Talos Energy: A Gulf Of Mexico Standout (NYSE:TALO)

Introduction

It’s been a year since we’ve discussed Talos Energy (NYSE:TALO). Last March, we covered them with a buy rating. The stock has done precisely nothing since and currently sits within a few pennies of where it stood last year. We aren’t going to do a post-mortem now. I think most of us understand that low oil and gas prices and debt are largely responsible for Talos’ sideways trading over the last year. It’s had a lot of company in that regard. Things could be looking up, if the recent trend in the stock is a guide.

Since early Feb-24, the stock of Talos Energy has gained about 20%. That’s enough of a move to suspect something fundamental might have changed about the Talos story, and invites further investigation.

Analyst EPS estimates have been cut significantly over the last three months from, $0.26 to -$-.04 for Q-1, 2024 and from $0.20 to $0.06 in Q-2. Curiously then, the good seagulls have slapped a buy rating on the stock with targets ranging from $15-$25 (median-$17.00). Those two lines do not converge, leading us to speculate there’s news to be uncovered.

On a technical basis the stock had couple of a huge buying trading days in late Jan, 28 million shares mas o menos, to which it responded by sagging down to the $12.00 level. As noted, since early Feb the stock has staged a nice rally to current levels, but remains below resistance at $14.55 and the 200 day SMA. Hopefully creating an opportunity to enter for fun and profit.

The thesis for Talos Energy

The company is a U.S. Gulf of Mexico-GoM-focused producer of oil and gas, with a deep inventory of drilling prospects, as noted in the slide below. It also has a WI in a field-Zama, operated by PEMEX-the Mexican national oil company. Talos originally discovered Zama, but it was found to be more in Mexican water than U.S. The company lost operatorship and the project has been delayed.

On a positive note in regard to Zama, last September Talos sold 49.1% of Talos Mexico to Grupo Carso, which is owned by Carlos Slim. Getting Mr. Slim involved was a very positive step in my view. Slim swings a fairly big stick south of the border, and in Latin America (other places as well) it helps to have a national partner when you are trying to deal with local bureaucracies and regulators.

Much of what enables Talos to keep production costs down are the wealth of Hosts and top side facilities it has acquired through acquisitions.

Talos has also been in the carbon sequestration business through its Low Carbon Solutions subsidiary. Recently it chose to monetize this portfolio with the sale to TotalEnergies (TTE). The proceeds of $148 mm will be used to pay down debt. Two good outcomes for shareholders in my view. A company Talos’ size probably had no business in the CCS trade. “Get out now while you can make some money,” seems to have been the operative phrase and we applaud management for taking this step. CEO Tim Duncan commented in regard to this transaction:

The transaction will further enable Talos to prioritize cash flow generation and optimal capital allocation in our core Upstream business.

Talos has over 216 million barrels of proved equivalent reserves with a total proved value of over $5 billion. In fact, just the PDP value alone at SEC prices is $4.2 billion, according to the company. Through acquisitions they have moved into the position of being the fifth largest operator in the Gulf of Mexico and the fourth largest by acreage.

So what gives on the move in January?

If you are wondering as I was why the stock became a Wall Street darling in January, you need look no farther than the announcement of the QuarterNorth deal. Just completed in early March the QuarterNorth acquisition brings 30K BOEPD of 75% oil-weighted production, a host at Tarantula-which will be getting a 7K BOPD upgrade to handle new production, and adds 69 mm bbls to reserves. The $1.29 bn transaction straps out at $43K per barrel which pays out in a couple of years with a field cash margin in the mid-$40’s.

It also brings a permitted drillable step-out, Katmai West-2, in the Katmai Field. This could be a barn-burner as Katmai is currently producing most of QuarterNorth’s net production. CEO Tim Duncan commented on the potential impact to their bottom line:

The increased scale that we achieved through the QuarterNorth transaction which, also increases our oil-weighted portfolio that we believe have high netback margins coupled with the reduced capital program, is going to achieve that goal of generating significant free cash flow.

I included the slide below as it gives a nice view of the different drilling horizons in the GoM. Most of the big fields in the near-shore Miocene and Upper Cretaceous have been drilled and are in the last stages of their life cycle-waterfloods and the like. Much of the activity now is in the Outboard Wilcox at tremendous water and absolute depths. That doesn’t mean there aren’t nice prospects remaining in the Miocene, Pliocene and Cretaceous eras. That’s where companies like Talos come in, to pick out and pluck tasty 40-60 mm bbl fields that just didn’t move the needle for the majors.

Deepwater barrels are generally high margin, low carbon footprint, and feature decline rates in the 6-10% per range, in contrast to shale at declines of 40-60% annually.

Risks

One of the things that’s impacted Talos stock other than price declines is their balance sheet. With roughly one turn of EBITDA I don’t see it as being all that impactful and the company notes they are applying cash flow and divestiture proceeds to reduce it. Sergio Maiworm, CFO noted:

We are very pleased with the financing transactions that we executed earlier in this year. We refinanced our old bonds and raised additional capital to close on the QuarterNorth acquisition at very attractive rates. We’ve moved our maturities out of 2026 and moved them all over to 2029 and 2031. As Tim alluded to earlier on the call, our production in 2024 represents a 35% to 40% growth compared to last year where our capital expenditures represents a reduction compared to 2023. Those are key metrics that will allow us to generate a significant amount of free cash flow in 2024 and ultimately allow us to pay down debt of approximately $400 million throughout this year.

If we see some evidence of movement in this area when TALOS reports, the stock could get a bid.

Future permitting could be an issue. The current administration is taking every step it can to derail U.S production, even as it quixotically asks for more. Who knows where it goes from here.

There is also some dilution risk as the company will print 24.8 mm new shares to pay out QuarterNorth.

Q4 2023 financials and forecast for 2024

As noted Talos missed significantly on the top and bottom lines for 2023. At $1,455 bn revenues were off from 2022’s $1,648 bn. Operating Margin improved to 69% from 2022’s 58%. Debt stood at $992 mm and total liquidity was $748 mm, with $33 mm of cash on the books.

For full year 2023 the company average 75K BOEPD with the liquids fraction at 86%. With the addition of the ~30K BOEPD coming from QuarterNorth and the startup of the Lime Rock and Venice startups, the company is guiding for daily output range of an 87,000 to 93,000 barrels of oil equivalent per day in 2024. For 2025, they see a potential upside to 105,000 and 110,000 barrels a day

Your takeaway

I think Talos is attractive at current levels. The EV/EBITDA is 2.5X which is in a sweet spot, and the full year flowing barrel cost is $28K per barrel. Both of those figures compete with other GOM operators we have discussed in recent times. If they hit that 110K BOEPD target those multiples would be quite eye-watering at 1.66X and $22K per barrel.

How do we get to the analyst’s upper end of $25? Figuring 2025 EBITDA of $1.5 bn at 2.5X you get an EV of $3.5 bn/150 mm diluted shares equals, $23.50 per share. I don’t think any of these calculations are particularly aggressive, providing oil stays in the $80-85 range.

Investors with a moderate risk tolerance might consider Talos for inclusion in their portfolios at the current price. Talos reports earnings on May 3rd and if analysts’ expectations are not met, the stock might see a reversion toward the upper $12’s. With no dividend to consider, price appreciation is our only lever. Accordingly I don’t think I would make move on Talos prior to earnings release.