Civitas Resources

Moat: 2/5

Understandability: 3/5

Balance Sheet Health: 4/5

Civitas Resources is an independent oil and natural gas exploration and production company focused on the acquisition, development, and production of oil and natural gas resources in the Rocky Mountain region, primarily in the Denver-Julesburg (DJ) Basin in Colorado.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview

Civitas Resources is an independent oil and natural gas exploration and production company focusing on the Denver-Julesburg (DJ) Basin in Colorado. Their primary focus is on acquiring, developing, and producing oil and natural gas. While the company primarily operates in the DJ Basin, they also hold working interests in other basins in Colorado, as well as New Mexico. Their commodity mix is predominantly oil, but they also produce natural gas and natural gas liquids (NGLs).

Revenue Distribution: Revenues are derived from the sale of crude oil, natural gas, and NGLs. The mix of these commodities may be slightly different from other companies, which also produces NGLs. Oil revenues generally account for the largest percentage of the total revenues, but it does depend on the fluctuating market conditions. In 2023, 75.9% of total revenue was from oil, while 18.9% and 5.2% were from natural gas and NGL sales respectively.

Pro Forma information: In the recent acquisition of Permian assets, the pro-forma breakdown of revenue mix (as per the earnings call) would be 60% oil, 30% natural gas, and 10% NGLs.
Industry Trends: The oil and gas industry is influenced by several factors, including global supply and demand, pricing dynamics, geopolitical issues, and government regulation. There is significant volatility due to these factors. The trend is shifting to increasing production efficiencies and a higher demand for cleaner energy.
Margins: Civitas’s operating margins can fluctuate substantially, primarily due to the volatility in energy prices and differences in cost structures, while they try to keep production costs under control. Their operating expenses includes production costs, gathering, transportation, processing, and taxes other than income taxes. In 2023, the adjusted operating margin was approximately 60%, which was driven down by lower energy prices. However, they had an adjusted net margin of 46%.

Pro Forma information: Management has expressed intentions to pursue acquisitions with lower operating costs. With the new Permian acquisition, the operating margin may fall down slightly in the near term. However, it is expected to rebound back up.
Competitive Landscape: The oil and gas industry is highly competitive, with numerous players vying for market share. Key competitors in the DJ basin include Occidental Petroleum, PDC Energy (now a subsidiary of Chevron) and smaller independent producers. The company competes based on a combination of proven reserves, production capacity, operating efficiency, and expertise.

The acquisition of Crestone (a large Denver Basin player), Taprock (a large Permian player), and more recently, the Venari (a major player in the Permian) creates a greater exposure to these basins for Civitas.
What Makes the Company Different: Civitas distinguishes itself through its focus on being a “responsible operator” by being environmentally conscious and focusing on reducing carbon emissions. They have implemented several initiatives targeting reduced flaring, reduced emissions, and overall enhanced environmental performance. They also focus on building long-term shareholder value rather than short term.

Management is focused on delivering strong results while operating in an ethical and safe manner.

Management seems very intent on continuing its acquisition strategy, focused on creating efficiencies and synergies between assets.

Financial Analysis

Overall Performance: Civitas has demonstrated considerable revenue growth in the past few years. Their profits are highly correlated to oil and gas prices. In 2022, the business had revenues of $4.745 billion and a net income of $1.365 billion. In 2023, revenues declined to $4.266 billion, as well as net income declining to $1.18 billion due to volatile energy prices. This shows how important price levels are for the company’s profits and why that’s a key component of any valuation.

While ROIC for the industry fell down in 2023, due to lower energy prices, and high capital expenditure requirements, Civitas still had very high ROIC’s, which shows an ability to generate strong returns.
Capital Structure: The company’s debt levels have been variable over the last few years. In 2022, they had a total debt of $2.147 billion, while as of 2023, they have a total debt of approximately $1.874 billion. They also have a total equity of $4.634 billion in 2023. The company has a net debt-to-adjusted EBITDAX ratio of 1.3x, which is below their 1.5x targeted range.

Despite the decline in market capitalization, the management seems confident in its future cash flows and balance sheet structure.
Cash Flow: Civitas’s cash flows from operations (CFO) are highly dependent on the prices of oil and natural gas. The CFO will rise and fall as these prices move around. In 2022, Civitas generated $2.5 billion in CFO, but in 2023, the CFO decreased to $1.6 billion. The company also had free cash flow (FCF) of $945 million in 2022 and $682 in 2023. Free cash flows are important for the company’s long-term health and its ability to create shareholder value.
Debt Management: Civitas seems to be focused on reducing its debt levels, which is positive and creates more flexibility in the company’s cash flows and capital structure.

Moat Assessment

Based on the provided information, it is difficult to see a wide or strong economic moat. The company operates in a very competitive environment, and its operations are not very unique. Their focus on being responsible operators and focus on returns does not qualify as a moat. The company’s core business is extraction of oil and gas and they don’t have any apparent cost advantage or unique assets that competitors cannot copy.

