Unit Corporation (OTCQX:UNTC) is an underfollowed Oil & Gas producer benefiting from elevated price increases and looking to divest assets. It was covered by Safety In Value and on ValueInvestorsClub if you are looking for information prior to the recent price surge. Unit appears highly attractive due to optionality, downside protection, and current strip pricing. Unit is currently exploring strategic alternatives for their main production segment which could provide a hard catalyst for rerating their valuation. That said, I believe the potential cashflow coming from their assets will make them a good investment even if the asset sale does not materialize.

Oil And Gas Segment

Unit's primary segment is their upstream production assets, which were officially marketed for sale beginning in January. Per materials made available by IR (no NDA required), the assets had the following characteristics when strip pricing was significantly lower, especially for their predominant % of gas production:

To forecast Unit's earnings from these assets in FY22/23, I've created a high-level estimate (using numbers from their presentation) that assumes no further development of assets. Note - I annualized Q4 to estimate current production and applied a 10% discount for conservatism:

Prior to hedges in FY21, UNTC realized an average $66.50 price for oil (vs Brent 70.68), $3.55 for natural gas (vs $3.89 HH), and $23.41 for NGLs (vs $50.51 EIA). The forward Brent curve is above $90 for oil in 2022 and $85 in 2023, Henry Hub is over $6 for all of 2022 and averages about $4.50 for 2023. NGL futures are harder to come by in link-able data sets, and are currently trading near $70. UNTC has hedged some production at low prices for FY22/23 (but less than FY21):

Taking last year's realizations and current hedges into consideration, I estimate $65 averaged realization for FY22 and FY23 oil, $4 for FY22 natural gas and $3.75 for FY23, and $35/$25 for NGLs in these years. We could be more precise, but this is for directional purposes. Prices change and production will depend on levels of investment.

Production costs were $5.56 per barrel equivalent in FY21 ($50m/$80m in segment operating costs). I will assume the production decreases are mostly offset by cost inflation and FY22/23 costs are $70m and $65m. This results in segment earnings of $180m in FY22 and $130m in FY23.

Contract Drilling

Unit owns 21 drilling rigs, of which an average of 10.9 were in operation during FY21 and 16 were contracted in Dec-21. Assuming these 16 rigs remain contracted through FY22/FY23 and the average day rate increases to $22k, contract drilling should generate around $130m in revenues, and operating costs will likely inflate to ~$100m, for $30m of earnings for this segment annually. I've heard estimates that day rates may approach $30k by year end, so I hope this forecast is conservative.

Midstream Segment

The Midstream segment is complicated by the 2018 sale of a 50% interest to private equity firm Partners Group. Per the 10-K:

• After April 1, 2023, either Member may initiate a sale process of Superior to a third-party or a liquidation of Superior's assets (Sale Event). In a Sale Event, the Agreement generally requires cumulative distributions to SP Investor in excess of its original $300.0 million investment sufficient to provide SP Investor a 7% internal rate of return on its capital contributions to Superior before any liquidation distribution is made to Unit. As of December 31, 2021, liquidation distributions paid first to SP Investor of $361.7 million would be required for SP Investor to reach its 7% Liquidation IRR Hurdle at which point Unit would then be entitled to receive up to $361.7 million of the remaining liquidation distributions to satisfy Unit's 7% Liquidation IRR Hurdle with any remaining liquidation distributions paid as outlined within the Agreement.

This amount was slightly lower than the $362.7m liquidation hurdle in Sep-21, but given significant earnings in the segment, I anticipate it will be reduced further throughout FY22. The 7% interest would accrue another ~$25m in FY22 but distributions of $19m were paid for Q4, which if continued in FY22 would leave this liquidation preference around $300m at Dec-22 (Partners is receiving 100% of next $72.7m of distributions).

In Q421, the Superior assets earned approximately $18m; and $55m for all of FY21. Some of the Q4 uplift is likely due to minimum payments for volumes not processed, which should be offset by higher resource prices in FY22, and the Q4 acquisition. In aggregate, I expect $70m to be a decent estimate of FY22 earnings for the segment.

Valuation

Unit generated $69m of net income in Q4-21 ($6.89/share), proving their potential even with painfully low hedges in place. Combining the segments, UNTC looks poised to earn $250-300m in FY22 based on current strip pricing, and $200-250m in FY23. Adding in $20m of annual maintenance CapEx and $20m of G&A (along with no interest payments or taxes due to $385.5m of Federal NOLs), Unit could generate $450-550m of FCF without material incremental investment in development.

This yield, vs their market cap under $600m and net cash approaching $50m (prior to estimated Q1 FCF of ~$50m), makes UNTC's ~50% FCF yield competitive with just about any other producer:

Further, assuming the Production assets are sold near the January PDP PV-10 for $750m, Midstream sells next year for $450m (net ~$150m to UNTC) and Rigs are valued at $200m, Unit's liquidation value would be around $100/share (1.8m warrants are dilutive at $63.74). Even $500m for production (~2x runoff FCF), $0 for midstream, and $100m for rigs would land a valuation near the current $550m EV.

• $750m upstream + 150m midstream + 200m rigs + 100m cash + 100m warrant "cash" - 100m hedge buyout = $1,200m / 12m FDSC = $100/share

• $500m upstream + 0m midstream + 100m rigs + 100m cash + 100m warrant "cash" - 100m hedge buyout = $800m / 12m FDSC = $67/share

Note - the best public comp for the Rigs business seems to be Independence Contract Drilling (ICD), which trades at a ~$200m EV and has 24 rigs available for use. ICD has significant debt overhanging the business which suggests the value is likely a cheap comparison for UNTC's better-capitalized operations. Nevertheless, I've tried to be conservative with the rig valuations above in the event they are sold.

Ownership

• 35% of outstanding shares are owned by Prescott Capital, a hedge fund based in Oklahoma that had a substantial position prior to Unit's bankruptcy filing. Prescott has about $500m in AUM (so this position is material to the firm) and their Managing Partner sits on the board of directors. While they have not publicly commented on the position, I am under the impression they are focused on recouping substantial losses from the subordinated notes. They are a more traditional hedge fund, so the risk they try to take some or all of the company private on adverse terms appears minimal. Actions taken by the company since emergence from bankruptcy have been shareholder-friendly, like share repurchases in 2021.

• One concern is the lack of shares owned by Management. There are no insider purchases since bankruptcy emergence. Many executives hold $45 option grants that provide some shareholder alignment. Such ownership alignment is not unusual in a post-bankruptcy situation. The presence of a CEO that NGP has used to wind down portfolio companies is also encouraging.

Risks

• Oil and gas prices pull back materially, though if prices do come down significantly, UNTC would be affected less than unhedged peers with more spot exposure.

• Company-specific issues (getting AMPY'd).

• Disappointing asset sales.

• Lack of shareholder engagement and OTC listing could mean stock remains underfollowed.

• Well production declines quicker than forecasted.

Conclusion

Unit Corporation makes for an attractive investment in this environment due to high cash generation, lack of coverage, and upcoming strategic alternative catalysts. Management has shown strong capital discipline since exiting bankruptcy via share buybacks and minimal production increases. For investors trying to find a safer way to get exposure to oil & gas production after a significant run up in prices, I believe Unit Corporation fits the bill.