HighPeak Energy: Unlocking Value Through Operational Efficiency and Oily Inventory (HPK) - HPK Stock Research Report

## Executive Summary / Key Takeaways * HighPeak Energy is demonstrating superior operational efficiency and cost control in the Midland Basin, translating high oil-cut production into peer-leading cash margins and robust free cash flow generation. * The company possesses a deep inventory of high-value, sub-$50 breakeven locations across its contiguous acreage, including promising upside from the Middle Spraberry zone, providing a long runway for profitable development. * Significant investment in life-of-field infrastructure is now yielding benefits, reducing operating costs, enhancing reliability, and positioning the company for further capital efficiency gains and lower maintenance CapEx in the future. * Management is actively focused on optimizing the capital structure in 2025 to reduce high interest expense and increase financial flexibility, while also pursuing a strategic alternatives process to maximize shareholder value. * Despite market volatility and geopolitical risks impacting commodity prices and costs, HPK is maintaining capital discipline, adjusting its development pace based on conditions, and is positioned for continued strong financial performance and potential value realization. ## A Permian Powerhouse Built on Efficiency and Oily Rock HighPeak Energy, Inc. emerged in October 2019 with a focused vision: to build a premier independent exploration and production company centered in the oil-rich Midland Basin of West Texas. Its strategy was clear from the outset – amass a highly contiguous acreage position through grassroots leasing and drive rapid, organic production growth via the drill bit. This approach, distinct in a consolidating industry, fueled a remarkable expansion, increasing production over 14-fold in its first four years as a public entity. HPK's core assets lie primarily in Howard and Borden Counties, encompassing the Flat Top and Signal Peak areas, characterized by extensive horizontal drilling opportunities, with over 90% of operated net acreage supporting laterals of 10,000 feet or greater. The company's foundational strength is rooted in the quality of its underlying rock and its relentless pursuit of operational excellence. HPK's acreage yields a highly desirable, oily production mix, significantly higher than many peers, which translates directly into superior realized prices per barrel of oil equivalent (Boe). Complementing this asset quality is a demonstrated ability to convert these high-value barrels into industry-leading cash margins. Management highlights converting approximately 80% of realized price per Boe into EBITDAX, resulting in EBITDAX per Boe that is over 65% higher than the peer group average. This is a critical differentiator, allowing HPK to generate substantial profitability even at lower commodity price points compared to less oil-weighted or higher-cost producers.

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A key enabler of this profitability is HPK's differentiated cost structure, particularly in drilling, completion, equipping, and facilities (D,C,E&F). Operating on the eastern side of the Midland Basin provides structural advantages, including shallower zones and lower reservoir pressures compared to the central basin or the Delaware Basin. These geological characteristics translate into lower drilling footage, reduced pipe and cement requirements, less rig time, and significantly lower hydraulic fracturing horsepower needs (frac pressures are approximately 30% lower than some peers). This structural advantage, combined with operational efficiencies and the strategic build-out of company-owned infrastructure, allows HPK to execute D,C,E&F operations at costs less than 75% of comparable peer expenditures. The company has seen tangible results from this focus, with D,C,E&F costs running 9% below Q1 2024 levels as of late 2024. Beyond well construction, HPK has invested significantly in comprehensive life-of-field infrastructure. This includes a company-owned water system capable of disposing of 100% of produced water not used for recycling (reducing reliance on more expensive third-party disposal), an overhead electrical power distribution system (enhancing reliability, reducing generator use, and lowering power costs, supplemented by a fully operational solar farm), and an expanded low-pressure gas gathering system (minimizing flaring and slightly boosting natural gas production). This infrastructure, representing a substantial investment over the past few years, is now largely in place and designed to support development across the entire acreage position, even at higher activity levels (capacity for 6-8 rigs). This investment is expected to drive future capital efficiency, with management projecting a potential 30% reduction in the all-in maintenance CapEx budget in 2026 compared to 2025, assuming no significant new acreage additions. ## Performance, Inventory Depth, and Strategic Flexibility HighPeak's operational and financial performance in early 2025 underscored the effectiveness of its strategy. For the three months ended March 31, 2025, the company reported total operating revenues of $257.4 million, a decrease from $287.8 million in the prior year period, primarily driven by lower average realized commodity prices per Boe. However, net income saw a significant increase, rising to $36.3 million from $6.4 million year-over-year. This improvement was largely attributable to a substantial decrease in derivative instrument losses ($7.9 million loss in Q1 2025 vs. $53.0 million loss in Q1 2024), lower depletion, depreciation, and amortization (DDA) expense (reflecting a lower DDA rate due to increased proved reserves at year-end 2024), decreased interest expense, and reduced stock-based compensation. These positive factors more than offset the impact of lower revenues and increases in production costs (driven by higher workover expenses and increased operating wells) and general and administrative expenses.

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Production volumes remained strong, averaging 53,128 Boepd in Q1 2025, a 7% increase over Q1 2024, exceeding guidance and consensus estimates. This growth was primarily fueled by increased NGL and natural gas sales volumes due to third-party midstream expansions and debottlenecking, despite a slight decrease in crude oil volumes. Cash flow from operations totaled $157.1 million in Q1 2025, down from $171.4 million in Q1 2024, reflecting the impact of lower commodity prices and increased operating costs on discretionary cash flow, partially offset by favorable changes in working capital. Capital expenditures for the quarter (excluding acquisitions) were $179.8 million, part of a heavily first-half weighted 2025 budget.

