Denbury Resources Inc. (NYSE: DNR) is back to where it started the year, after coming under immense short selling pressure on crude prices dropping. The stock has also lost more than 60% in market value ever since it announced it was in the process of acquiring Penn Virginia in a deal worth $1.7 billion. While the management team has tried to reiterate that the acquisition will accelerate growth rate, investors have continued to push the stock lower. The share price plunge has also come on oil prices plunging. The stock is currently hovering at the $2.35 a share level after feeling the full effects of short sellers. Denbury Resources faces immediate support level at the $1.80 level on further sell-offs. A breach of the critical resistance level could open the door for short sellers to push the stock to the $1.20 level seen as the next substantial support level.
Why Denbury Resources Imploded
Denbury Resource has come under immense pressure on growing concerns about a potential change in strategy, with the acquisition of Penn Virginia. Denbury relies on enhanced oil recovery techniques to boost production in its oil fields. In contrast, Penn Virginia drills horizontal wells into shale formations as part of the oil extraction process.
The chief executive, Chris Kendal, did try to quash concerns about a potential change in strategy. However, if price action activity is anything to go by the same could as well have fallen in deaf ears. “This transaction is not a shift in strategy. It is a reinforcement that I see fitting perfectly with Danbury’s strategy, and here’s why […]. Primary development of Penn Virginia’s unique position adds significant and flexible short-cycle growth capacity and generates even more free cash flow than Denbury does all on its own,” said Mr. Kendal.
Denbury-Penn Virginia Merger Synergies.
The CEO expects the acquisition to act as a short-term growth engine as it continues to drill its shale wells. For starters, he expects the merger to result in a 10% increase in oil production starting next year. Such an increase would be a milestone achievement given that Denbury Resources did experience a 4% production decline last year. In addition to production growth, a merger of the two companies should result in a combined company capable of generating significant free cash flow. Assuming increasing production levels and oil price stabilizing between $60 and $70 a barrel, the management team expects the combined company to generate up to $200 million in free cash flow next year. Free cash flow should increase to between $300 million and $600 million in 2020. Such an achievement should allow the company to pay down its debt by 2020. However, the company faces an uphill task to achieve its goals while relying on oil prices. Oil prices have plummeted closer to the $50 a barrel in recent months. This explains why investors were not enthusiastic about Denbury Resources paying a $1.7 billion for Penn Virginia. Uncertainty had already started to grip the sector just as was the case in 2014 when prices plunged to below the $40 a barrel mark.
Denbury Resources might have to readjust its spending plan if it is to meet its financial goals and become free cash positive. Over the years, the correlation between Denbury Resources stock price and the crude price has grown increasingly clear.
The stock price tends to rise whenever crude prices are rising. Conversely, whenever the prices are dropping so does the stock price. The fact that the company’s prospects are mostly tied to the selling price of oil all but explain, its underperformance, at a time when oil prices have taken a significant hit