Jones Energy Inc. · 2016-03-15 · EPG Commentary by Dan Steffens Jones Energy, Inc. (JONE) has been dropped from our Small-Cap Growth Portfolio because they have halted all drilling

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Jones Energy Inc.

March 15, 2016

EPG Commentary by Dan Steffens Jones Energy, Inc. (JONE) has been dropped from our Small-Cap Growth Portfolio because they have halted all drilling activity and I expect production to decline by 35% in 2016. However, thanks to the best hedge position I’ve seen, the company will generate free cash flow this year, pay down debt and be in great position to resume production growth when oil prices improve.

JONE has more than 90% of their 2016 production hedged at very good prices.

The company’s hedge book allows them to generate strong cash flow from operations and pick up additional working interest in their Cleveland area. They recently started buying back their long-term debt at deep discounts to face value.

This company is well positioned to take advantage of the low oil price environment. With over 90% of their 2016 oil and gas hedged at very good prices, the economics on their Oklahoma wells is quite attractive. They have picked up additional working interests since our last profile as many of their non-operating partners, who did not hedge their share of production, elected to go non-consent on the company’s aggressive 2015 drilling program. Management has decided to halt all drilling efforts until oil prices improve. New wells would be selling their production at below strip pricing, making the wells be sub-economic. A better use of capital is to acquire bolt-on leasehold and continue paying down debt. Jones needs WTI pricing north of $50/bbl before they resume development drilling. This stock is now a “value play” for those of you that believe oil prices will rebound by year-end.

My Fair Value Estimate for JONE is $5.90/share Compared to First Call’s Price Target of $4.33/share

Disclosure: I do not have a position in JONE and I do not intend on buying or selling it in the next 72 hours. I wrote this profile myself, and it expresses my own opinions. I am not receiving compensation for it from the company. I have no business relationship with any company whose stock is mentioned in this article.

Management Jonny Jones, Chairman and CEO Mike McConnell, President Robert Brooks, EVP and CFO Eric Niccum, EVP and COO

www.jonesenergy.com


Jones Energy Inc.

March 15, 2016

Based on my forecast model attached below, JONE should generate approximately $1.60 operating cash flow per share in 2016. Compare my CFPS forecast to what other analysts are reporting to First Call for annual cash flow per share in the table below. As of the date of this report, JONE is trading for less than 2X CFPS.

Average of Analysts’ Operating Cash Flow Forecasts Submitted to Reuters


Jones Energy Inc.

March 15, 2016

Company Overview Jones Energy, Inc. (JONE) is an independent oil and natural gas company engaged in the exploration, development, production and acquisition of oil and natural gas properties in the Anadarko and Arkoma basins of Texas and Oklahoma. The Company has accumulated extensive knowledge and experience in developing their Anadarko and Arkoma basin assets, having concentrated their operations in the Anadarko basin for over 25 years and applied their knowledge to the Arkoma basin since 2011. Jones Energy’s Chairman and CEO, Jonny Jones, founded its predecessor company in 1988. The Company is headquartered in Austin, Texas. Jones Energy, Inc. was formed in March 2013 as a Delaware corporation to become a publicly-traded entity and the holding company of Jones Energy Holdings, LLC (JEH). As the sole managing member of JEH, the Company is responsible for all operational, management and administrative decisions relating to JEH's business and consolidates the financial results of JEH and its subsidiaries. Business Strategy Jones Energy’s goal is to increase shareholder value by managing their capital expenditures and level of activity to maximize well level returns in the current commodity environment while also evaluating and executing opportunities for growth of reserves, production, and cash flow through potential partnerships, acquisitions, and leasing opportunities. The Company seeks to achieve this goal by executing the following strategies:

• Developing Their Multi-Year Inventory – The Company intends to add production and reserves through the development of their existing drilling inventory, which they believe to be repeatable and low-risk. The Company has a long history in the Midcontinent, having drilled over 775 wells in the area since 1988. They believe their historical drilling experience, together with the results of substantial industry activity within their operating areas, reduces the risk and uncertainty associated with drilling horizontal wells in these areas.

