Exploration And Production Industry Loves To Adjust

By Eric Fox | May 28, 2012 AAA

The exploration and production industry is required to report GAAP earnings every quarter, and also reports several non GAAP measures along with the official numbers that are specific to the sector. These extra measures make it even harder for investors to sort through the mass of information released every quarter.

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Non GAAP Measures
One of the more common non GAAP measures reported in the industry is earnings before interest expense, income taxes, depreciation, depletion, amortization and exploration expenses, or EBITDAX. Some companies refine this measure further as adjusted EBITDAX and add back any impairment of properties or losses from discontinued operations.

SEE: 5 Must-Have Metrics For Value Investors

The Adjusters
Penn Virginia (NYSE:PVA) reported a net loss of $11.9 million or (26 cents) per diluted share in the first quarter of 2012, and came up with an adjusted EBITDAX of $64.2 million. Items that were added back in to arrive at this final number were interest expense of $14.7 million, depreciation of $50.8 million and exploration expense of $8 million.

Chesapeake Energy (NYSE:CHK) reported a GAAP loss of $71 million, or 11 cents per diluted share in the first quarter of 2012. The company made several adjustments to that number and reported adjusted net income of $137 million or 18 cents per diluted share. One major item that was excluded was a $167 million unrealized mark to market loss on a derivative portfolio used to hedge the company's production and interest rate exposure. The company also excluded preferred stock dividend payments of $43 million made in the first quarter.

Chesapeake also reported EBITDA of $597 million in the quarter, and after further tinkering came up with an adjusted EBITDA of $838 million. Once again, the main item was an unrealized loss on the derivatives portfolio.

Whiting Petroleum (NYSE:WLL) also adjusted its net income in the first quarter of 2012. The company reported GAAP net income of $98.2 million or 83 cents per diluted share and adjusted this number upward to $122 million or $1.03 per share. Whiting Petroleum excluded unrealized derivative losses and an impairment expense. The company also took out a one time charge of $5.9 million related to the Whiting USA Trust II (NYSE:WHZ), a trust offering the company conducted earlier in 2012.

SEE: Derivatives 101

Rationale
Although these non GAAP measures almost always make the financials look better for the companies involved, they insist that using the adjusted numbers are a better method of examining the results and performance of business on a recurring basis. While there is some validity to this argument, one wonders whether it makes sense not to count interest, dividends or exploration charges against a company's performance as these are real expenses that are required for most companies in the sector.

SEE: A Guide To Investing In Oil Markets

The Bottom Line
The confusing array of GAAP and non GAAP financial measures reported by the exploration and production industry can stump investors with years of experience in the sector. This situation should make investors tread carefully before putting money to work here.

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At the time of writing, Eric Fox did not own shares in any of the companies mentioned in this article.

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