Hedging Missteps And Acquisition Risks To Hamper Earnings Amidst Volatile Times

Key Takeaways

• Emphasis on grassroots acquisitions and asset enhancement may increase debt without immediate returns, affecting net income and cash flow if expectations are not met.
  
• Hedging a significant portion of expected volumes at rates above current market prices carries the risk of revenue decline if market conditions change unfavorably.
  
• Strategic acquisitions and a focus on organic growth, alongside a strong hedging strategy, position Black Stone Minerals for enhanced shareholder value and stable earnings.

Catalysts

Owns and manages oil and natural gas mineral interests.

• The company's emphasis on grassroot acquisition programs to enhance asset position might lead to increased debt or expenditure without immediate return, potentially affecting net income and cash flow, especially if these acquisitions do not yield the expected value or take longer to develop.
  
• With over 60% of expected volumes hedged for 2024 at prices well above current market rates, there is a risk of significant revenue decline if natural gas prices increase or if hedging strategies fail to cover price volatility, impacting earnings negatively.
  
• The delayed initial production from some wells, as discussed, could imply operational inefficiencies or geological challenges, potentially reducing future revenue growth if such delays become a pattern or affect a significant portion of new wells.
  
• The focus on targeted acquisitions and development in uncertain or emerging areas, such as the undisclosed Gulf Coast area, presents a risk of capital misallocation or lower than expected returns on investment, which could affect future earnings and cash flow.
  
• The strategy of keeping distributions flat to use excess coverage for pursuing mineral and royalty acquisitions could lead to a misalignment with investor expectations for dividend growth, potentially impacting the company’s stock valuation if these investments do not contribute to earnings growth as anticipated.

Assumptions

• Analysts are assuming Black Stone Minerals's revenue will grow by 1.6% annually over the next 3 years.
• Analysts assume that profit margins will shrink from 64.4% today to 55.4% in 3 years time.
• Analysts expect earnings to reach $285.4 million (and earnings per share of $1.34) by about October 2027, down from $316.0 million today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 13.6x on those 2027 earnings, up from 9.9x today. This future PE is greater than the current PE for the US Oil and Gas industry at 10.5x.
• Analysts expect the number of shares outstanding to grow by 0.27% per year for the next 3 years.
• To value all of this in today's dollars, we will use a discount rate of 6.84%, as per the Simply Wall St company report.

Risks

• The company’s focus on organic growth strategy and targeted acquisitions could significantly increase its asset base and future revenue streams, positively impacting earnings.
  
• Black Stone Minerals' clean balance sheet and strategic acquisitions worth about $65 million since September 2023 suggest strong financial health and growth prospects, which could enhance shareholder value and potentially lead to earnings growth.
  
• The extensive undeveloped inventory, including over 15 Tcf on the Gulf Coast with multiple successful well results, indicates a significant opportunity for production and revenue increase, possibly improving net margins.
  
• Having over 60% of expected volumes hedged for the remainder of 2024 provides financial stability and protection against price volatility, potentially stabilizing cash flows and supporting earnings.
  
• The company benefits from a realized gain of approximately $12 million due to effective hedging strategies against lower natural gas prices, indicating a proactive approach to risk management that could safeguard and enhance profitability.

Valuation

• The analysts have a consensus price target of $15.0 for Black Stone Minerals based on their expectations of its future earnings growth, profit margins and other risk factors.
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2027, revenues will be $514.8 million, earnings will come to $285.4 million, and it would be trading on a PE ratio of 13.6x, assuming you use a discount rate of 6.8%.
• Given the current share price of $14.86, the analyst's price target of $15.0 is 0.9% higher. The relatively low difference between the current share price and the analyst consensus price target indicates that they believe on average, the company is fairly priced.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.