Ring Energy, Inc. (NYSE:REI) management has long been trying to get this company to an appropriate operating model with adequate cash flow and a market-acceptable debt ratio, as the last article (and more before it) discussed. This kind of transition can weigh on an investor's patience. However, the result should be a higher stock price valuation based upon fewer debt fears combined with an ability to return capital to shareholders that the market now demands.
This time around, management reported significant financial and operating improvements from several acquisitions made in the last few years. The hope of the acquisition campaign was to speed the transition to the stock market and debt market requirements. That hope appears to be becoming realized.
Progress Made
Management has managed to keep some ratios from heading back to "sky-high" levels where they were before the commodity price rise in fiscal year 2022 that allowed many companies to make significant financial progress.
Probably the key improvement shown above is the large percentage increase in free cash flow, even though oil prices did not change all that much. Mr. Market generally uses free cash flow as a gauge for oil and gas companies to repay debt. This goes back to the earlier days when the unconventional group of companies could not grow unless they borrowed money because initial costs were that high (relatively speaking) compared to profits.
This is a conventional opportunity that just does not have enough production yet. However, management is clearly "getting there" with the acquisition strategy. The debt balance was roughly the same as a year ago, despite an acquisition and an increase in production.
Far more importantly, the debt ratio remained roughly the same despite natural gas prices dropping sharply. The first goal of management is to get that debt ratio below 1.5 (and later below 1.0). Companies reporting better debt ratios can receive a credit rating upgrade that often helps to increase the value of the outstanding shares of stock.
That debt ratio lack of movement could well imply that this company may be able to show significant progress if commodity prices remain at the same level.
For Shareholders
The slide shown below gives some idea as to the price improvement in the stock that is available if management brings some key ratios to acceptable levels.
As shown above, the company stock could easily double or more just by getting the debt ratio below 1.0.
Conventional Opportunity
One of the differences between Ring Energy and many of the competitors is that Ring Energy is a conventional opportunity. The company wells therefore show a lower initial decline rate than is the case with unconventional opportunities. The company, often, has a solid chance of earning more money on the production in the first few years from the greater cash flow provided by that lower decline rate.
Out of all the competitors mentioned on the slide, only Riley Exploration Permian, Inc. (REPX) has a conventional opportunity and actually does compete in the same type of business. The other companies are all unconventional with very high first year decline rates.
Benefit Of Founders Acquisition
The Founders acquisition was done using debt (and no stock). Therefore, some wondered how such an acquisition could help the debt ratio.
This acreage has already raised the production mix to a greater oil percentage of production. Over time, it could similarly repeat the process.
The greater oil as part of the production mix allows the company to make debt progress without having to increase production. If for some reason, no more assets can be purchased because they are accretive or if oil prices plummet, this is an area that is likely to still make money for the company and allow progress at a time when much of the industry is likely being financially stressed.
Earnings Results
The cash flow was probably the best measure as to how the company strategy was doing.
Note that the realized price and the free cash flow really changed very little. This shows that for the most part, weakening commodity prices between 2023 and 2024 had little effect on the company's free cash flow. This is important because the last thing management needs is for the debt ratio to head back up because commodity prices declined.
The next step, of course, would be to do some more acquisitions to get that debt ratio down before commodity prices rally to make acquisitions too expensive.
Adjusted net income is basically the net income shown above without the effects of unrealized commodity losses. The more profitable mix of the Founders acquisition has obviously had an effect on the company comparison without the Founders production.
Summary
This is a stock that is going to take some patience (if it has not already). Progress toward the goal of a lower debt ratio has been slow, but it has been significant. The objective of finding accretive acquisitions is apparently proving a challenge to management.
Once the debt ratio is where it needs to be, then this stock could revalue considerably. Whether that is worth waiting for is up to the individual investor. Hopefully, management will make at least one more acquisition this year.
As part of a basket of well-chosen oil and gas stocks, this speculative strong buy should enable that basket to outperform long-term. If it is your only holding, it may have to be closely watched.
The wells still appear to be every bit as profitable as when I began following the company. The major problem is that in converting from an exploration stage company to a going concern, the coronavirus pandemic hit with all of its challenges. What was a conservative situation turned into the current set of challenges. Management is doing well with "the hand it was dealt" because debt market demands and stock market conditions changed "overnight." Many small companies get into a financial jam like this one through no fault of their own.
Risks
This company needs some cooperation from commodity prices until that debt ratio comes down. Commodity prices are low visibility and highly volatile. Still, the market demands of "living within your means" and shareholder returns have limited industry growth. That can ensure that commodity prices remain in a helpful range for a company in this situation.
Growing by acquisition can be derailed if any acquisition does not perform as desired.
The loss of key personnel can be devastating to a company in a situation like this one.
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