• Maintain the Lowest Cost Structure in the Plays Where They Operate – Decades of experience in the Midcontinent and emphasis on operational execution and cost control have allowed Jones to drill and complete wells at significantly lower cost than most other operators and, as a result, to realize compelling economic returns. The Company will continue to apply their expertise while also leveraging their leading position in their focus areas to obtain the best possible pricing from service providers which they expect will further reduce capital costs and ultimately enhance returns. The Company’s cost structure is particularly important in periods of low commodity prices and gives them an advantage over other operators as they compete for acquisitions and strategic partnerships.


Jones Energy Inc.

March 15, 2016

• Opportunistically Grow through Exploration, Acquisitions and Strategic Partnerships – As a complement to their development program, the Company looks to execute acquisitions, leases and partnerships where their operating experience can be leveraged. Given the Company's ability to decrease costs and ramp up drilling activity, they seek opportunities that have less PDP reserves and a large number of high-quality drilling locations.

• Exploit Upside Within Their Existing Assets – Jones plans to continue exploiting their proved reserves to maximize production through optimized drilling and completion techniques. Furthermore, the stacked reservoirs within their asset base provide exposure to additional upside potential in several emerging resource plays. They have begun assessing the potential of both the Tonkawa and Marmaton formations in the Anadarko Basin. The Company expects to engage in additional development activity within these plays as commodity prices improve. Their current leasehold position provides longer term potential exposure to other prospective formations found in the Anadarko basin, including the Douglas, Cottage Grove, Cherokee Shale, Atoka Shale, and the Upper, Middle and Lower Morrow formations. In addition, they continue to apply their proven geoscience expertise in the search for new exploration opportunities in the greater Midcontinent region.

• Maintain Operational Control – Jones operated substantially all of the wells that they drilled and completed during 2014 and 2015, allowing them to effectively manage the timing and levels of their development spending, overall well costs and operating expenses. In addition, the Company expects to operate the drilling and completion phase on approximately 67% of their 2,765 gross identified drilling locations. With over 80% of their acreage held by existing production, they also will not be required to expend significant capital to hold acreage in their portfolio. They believe that continuing to exercise a high degree of control over their acreage position will provide them with flexibility to manage their drilling program and optimize their returns and profitability.

• Focus on Well-Level Returns – The Company’s management and technical teams are focused on maximizing well-level returns, which they believe drives shareholder value. In addition to their focus on costs and optimizing drilling and completion techniques, their team maximizes returns by allocating capital to areas with the highest rates of return based on commodity mix. The Company’s drilling inventory comprises oil, natural gas and NGLs, which enables them to adjust their development approach based on prevailing commodity prices. Despite recent declines in commodity prices, they currently intend to capitalize on the relatively more favorable oil pricing environment as compared to natural gas and NGLs by continuing to drill acreage with significant oil components. In addition, they expect that continuing to operate the substantial majority of their drilling locations will allow them to reallocate their capital and resources opportunistically in response to market conditions. The Company’s disciplined focus on well-level returns in allocating their capital and resources has been a key component of their ability to deliver successful results through various commodity price cycles.

Fourth Quarter and Full Year 2015 Highlights

• Production for the full year 2015 of 9.2 MMBoe (25.1 MBoe/d), up 8% from 2014 • EBITDAX for the full year 2015 of $268.4 million • Adjusted net income for the fourth quarter 2015 of $0.6 million, or $0.03 per share


Jones Energy Inc.

March 15, 2016

• Repurchased $171 million in face value of senior notes for $74 million (43% of par), resulting in a $97 million decline in total debt outstanding and $12.5 million in expected annual interest expense savings

• Mark-to-market hedge value of $261 million incorporating strip pricing as of February 29, 2016. [Note that the value of their hedges is currently double the market cap of the entire company.]

