, a temporary plug was set and three shallower zones were tested at 14.2 mmcf/d. The well will be tested for
commingling of the lower zones. An offset location and other possible prospects are being evaluated.
In Louisiana, at the West Arcadia Field in Bienville Parish, the company completed the Thomas 16#1 well (WI 53%) in
Hosston intervals at a rate of 3.2 mmcf/d. In North Louisiana, at the Elm Grove Field, two wells were drilled in the fourth
quarter: The Pilkington 5#2 began producing at 1.2 mmcf/d in the Cotton Valley formation, and the Roos #10 was completed
at 0.96 mmcf/d. KCS has a 100% WI in both of these wells.
So far in 2003, KCS has drilled 15 wells, with only one dry hole. The company also worked over about 15 wells and plans to
spud an additional 30 to 40 wells in a few months. A total of 60 to 80 wells could be drilled this year, with 16 to 24 slated for
North Louisiana and East Texas; 5 to 10 in Oklahoma; 13 to 22 in West Texas; 14 to 20 in South Texas; and 2 to 4 in other
areas. While most of the wells will be targeting traps in the 1 bcfe to 3 bcfe range, KCS has 5 to 7 wells looking for big targets
in the 20 bcfe to 50 bcfe range in South Texas. With a strong drilling inventory and a healthy capex, we are hopeful that KCS
can grow production organically in 2003.
Valuation and Price Targets
In valuing our E&P companies, we use a price-to-cash flow multiple. We establish a reasonable range based on historic
averages of a group of broad-based E&P companies, which includes ten E&P companies with market capitalizations ranging
from $900 million to $10 billion. Our 12-month price target of $5.00 is based on 3.5 times our 2003 cash flow per share
estimate of $1.41. We used a low multiple to reflect KCS’s high leverage, which is currently about 119%. We also revised our
Sanders Morris Harris: KCS 4
net asset value (NAV) analysis for KCS. Using our 2003 price forecast of $28.75/bbl for oil and $5.00/mmbtu for gas, we
arrived at $8.43 per share, net of debt. Under a more modest assumption of $26.00/bbl oil and $4.50/mmbtu for gas, KCS’s
NAV is $7.17.
Investment Risks
• KCS has a small market capitalization, a relatively thin float and light trading volume, which, under certain circumstances,
could make the stock more volatile.
• The company’s production mix is roughly 79% natural gas: with each $0.10/mmbtu change in Henry Hub natural gas prices,
both 2003E EPS and CFPS could be impacted by $0.04 each. Also, with each $1.00/bbl change in WTI oil price, the 2003E
EPS and CFPS could both be impacted by $0.02. In addition, the high debt level makes KCS more sensitive to positive or
negative outlooks on U.S. natural gas prices.
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