(Note: This article is an updated version of an article that appeared in my newsletter in April 22, 2022.)
Range Resources (NYSE:RRC) recently announced the initiation of a dividend as well as a goal to repay debt. While the market may welcome that dividend. It could prove risky in an industry where debt repayment opportunities can be fleeting because of unexpected developments. It was not that long ago that there was the 2018 oil price rally followed by the coronavirus demand destruction after the OPEC pricing war. The political interference in this industry makes for very low visibility that probably demands every last dollar go for debt repayment until debt is no longer an issue.
Similarly in the first quarter, management expanded the share repurchase program to $500 million. It is always tempting to distribute money to shareholders or even go on buying sprees when the cash rolls in. The key debt ratio is likely to fall below 2 in the current fiscal year if the strong commodity prices persist. So, what is the worry?
I have followed too many companies that found themselves with debt repayment deadlines at an inconvenient time. That situation ended up costing shareholders dearly. Even though this time appears to be different with a lasting recovery, the industry has proved itself too unpredictable for any management to bank on that idea.
The successful companies I follow tend to make debt goals happen as fast as possible. That should probably be the case here. This company had been selling assets to reduce debt for some time. Therefore, the decision to pay a dividend and repurchase stock while $2.6 billion of debt remains at the end of the first quarter probably raises the risk factor somewhat.
This is a company where the debt ratios were frequently not within industry guidelines during the downturn. That downturn was extended and is unlikely to repeat. Nonetheless, the market has become a good deal more conservative. Even if “no one cares” because sales prices are “sky high” compared to the recent past. That can quickly change when an unexpected pricing downturn occurs. Come to think of it, most pricing downturns in this industry are unexpected.
Management appears to be “banking on” the idea that the future cash flow will be generous. Nonetheless, it is hard to be too conservative in this industry. This time, management may escape the usual punishment of companies that do not quickly repay debt. But that does not mean this is not a riskier choice than many in the industry chose.
Many investors are tempted to invest in financially leveraged companies because they believe that leads to superior returns. Nothing could be further from the truth in an industry like this one with low visibility. Instead, its usually operating leverage that causes above average long term returns that are sustainable. Every now and then though, there comes a period where a few highly leveraged companies “hit a home run”.
The company does have a liquids rich production as well as some of the better dry gas wells. The ability to hedge is also another way to protect cash flow should prices decline.
Opportunistic hedging is often another risky strategy that has failed a lot of companies. Management does not always see a price decline coming until it is too late. Therefore, the ability to protect cash flow opportunistically has to be consider risky just because so many have failed using this strategy in the past.
Risk intolerant investors need to consider the strategy chosen by management because this management appears to tolerate more risk. That toleration can appear at any part of the industry cycle and in many forms. In the past, that risk appeared as a sizable debt load for the cash flow. Now there is the initiation of the dividend before the debt reduction goal is met.
Some managements are very good at this type of strategy. They always seem to survive steps that befalls competitors. To its credit this company appears to be able to handle the other risk. That does not mean that the investor has to. Therefore, as investor, one would need to decide if one can handle another risky strategy by management in the future before an initial investment is made.
As management notes, the current pricing will allow the company’s debt ratios to look conservative. The goal for much of the industry is to have conservative debt ratios under far less favorable industry conditions. Such a strategy builds confidence that management is definitely going to repay debt to decrease the debt load.
The warning is in the debt that was redeemed. The interest rate was far higher than the recent interest rate. Many will say, “hey they refinanced, so no problem”. But the challenge is that high interest rates often verge on the edge of not being able to refinance.
Besides, in this industry, debt often comes due at inconvenient times. The (probably) best strategy is to devote all excess cash flow to get that debt below $1 billion. Then management will have considerably more flexibility during the next industry downturn if it happens sooner than expected.
The cash flow projection to retire debt means that the current favorable conditions have to last long enough to do just what management states above. That is always an “iffy” proposition in this industry. Right now, things appear to favor managements projection. In the past, there were a lot of managements that appeared to know what they were talking about. But their companies are no longer around.
The really sad part about this is if the strategy succeeds, there will be a lot of imitators in the future that do not succeed. That is just how this industry is. I am repeatedly asked through the years about companies that “try” putting off debt repayments. You can go to my profile and see a lot of companies no longer around because they “tried” too long.
Range Resources has some of the best wells in the business. The result is some very low costs. However, management chose to offset this advantage with debt. Now there will be a dividend and an enhanced stock repurchase program that will somewhat lower the amount of cash available to repay debt. Therefore, the risk taking by management continues. Any potential investor needs to realize that regardless of the company debt rating, this management will take a riskier pathway than many in the industry.
It is true that the current recovery appears to be one that lasts longer and is stronger than several in the past. The future may even “be different” in the favor of the industry due to the ability to export.
However, there will be managements that “go overboard” and take on too much risk for the situation in the future. So far this management has not been one of those.
Good acreage and low costs cannot offset a financial strategy like the one chosen here because debt has to be serviced and paid regardless of industry conditions. In the past, that meant selling assets to repay debt. Fortunately, management had the assets to sell so that debt could be paid.
So far, it does not appear that risk takers with leveraged balance sheets have done any better than the companies that chose a conservative financial strategy. That could easily change in the future because different strategies tend to work better at different times in this industry. However, whenever a leverage strategy does not work, the results tend to be fatal. Highly leveraged companies often cannot afford unpleasant surprises or missteps.
Conservative managements usually get to try again until they are successful. The lack of leverage is never a “bet the company” strategy. Therefore, investors may want to consider some of the less leveraged companies I follow.
Any company with less debt to repay (proportionately) or no debt has the ability to raise the dividend sooner rather than later. Clean balance sheets often allow a company to become a takeover candidate because debt is often acquired during expensive times.
The future appears to be decent for the common. And the more debt that gets paid, the less risky that future will be.
Tags: #Range #Resources #Stock #Mixed #Priorities #NYSERRC #Seeking #Alpha