Gulfport Energy

Moat: 2/5

Understandability: 3/5

Balance Sheet Health: 4/5

Gulfport Energy is an independent natural gas exploration and production company, primarily focused on the Appalachian and Anadarko basins. Their operations are centered on finding, extracting, and selling natural gas and natural gas liquids (NGL).

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 and Moat Assessment Gulfport Energy’s primary business is the exploration and production of natural gas and NGLs. This inherently exposes them to commodity price risks, and the company lacks significant control over their selling prices. They operate primarily in the Utica and Marcellus formations.

A moat arises from a company’s sustained competitive advantage. In the case of GPOR, we do see some characteristics that are somewhat beneficial, but on the whole don’t make up a strong moat. Here’s the analysis of the sources of its competitive edge, and if they help to form a moat:

1. Intangible Assets:

  • Brands: GPOR has no brand recognition or differentiation and it is not a differentiating factor from its competitors, as their products are essentially the same. Brands like Coca-Cola or P&G would have this moat.
  • Patents/Regulatory Licenses: GPOR relies on government approval to operate within its leases. This is a barrier to entry for other companies, but these approvals are common in the industry and other competitors have it, so it’s not a differentiating factor.

This moat is a regulatory license or access to resources kind of moat. However, it’s quite common in the energy sector and it does not offer any additional protection to the business against other competitors. It could be rated a low/narrow moat.

2. Switching Costs:

  • GPOR products are considered commodities. It’s not hard for customers to move to another supplier of natural gas or NGL since there isn’t any switching cost for customers to do so. Hence, it’s a no-moat industry.

In other industries such as software and banking we see tight integration to customer’s day-to-day lives which is difficult to break. This does not happen in the oil and gas industry and thus, GPOR doesn’t have any switching cost moat.

3. Network Effects:

  • This type of moat does not apply to the business, because GPOR has very little to no interaction among its users. Users are those that purchase their products and the number of people doing that does not make the company any more valuable. Companies like credit card networks and Facebook have this moat.

4. Cost Advantages:

  • This is where GPOR might have an edge. The company’s operations in the SCOOP and Utica formations could provide some production or cost advantages.
    • They utilize advanced drilling techniques and technology, which allow them to efficiently recover natural gas.
    • In some regions, they have lower well costs due to geological and operational conditions. For example, its operations in the SCOOP generate a significant profit.

However, these advantages are not proprietary. Competitors use similar drilling techniques and they may have access to geological resources that allows them to produce at low costs as well.

Hence, this type of moat seems weak, as it can easily be replicated and it’s not unique to GPOR. Hence, it’s a narrow moat

Moat Rating: Given the above analysis, GPOR’s moat would be rated as a 2 out of 5. The company has some protection through regulation but is mostly limited by cost advantages stemming from the locations of their resources which are easily replicable by others. In the long term we expect some competition in this field.

Legitimate Risks to the Moat and Business Resilience:

  • Commodity Price Volatility: GPOR is heavily reliant on the prices of natural gas and NGL. These prices can fluctuate wildly, influenced by global supply, demand, geopolitical events, and weather conditions, hence it’s a major risk to profitability.
  • Technological Disruption: New technologies in alternative energy sources (such as renewables) or production processes could alter the demand and supply dynamics of the industry. This could make their business less profitable.
  • Regulatory Changes: changes in environmental regulations, taxation and production restrictions can drastically affect GPOR’s operations and cost structures.
  • Production risks: Accidents, disruptions due to weather or unexpected conditions could make their productions inconsistent. This adds a great degree of uncertainty for their business and reduces revenues.
  • Capital Intensity: The oil and gas industry is highly capital intensive which means it requires huge sums of capital to fund operations. Changes to the markets that would negatively impact their access to funds or raise their interest rates can cause them severe financial strain.
  • Environmental and Societal Pressures: Negative public sentiment towards fossil fuels, increasing awareness of climate change, can have an impact on demand and GPOR’s long-term profitability and future expansion.
  • Economic slowdown: We are already starting to see a slowdown in the world economy and any further decline in economic growth could negatively affect the energy sector and thus put more strain on the prices of commodities. This is a systemic risk that GPOR cannot control.

