On Orphan Trail: ProspEX (PSX)

This article was originally sent to TickerTrax subscribers on Jan 20, 2011.

ProspEx (TSX: T.PSX, Stock Forum; $1.84)
www.prospex.ca

Featured to Ticker Trax Subscribers: Dec 9th $1.34
Sector: Oil & Gas

Tuesday the 18th ProspEx released a new reserves report and operations update. Because this company is heavily weighted to natural gas I can understand the lack of broad based interest. However, it took an hour for even 10,000 shares to trade. Eventually it did move from $1.53 to $1.78 but it became very evident that few follow this company. As I explained in December when the stock traded near $1.34, this can work to your advantage if you have patience.

The numbers ProspEx released were terrific yet it trades like no one in the oil & gas investment community has ever heard of it. I am at a loss to try and explain how a company could release numbers like this and have no brokerages pay attention. Obviously unless they have helped finance them, many firms could care less. The stock recently moved up from the $1.30’s on very low volume but even now the gap between true value and market capitalization is dramatic.

Ignoring everything else summarized below, one can do a quick analysis:

1) Current oil & gas production is 4200 boepd (barrels of oil equivalent per day). This includes crude oil, natural gas liquids, and a conversion factor they use for the natural gas. This number will easily be 4500 in Q1. If we assume “cash flow” equivalent of $20 per boepd X 4500 boepd X 345 days average production, they could generate approx. $32 million in pure cash flow (annually) on those production numbers. With 61 million shares out we’re looking at 50 cents/share cash flow at the current low natural gas prices. Given low debt level and strong growth potential, the stock should be valued on a cash flow basis at approx. five times, or $2.50/share

2) In 2010 the company reporteda big jump in reserve value (almost 50%) based upon independent engineering reports. These reserves when combined with the value of field facilities, gives a net asset value per share of $3.52 per share (as per the news release).

Realistically the stock should trade closer to that net asset value (NAV) of $3.52. If there was better strength in the oil & gas sector or a decent recovery in natural gas prices, it would trade above that. However, I think we can split the difference on the NAV and the cash flow analysis ($2.50) and say fair value should be closer to $3 – given the fact few people follow this company.

If it was bought out, I would think we would see the NAV or higher. It’s also important to remember that Prospex is targeting high-impact wells with horizontal drilling. Its production numbers can change in the blink of an eye with further success. In areas where they have big hits already, they have another 30 drill locations. However, these must be planned carefully as the wells cost $3 to $4 million (payback in one year).

As an example of this, take a look at its 13-8-64-4W6 well (below). This well averaged 10.7 million cubic feet ("mmcf") per day (equivalent to 1,100 boe per day net to ProspEx's working interest) of liquids rich production over the first 30 days of production.

Also note the land value at the bottom. The engineering report gave them a value of $150 per acre on approx. 93,000 net acres owned by Prospex. They recently sold a small block of land (rights to shallow drilling) for $8 million that had no production or facilities on it. They received over $1000 per acre. I believe the $150 used on the report is ultra conservative given the success they are having.

HIGHLIGHTS

• Total proven plus probable ("P+P") reserves, as independently evaluated by GLJ Petroleum Consultants Ltd. ("GLJ"), have grown to 18.6 million barrels of oil equivalent ("boe") of oil, NGLs and natural gas at December 31, 2010, an increase of 6.4 million boe or 52% compared to the prior year. Reserves per fully diluted share increased by 42% on a proved basis and 44% on a P+P basis
• December 2010 production averaged an estimated 4,480 boe per day, in excess of the Company's exit rate guidance of 4,000 boe per day
• The Company continues to have substantial financial flexibility with estimated net debt at December 31, 2010 of approximately $19 million (unaudited), compared to $21.6 million at the prior year end, and an approved credit facility limit of $40 million
• ProspEx's net asset value per share at December 31, 2010 is estimated at $3.52 per basic common share outstanding, using P+P reserve values from GLJ's evaluation.
• ProspEx remains committed to its focus on liquids rich natural gas projects, such as Kakwa and Pembina, where anticipated payout periods of approximately one year at current gas prices have allowed the Company to recycle cash relatively quickly back into its capital program. ProspEx's Kakwa and Pembina Falher assets provide an inventory of 30 (18 net) identified undrilled locations in proven plays with economics that are very competitive, even at today's lower gas prices.

OPERATIONAL UPDATE

At Kakwa, the well at 13-8-64-4W6 has demonstrated initial production performance superior to all wells previously drilled by the Company. This well was brought on stream in late October, and averaged 10.7 million cubic feet ("mmcf") per day (equivalent to 1,100 boe per day net to ProspEx's working interest) of liquids rich production over the first 30 days of production.