• Initial capital budget of $25 million, primarily for workovers • Proved reserves at year-end 2015 were 101.7 MMBoe based on SEC pricing; Cleveland area proved

reserves were 80.6 MMBoe • Leased over 10,000 net acres in the Cleveland in 2015 for approximately $3 million

Fourth Quarter 2015 Financial Results Total operating revenues for the three months ended December 31, 2015 were $38.2 million as compared to $75.6 million for the three months ended December 31, 2014. For the full year 2015, operating revenues were $197.4 million as compared to $380.6 million for the full year 2014, reflecting lower prices for all commodities partially offset by increased production volumes. Total revenues including current period settlements of matured derivative contracts were $347.2 million for the full year 2015 as compared to $385.1 million for the full year 2014. Total operating expenses for the three months ended December 31, 2015 were $66.9 million as compared to $63.4 million for the three months ended December 31, 2014. For the full year 2015, operating expenses were $303.9 millionas compared to $272.0 million for the full year 2014, with higher well count and increased production volumes driving the year-over-year increase. For 4Q15, the Company reported adjusted net income of $0.6 million as compared to adjusted net income of $15.7 million for 4Q14. Adjusted net income for the full year 2015 was $2.2 million as compared to $68.8 million for the full year 2014, with significantly lower commodity prices offsetting higher production volumes. Capital Expenditures During 4Q15, the Company spent $14.1 million on capital expenditures, of which $8.0 million was related to drilling and completing operated wells, representing 57% of the total capital expenditures in the quarter. The remaining $6.1 million was primarily related to field maintenance and leasing. For the full year 2015, the Company spent $200.1 million on capital expenditures, of which $173.2 million was related to drilling and completing operated wells, representing 87% of the total capital expenditures in the year. This compares to revised 2015 capital expenditure guidance of $210 million. The Company’s initial capital budget for 2016 is $25 million, the majority of which will be dedicated to capital workovers and field optimization activities.


Jones Energy Inc.

March 15, 2016

Liquidity As of December 31, 2015, the Company had $400 million undrawn on its revolving credit facility (with $110 million in outstanding borrowings) and approximately $22 million in cash. In January and February 2016, through several open market and privately negotiated purchases, the Company purchased an aggregate principal amount of $170.5 million of its senior unsecured notes. As of February 29, 2016, the Company had purchased $70.5 million principal amount of its 6.75% senior unsecured notes due 2022 for $27.1 million, and $100 million principal amount of its 9.25% senior unsecured notes due 2023 for $46.5 million, in each case excluding accrued interest and including any associated fees. The Company used cash on hand and borrowings from its revolver to fund the note purchases. As a result of these purchases, as of February 29, 2016, the Company had aggregate principal amount of senior unsecured notes outstanding of $579.5 million, outstanding borrowings under its revolving credit facility of $185 million, $325 million undrawn on its revolving credit facility, and $46 million in cash.


Jones Energy Inc.

March 15, 2016

As a result of the Company’s reduced drilling activity and its expectation of recognizing a gain associated with the debt repurchases, the Company is likely to generate taxable income in 2016. Hedging

The estimated mark-to-market value of the Company’s commodity price hedges in 2016 and beyond was $261 million incorporating strip pricing as of February 29, 2016. In recent months, the Company has entered into offsetting transactions in order to lock in gains associated with hedge volumes above projected production.The Company also has oil and natural gas hedges in place for 2018 and the first half of 2019, although at less significant levels. Approximately 100% of the Company’s existing oil and natural gas production, or PDP, is hedged through the first half of 2019. A table providing the latest summary hedge positions is shown below.


Jones Energy Inc.

