From Today's Energy reportThis from today's Energy Report:
https://www.theenergyreport.com/pub/na/9215
I'm interested in finding really significant mispricings. And in the smaller cap O&G space, there are some great value opportunities—particularly in companies going through transition processes. One example is a company I'm investing in that's in this process of transition; in fact, it's practically a textbook case for transition. Most investors who have heard of it haven't looked at it in a few years because it was a mess—it was overlevered and was forced to sell one of its core assets to pay down that debt. It was asset rich but did not have a lot of production, and it was forced to take meaningful write-downs on the book value of those assets. And it was producing 100% natural gas in a rising-oil-price/falling-gas-price environment.
Today, the story is different and the market is just beginning to recognize that. The company sold an asset and, virtually, has no debt. It joint ventured (JV'd) an asset and is in the process of ramping-up production. It has major liquids discoveries in both of its core assets and will be increasing the percent of its production coming from liquids and oil substantially and is the most levered company on an acreage versus enterprise value (EV) basis to the Marcellus Shale. The company is trading for a fraction of the valuation of other Marcellus companies and the market misunderstood its recent oil discovery, which could move the needle significantly.
The company,
Gastar Exploration Ltd. (NYSE:GST), also has 17,000 acres of the lowest-cost onshore dry gas play in the U.S.—80,000 net acres in the Marcellus and a JV that will be funding the majority of the 8–10 net wells it is drilling primarily in the liquids-rich area of the play in 2011. Gastar has an oil discovery in East Texas with 30 locations and substantial potential value from the development of that play, which the market does not seem to understand and has yet to price in. And it has 17,000 net acres prospective for oily Eagle Ford and Deep Bossier gas, which is widely recognized as one of the lowest-cost natural gas plays in the U.S.
Gastar trades at a big discount to its Marcellus-levered peers, such as Cabot, EQT, Range Resources,
EXCO Resources Inc. (NYSE:EXCO), etc. In fact, it trades at almost one-quarter the price per acre, despite having similarly prospective acreage. This value gap should close as the company drills numerous wells this year, most of which will be funded by a JV agreement it entered into last year, and ramp-up its production and cash flow.
That doesn't even consider Gastar's recent oil discovery in East Texas, which could contribute substantial additional value. The company recently announced a Glen Rose well producing 250 barrels of oil per day (bpd) and 1,300 barrels of completion fluid, with inclining oil production. Generally, as a well produces, the amount of completion-fluid production declines and the oil production inclines. From some of the wells I've seen, the initial production (IP) rate on this well could be over 500 bpd with an implied EUR (estimated ultimate recovery) of more than 250,000 barrels of oil. For a $4 million per-well cost on the 30 remaining locations, this could significantly shift Gastar's production toward oil and lead to a substantial revaluation of the company after the official initial production rate of this well is announced.
TER: Gastar is up 25% over the past six months but flat over 12 months.
JY: It is; and despite the recent move, it hasn't come close to my estimate of its intrinsic value or where I think it could trade at in the near term. When I think about the transition Gastar is making, I think about companies like
Approach Resources Inc. (NASDAQ:AREX), which was very similar to Gastar. Approach was in a conventional natural gas field and was having trouble growing production and making the economics work. Although the well economics were great at the well level, it was just hard for a company of its size to really make it work. Then, Approach figured out that it had some oil under the areas it had been drilling for gas; so, it started drilling for oil and the wells came on great—similar to Gastar.
As Approach started showing good wells, its stock went from $7 at the time to the current price of around $29—in just over nine months. You can look at Gastar's history, metrics and chart and see that it has a lot of characteristics in common with Approach and some of the other companies that have gone through similar transitions, such as
Brigham Exploration Co. (NASDAQ:BEXP) or
Magnum Hunter Resources Corp. (NYSE.A:MHR), or companies in the process of transition like
Double Eagle Petroleum Co. (NASDAQ:DBLE). Gastar's stock has a high probability of outperforming in a similar manner.
TER: Is Gastar your favorite play?
JY: It's one of my largest positions, and it's among my favorite investments at the moment.