Business Explanation:

  • Revenue Distribution: GPOR primarily derives its revenue from the sale of natural gas and NGL from its Utica and Marcellus assets. These are commodities in which the company sells to other market participants.
  • Trends in the Industry: The industry is heavily influenced by supply and demand forces, macroeconomic conditions, global developments, and regulatory changes. There is a push towards cleaner energy, which will definitely affect demand and prices in this sector and thus can affect the business. The industry has seen a consolidation recently through mergers and acquisitions. The price increases following the Russian Ukraine conflict and subsequent economic crisis in Europe has significantly affected the market.
  • Margins: GPOR’s margins are directly influenced by commodity prices, meaning they may be unpredictable and volatile. The company’s profitability can fluctuate wildly based on commodity prices and thus is a significant risk.
  • Competitive Landscape: GPOR operates in a competitive market with many other small and large producers. The competition tends to be from price of products as the goods are very difficult to differentiate. Major competitors include EQT and Chesapeake Energy.
  • What Makes GPOR Different: GPOR utilizes advanced drilling technologies and techniques, such as horizontal drilling and hydraulic fracturing to reduce costs and be efficient in the operations. As of the last earnings call management is focused on reducing costs and creating operational efficiency in the business.

Despite some advantages, the company struggles to get consistent profits, as evident by its historical data. This is due to the volatile nature of the industry. It does have some operational efficiencies but so does every other competitor in the space. Hence, there’s nothing truly differentiating about the business.

Financial Analysis:

  • Income Statement:
    • The company’s revenues are heavily influenced by commodity prices. Volatility in prices can create swings in their revenues and profits.
    • Operating expenses need to be carefully managed and optimized to maintain profit margins amid the market changes.
    • The company has a history of volatile earnings.

As per the latest earnings call (Q1 2024), the company was forced to lower its production guidance due to lower well performance in SCOOP and lower than estimated completion times in the Utica region. Furthermore, their margins are getting squeezed by increasing costs and lowering prices. These are negative catalysts for the business.

  • Balance Sheet:
    • GPOR had some debt (roughly $1.73 billion as of September 2023). The current ratio is less than one, which indicates the company may have trouble in paying its short-term liabilities. However, the long-term debt has been declining and does seem manageable. The company has been aggressively paying off debt during recent years.
  • Cash Flow:
    • GPOR has been generating a good amount of free cash flow during the recent high-price environment. We would like to see management continue to utilize excess cash to pay down debt.

Understandability:

  • The business is moderately easy to understand. It’s a commodity business with some complexities added due to specific geographical locations and its leases. The financial statements are complex for the uninitiated, but can be easily assessed. Hence, the understandability of the business is a 3 out of 5.

Balance Sheet Health:

  • The company’s debt load has decreased significantly in recent times, indicating good management of its finances. The company’s focus is on paying down debt, which is good in the long-term. However, it still has some debt and its current assets are not enough to pay off its liabilities, hence we rate its balance sheet a 4 out of 5.

Recent Concerns/Controversies and Problems

  • Production Miss: The company reduced its production guidance by 10% due to underperformance and slower than expected completion times in the Utica and SCOOP regions.
  • Cost Increases: GPOR management notes the input cost are rising, while prices are reducing, putting more strain on the business margins and profitability.
  • Management Change: The company’s CFO recently left which does raise some question marks. However, a new CFO has been chosen and seems to have experience in this field.

Conclusion

GPOR is a commodity-based business with volatile prices that significantly impact its performance. While it does have certain operational efficiencies and a strong focus on capital allocation, it does not demonstrate a strong sustainable competitive advantage or a wide moat. Its high dependency on prices and a weak business structure makes it a very risky business. Investors need to be extremely careful before investing into such a business.