March 15, 2016

2016 First Quarter and Full Year Guidance The Company will continue to monitor market conditions and may determine at a later date to spend additional capital which may include redeploying rigs to resume drilling activities or leasing. At present, the Company continues to negotiate with vendors regarding service costs and does not plan on resuming its drilling program until well costs create acceptable rates of return at strip prices. JONE projects 2016 average daily production of 15,500 to 17,000 Boe per day. The Company’s average production for 4Q16 is expected to be between 13.0 MBoe/d and 14.4 MBoe/d, which is approximately 40% below the average production rate of 23.6 MBoe/d for 4Q15.


Jones Energy Inc.

March 15, 2016

Area of Operations

Andardako and Arkoma Basins The Anadarko and Arkoma basins are among the most prolific and largest onshore producing oil and natural gas basins in the United States, enjoying multiple producing horizons and extensive well control demonstrated over seven decades of development. The Company targets formations that are generally characterized by oil and liquids rich natural gas content, extensive production histories, long lived reserves, high drilling success rates and attractive initial production rates, like these two basins.


Jones Energy Inc.

March 15, 2016

JONE focuses on formations in their operating areas that they believe offer significant development and acquisition opportunities and to which they can apply their technical experience and operational excellence to increase proved reserves and production to deliver attractive economic rates of return. The Company’s goal is to build value through a disciplined balance between developing their current inventory of 2,371 gross identified drilling locations and other opportunities within their existing asset base. The Company is actively pursuing joint venture agreements, farm out agreements, joint operating agreements and similar partnering agreements, which they refer to as joint development agreements, organic leasing and strategic acquisitions. In all of the Company’s joint development agreements, they control the drilling and completion of a well, which is the phase during which they can leverage their operational expertise and cost discipline. Following completion, JONE in some cases may turn over operatorship to a partner during the production phase of a well. Jones Energy believes the ceding to them of drilling and completion operatorship in their areas of operation by several large oil and gas companies, including ExxonMobil and BP, reflects their acknowledgement of Jones Energy’s low cost, safe and efficient operations.


Jones Energy Inc.

March 15, 2016

Cleveland Formation The Company increased activity from a four rig program to a five rig program in early July, 2015. Following the drop in oil prices during the month of August, the fourth and fifth rig were released in early September and activity was reduced to the previous three rig program. During the third quarter, the Company spud 21 wells and completed 22 wells, with a total of 24 wells seeing first production during the quarter. As of September 30, 2015, four wells were in various stages of completion and three wells were being drilled. As of the date of this report, all rigs have been released and JONE does not anticipate drilling more wells in 2016 unless oil prices improve. Throughout 2015, JONE focused primarily in the Cleveland formation of the Anadarko Basin. For the full year 2015, the Company spud 51 wells, completed 70 wells and brought on first production from 77 wells, all in the Cleveland. The Company has not spud any wells thus far in 2016. Daily net production in the Cleveland was 17.7 MBoe/d in the fourth quarter of 2015 as compared to 17.2 MBoe/d in the fourth quarter of 2014. Full year 2015 production in the Cleveland was 18.4 MBoe/d for 2015, an 8% increase from 2014 full year production of 17.0 MBoe/d.


Jones Energy Inc.

March 15, 2016

“2015 was a tough year for the oil and gas industry, but I am extremely proud of what our team was able to accomplish. We had one of our best years ever from an operating perspective. We were able to grow production while cutting spending significantly and becoming more efficient with every dollar spent. 2016 will be a defining year for the oil and gas industry. It is sure to bring many challenges, but also opportunities. Our team is focused on taking advantage of those opportunities, and we will be creative, yet deliberate in our approach. I am confident in our ability to create value for our stakeholders and firmly believe that Jones Energy’s future is bright.” – Jonny Jones, Founder, Chairman and CEO of Jones Energy Looking Forward


Jones Energy Inc.

March 15, 2016


Net Income and Cash Flow Forecast Model

Jones Energy Inc.

March 15, 2016

Jones Energy Inc. · 2016-03-15 · EPG Commentary by Dan Steffens Jones Energy, Inc. (JONE) has been dropped from our Small-Cap Growth Portfolio because they have halted all drilling

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