Not surprisingly, this past week had many ups and downs, as the market responded well to bad news early in the week and then gave up some of those gains on Friday. By week’s end the S&P 500 had gained 0.46%, the Dow had risen by 0.79% and the Nasdaq had fallen marginally.
The Stock – Permian Resources (PR)
Why the Strength
Permian Resources was already the largest pure-play Delaware Basin-focused explorer, with 180,000 net acres and 43,000 net royalty acres that includes 15-plus years of solid drilling inventory. And while the firm was still expanding production, it was also following the new playbook in the industry, spinning off plenty of cash flow (14 cents per share in Q2) and returning half of it to shareholders (10 cent total dividend in Q2, five cents base plus five cents variable). Thus, the story has been solid for a while.
But the reason the stock is peppy is because of a bold move by management in August to acquire Earthstone Energy for $4.5 billion (paid for entirely in stock), which will add another 223,000 acres in the Permian (56,000 in the Delaware basin, 167,000 in the Midland basin) and nearly double the firm’s production!
The top brass sees the usual synergies given the not-far-apart wells and acreage ($175 million annual synergies is expected), and because of that and what it thinks is a great buy price, it also thinks it will bolster its free cash flow per share by 20%-plus in both the near- and longer-term, so much so that it lifted its base dividend (to six cents per share, per quarter—there are also variable dividends on top of that). And, of course, the all-stock deal should keep leverage in check, with no debt maturities here until 2026 and net debt equal to about one year’s worth of cash flow. The buyout, then, should improve the metrics and scale (the new firm will have the sixth-most rigs operating on the fourth-most acreage)—and ironically, the combined outfit may also be more attractive to a whale looking to increase Permian exposure in the wake of Exxon’s buyout of Pioneer Natural last week.
With oil prices up, Permian Resources’ story is very sound, and there’s an M&A kicker that should support the price as well.
Technical Analysis
PR actually lifted to clear new price and relative performance highs in November of 2022 and even hit a marginal new high in early March of this year, much better than most peers. The action was a bit wild after that, but there was support at the 40-week line in May and the rally from there was exceptionally smooth, lifting PR to 15 before the September correction. The shakeout was a doozy, but the stock’s move back to new closing highs last Friday is a good sign. Stop — 12.5
The Covered Call Trade
Buy Permian Resources (PR) Stock at 15, Sell to Open November 15 Strike Calls (exp. 11/17) for $0.70, or a Net Price of 14.30 or less
Static Return: $70 per covered call (4.89%)
Breakeven: 14.30
Covered Call Return (if assigned): $70 per covered call (4.89%)
Please note, the stock and options prices will be moving throughout the day, so these prices are simply an approximation of prices that you should be able to achieve.
However, the important component of this equation is that the stock price paid, minus the premium received via the call sale, equals the Net Price, or 14.3 or less. (In this case 15 minus 0.70 = 14.3. Or another example is you could pay 15.15 for the stock and sell the call for 0.85, which also equals 14.3)
For every 100 shares of stock you buy, you can sell 1 call. For every 200 shares of stock you buy, you can sell 2 calls. And so on …
Open Positions
If our stop is hit, I will send an alert giving detailed instructions on how to exit the trade. But don’t get too worried about setting the stop. I will manage that for you.
The next Cabot Profit Booster issue will be published on October 24, 2023.