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The company's inventory depth is a critical component of its investment thesis. HPK has delineated a long runway of high-value locations across its acreage. The core Wolfcamp A and Lower Spraberry zones alone offer approximately 15 years of remaining inventory at the current two-rig development pace. Furthermore, recent delineation efforts have highlighted the significant potential of the Middle Spraberry zone. The first operated Middle Spraberry well (Kallus) achieved a peak oil IP of approximately 1,500 barrels per day from a two-mile lateral, outperforming the Wolfcamp A type curve. This zone, located about 800 feet above the Lower Spraberry, allows for efficient co-development without parent-child interference. HPK has identified approximately 300 Middle Spraberry locations, and based on initial results and technical data, expects a significant portion of these to break even well below $50 per barrel, adding substantially to the existing inventory of over 1,000 sub-$50 breakeven locations. The company plans to drill 2-3 additional Middle Spraberry wells in 2025 to further prove up this potential. In response to market volatility and having achieved significant operational efficiencies, HPK is demonstrating capital discipline. Despite efficiency gains that would allow a single rig to drill over 30 wells per year (up from 25), the company is moderating its 2025 development plan. This includes dropping one of its two rigs for a four-month period (May-August) and implementing occasional pauses in its completion schedule to manage drilled but uncompleted (DUC) inventory. This revised plan aims to keep activity levels and capital expenditures within the original 2025 guidance range ($375M-$405M D,C,E&F, plus infrastructure/other) while still completing the same number of wells as initially planned due to improved efficiency. Management emphasizes flexibility to further adjust the program if conditions warrant. ## Competitive Landscape and Value Maximization HighPeak operates in the highly competitive Permian Basin, competing with larger, established players like EOG Resources (TICKER:EOG), Devon Energy (TICKER:DVN), Pioneer Natural Resources (TICKER:PXD), and Occidental Petroleum (TICKER:OXY), as well as numerous smaller public and private E&P companies. While HPK's scale is smaller than these majors, its competitive edge lies in its differentiated cost structure, high-quality, oily inventory, and operational agility. HPK's ability to achieve significantly lower D,C,E&F costs due to structural advantages and operational efficiencies allows its wells to compete economically with those in the core of the basin, despite potentially yielding slightly less gas/NGL revenue per well. This cost advantage, coupled with its peer-leading cash margins, positions HPK favorably in terms of profitability per Boe and return on capital relative to its size. The company's deep inventory of sub-$50 breakeven locations is particularly valuable in the current industry environment characterized by increasing core inventory scarcity and ongoing consolidation. HPK's acreage and operational capabilities make it a compelling potential partner or acquisition target. Optimizing the capital structure is a key strategic objective for 2025. The current Term Loan Credit Agreement, with a balance of $1.05 billion as of March 31, 2025, carries a high interest rate (SOFR + 7.50%), resulting in significant cash interest expense (approximately $150 million annually in 2024) and mandatory quarterly amortization payments ($30 million). Transitioning to a more traditional capital structure, potentially through a high-yield bond issuance once capital markets stabilize and the Term Loan's Make-Whole provisions expire in March 2026, is expected to materially reduce interest expense, extend debt maturities, and increase financial flexibility by removing mandatory amortization. The company's generation of positive free cash flow, even with the current debt burden and capital program, supports its ability to strengthen the balance sheet and pursue shareholder returns (dividends and opportunistic share buybacks).

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## Risks and Outlook The investment thesis for HPK is subject to several key risks. Commodity price volatility remains a primary concern, influenced by global supply/demand dynamics, OPEC actions, geopolitical events (war in Ukraine, Middle East conflicts), and macroeconomic conditions (recession prospects). Recent U.S. tariffs and trade policies also introduce uncertainty regarding potential impacts on operating and capital costs, although HPK's reliance on US-made steel for tubular goods may mitigate some direct effects. Supply chain disruptions and oilfield service cost inflation, exacerbated by global events, could also pressure margins and capital efficiency. The company's concentration of revenue with a few significant purchasers (largest accounted for ~81% of Q1 2025 revenue) presents counterparty risk, although the fungible nature of crude oil and natural gas and the availability of other purchasers mitigate this to some extent. Interest rate risk on variable rate debt also impacts financial performance. Despite these risks, HighPeak's outlook is positive, underpinned by its operational efficiencies, differentiated cost structure, and high-quality inventory. The company's ability to generate significant free cash flow, even at current commodity price levels, provides financial resilience. The strategic focus on cost control, capital discipline, and balance sheet optimization is expected to enhance profitability and flexibility. The successful delineation of the Middle Spraberry adds substantial high-return inventory, extending the development runway. Management's commitment to evaluating activity levels monthly allows for responsiveness to changing market conditions. ## Conclusion HighPeak Energy has established itself as a highly efficient operator in the prolific Midland Basin, leveraging structural advantages and operational expertise to achieve a differentiated, low-cost structure. This, combined with its high oil-cut production, translates into peer-leading cash margins and robust free cash flow generation. The company possesses a deep and expanding inventory of high-value drilling locations, providing a clear path for profitable development for years to come. While navigating a volatile market and working to optimize its capital structure, HPK's focus on operational efficiency, capital discipline, and shareholder value creation positions it favorably. The successful execution of its strategic objectives, particularly the optimization of its balance sheet and continued conversion of its vast inventory into high-margin production, represents a compelling opportunity for value realization for investors.