Following better-than-expected second quarter results, we maintain our Neutral recommendation for Denbury Resources Inc. (DNR) shares with the Zacks #3 Rank (Hold). The company experienced a solid uptrend in production volumes driven by contributions from recently acquired properties such as Encore Acquisition Company (“EAC”).
As Denbury completed the Encore acquisition in March, the second quarter was the first full quarter of combined operations. Encore not only added sizable properties to Denbury’s business, but also had higher-growth plays to aid the company’s long-term growth trajectory.
The company remains on track, retaining its positive growth momentum. As the company’s production is fairly oil-weighted, we view strong earnings and cash flow visibility for the future. In addition, the company assessed a 14% larger proved reserves number at the end of second quarter, compared with year-end 2009 reserves base.
We continue to like the company’s asset mix, including the low-risk nature of tertiary production properties. Additionally, the Encore acquisition will position Denbury as one of the largest crude oil-focused independent North American exploration and production companies.
We consider Denbury’s sale of Permian Basin assets and its entire interest in Barnett Shale assets as a prudent step, which will allow the company greater liquidity and flexibility to focus on its core tertiary oil operations. These are more profitable, carry lower risk and face virtually no competition.
Management indicated that tertiary production will escalate with the growing momentum at Tinsley, Heidelberg and Delhi fields. However, its growing cost structure is currently our concern as lease operating expenses increased 41% in the first six months of 2010 from the year-earlier level.
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