Also at Kakwa, the well at 13-16-64-4W6 came on stream in mid-December and averaged 4.5 mmcf per day (equivalent to 460 boe per day net to ProspEx's working interest) over the first 30 days of production. At Pembina, ProspEx's first horizontal well was brought on to production in early December, and is currently producing at a restricted rate of 5.3 mmcf per day of gas (equivalent to 1,040 boe per day net to ProspEx's 100% working interest).

ProspEx's winter drilling program is currently under way. Two horizontal wells have been drilled to date: one at Kakwa (35% working interest) and one at Pembina (100% working interest). Both of these wells are currently awaiting completion.

Current production is approximately 4,200 boe per day, reflecting the expected initial declines from the new wells brought on-stream in December. ProspEx has an inventory of three (1.65 net) wells drilled but not yet producing: two (0.65 net) at Kakwa, and one (1.0 net) at Pembina.

OIL AND GAS RESERVES DATA

On a proven basis, total Company Interest reserves were estimated to be 57.5 bcf of natural gas and 2,319 mbbls of oil and NGL for a total of 11,897 thousand boe at December 31, 2010.

This reserves growth was achieved in a difficult business environment with a limited capital program. The Company's preliminary unaudited estimate of 2010 capital spending is approximately $20 million, including acquisitions and dispositions.

Based on estimated 2010 annual average production of approximately 3,057 boe per day, the Company estimates that it replaced 454% of 2010 production on a proved basis, and 672% of 2010 production on a P+P basis. The Company's P+P reserve life index at December 31, 2010 was estimated to be 14.7 years and the proved reserve life index was 9.4 years (both calculated using estimated fourth-quarter 2010 production of 3,463 boe per day on an annualized basis).

The GLJ Report demonstrates an underlying net asset value substantially in excess of ProspEx's current share price. ProspEx's net asset value at December 31, 2010 is estimated to be $3.52 per basic share.

The net asset value calculations use GLJ's estimates of the Total Company Interest of P+P reserves from the GLJ Report; GLJ's December 31, 2010 forecast of commodity prices; a discount rate of 10% and a notional value of $150 per acre (total $14 million) for undeveloped land at December 31, 2010, and estimated year-end net debt of $19 million. The net asset value per basic share was calculated by dividing the net asset value by 60.5 million shares.

Thanks folks. I own 15,000 shares of ProspEx. – Danny Deadlock

THOM CALANDRA: Thank you, Danny. That is quite an analysis.

Just a word to subscribers on what we mean when we say something appears to be a worthy investment – such as African Gold Group (TSX: V.AGG, Stock Forum) or Golden PhoenixMinerals (OTCBB: GPXM, Stock Forum) or TrueClaim Exploration (TSX: V.TRM, Stock Forum) one of the half-dozen or so recent featured prospectors and miners.

Worthy to me means I have met the principals. In most cases, I have reviewed the properties or intend to visit them. Goldgroup Mining (TSX: T.GGA, Stock Forum) is a case in point: Mexico next week at Caballo Blanco. And Ghana and Africa for AGG in February. Most importantly, I have reviewed the company’s operations and believe that if the principals notch their goals – as most of our former Planetary Prospects did – then the current price of the stock is cheap.

I prefer to steer clear of most ownership in 2011 so that I am not in the category of talking one’s own book. Besides, I cannot spend the rest of my days on this planet chasing every development at stocks that I own and ones I am researching. Occasionally, I will track something that I am considering for purchase. Also, as stated here many times, I own most of the former Planetary Prospects, in some cases “own” a lot. Great Basin Gold (TSX: T.GBG, Stock Forum), which just reviewed its production numbers, is a great example. This is a company that one day could boost its output to a half-million ounces per year of gold (by 2012?) and add another half-million ounces (by 2014?) – with its two operations at Hollister in Nevada and Burnstone in South Africa, which I intend to revisit next month. See release. I still own US$103,000 worth of GBG. Please see the archives for research.

So, take it from me and our Ticker Trax team. If a company and its properties make it into this space and are served up to you, they are worthy. Otherwise they would not be here. This was the case, I am reminded, with Encanto Potash (TSX: V.EPO, Stock Forum) – a company I looked at (on paper) briefly a year or so ago (but never made a Planetary Prospect in the days when we defined our universe as Planetary Prospects). Encanto and other potash companies have performed well, and no, I have never owned the stock. So has Comstock Mining (OTC: BB: LODE, Stock Forum) … although it has lost ground of late. We can name at least a dozen examples that have been served to subscribers in the past six months and have been deemed “worthy.”

This does not mean this service is exemplary. Nor I. A rising tide lifts many ships, as we all know in financial markets. But we believe we are outpacing some investment newsletters in our two years and two months of service to you. Thanks, and please track me down at the Vancouver Investment Conference this weekend if you have other queries. I am glad to see you all. – Thom Calandra

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