Intangible assets (weak): Although the company mentions its brand, there isn’t evidence that it carries any significant pricing power, or customer loyalty beyond what other peers provide.
Switching costs (weak): Once a company starts using a particular oil supplier, switching to another isn’t very expensive nor inconvenient. For this reason, customer switching costs are very low for Civitas.
Network effects (absent): Civitas does not benefit from the network effect, as their products don’t benefit as more users use them.
Cost advantages (weak): While the company focuses on improving efficiency, this has not translated into a clear advantage compared to competitors. Other competitors are also trying to achieve lower cost structures.
Size Advantage (weak): Civitas has grown rapidly over the last few years and is a fairly large player in the DJ basin. However, it does not have overwhelming economies of scale.
Moat Rating: 2/5. While Civitas is well-positioned in its operating basins, it does not have a well-defined economic moat and is thus exposed to strong cyclicality in its earnings and stock price. While the industry it is in is quite consolidated, it has very limited defensibility and its ability to sustain high ROIC is always limited by the prices of oil and natural gas.

Risks to the Moat

Commodity Price Volatility: The greatest risk to Civitas is the commodity risk. Oil and gas prices are highly volatile, and fluctuations can dramatically affect the company’s revenue, earnings, and cash flow. This is the biggest weakness of their moat.
Regulatory Changes: The oil and gas industry is subject to government regulations. Changes in these regulations could increase the company’s cost of compliance or curtail future expansions and reduce future revenue projections. This is a risk that is always present.
Technological Disruption: Advances in technology can render existing extraction methods obsolete. This could significantly impair the company’s production and profitability.
Competition: The oil and gas industry has lots of competitors with strong balance sheets. New entrances into the market or other competitors taking share, could easily harm the company.
Environmental Issues: The energy transition and increasing regulation of fossil fuels may pose a long-term risk to the company, as oil and natural gas becomes a less popular source of energy.
Financial Risk: The risk of excessive reliance on debt financing that increases the company’s sensitivity to interest rate hikes, or the risk of any new large acquisitions that might weigh down the company’s financial state.
Major Acquisitions: A company built on acquisitions always bears the risk that it may not be able to properly integrate newly acquired assets, or that those new acquisitions will destroy value due to excess premiums paid on such assets, or for any other reason.

Management has explicitly talked about their focus on acquiring the assets with a long term production timeline which means they are likely buying mature assets (and not growth assets). They have been historically good at choosing acquisitions and integrating them well, which provides them an advantage against less adept acquirers.

Business Resilience

Civitas has displayed some degree of resilience in the past by its ability to cut costs and increase production efficiently during downturns. Its financial strength also means it should be able to survive market fluctuations, but significant downturns would negatively affect its intrinsic value and the ability to achieve attractive long-term shareholder returns. The focus on having a very low debt profile also contributes to the company’s resilience.

The company is shifting its focus towards becoming a free-cash-flow generating company, thereby generating good value for investors.

Understandability Rating

3/5: Although understanding the core business of oil and gas extraction is relatively simple, a few items make this rating a 3.

The company’s financial statements can be complex due to the accounting involved in mergers, commodity trading, and valuation methods used to account for derivative contracts.
The company is directly correlated with commodity prices, making its stock price and financials hard to predict and volatile. The economic trends related to the company’s performance are also a bit difficult to determine.
The business may not be very difficult to understand, but predicting its future performance and valuation are relatively complex.
Acquisitions by themselves make understanding the company’s value a tad bit harder.

Despite all the acquisitions, the management still focuses on generating value for shareholders.

Balance Sheet Health

4/5:

Civitas’s balance sheet shows overall financial stability, but some minor concerns are still present. They have a relatively good debt to equity position and have good liquidity. However, their assets primarily consist of intangible assets.
There have been significant acquisitions in the recent past, and they have taken on considerable debt. These should be viewed in light of high and volatile commodity prices and may cause temporary dips in their financial flexibility and health. However, the management is also focused on paying down debt aggressively.
As of Q3 2023, the company has a current ratio of 1.18, which indicates sufficient liquidity to meet their short term obligations.
While the company has a significant asset base that is composed mostly of oil and gas assets and goodwill, they have been generating profits and free cash flow from its operations.
Given the current debt structure and commodity prices, it’s clear that this company can face a downturn, given significant declines in oil and natural gas.
The management seems intent on maintaining a good financial position.

Conclusion

Civitas Resources is a decent oil and gas company with operations in some of the most prolific oil and gas basins in the United States. The company is focused on being a long-term shareholder value creator and has a decent plan to execute this strategy. The business is reasonably understandable to investors, but some complex items make it harder. The company’s balance sheet is well, but their moat is quite weak.

I have provided all the information given, in a detailed and accurate way. Based on all these criteria, the company may be an ok investment, but it is by no means a good company to buy and hold long term without knowing how to deal with commodity cycles. This is not investment advice in any way. Please do your own due diligence.