In April 2012, Jeff Gundlach said at the New York Yacht Club: "If I were one of the nutty hedge fund guys, I would go short Apple (AAPL), long natural gas, and leverage it 100x." Apple is loved by everyone, and natural gas is ultra-cheap. Just 8 months later, we can all confirm that he was so right.
I am also a contrarian investor like Jeff although it is extremely hard to be contrarian when everybody is bullish. However, I am not a contrarian investor by nature. I am not a contrarian investor just because I want to be different from those who feel protected by adopting the herd behavior. I am an investor who tries to be proactive and pick the undervalued stocks which are fundamentally stellar. I am an investor who tries to see the forest ignoring the tree. Thus, I evaluate the companies in comparison to their peers and I do not evaluate them as "stand-alone" companies because there are not any "stand-alone" companies in the markets.
Additionally, the statistics show that an investor will not hit high returns when he buys overvalued companies or stocks that have run too much despite their fundamentals. Sooner or later, the valuation of these companies will implode abruptly or, at best, will stabilize.
These principles have driven me to be bullish on Rock Energy (OTCPK:RENFF) at $1 and buy Surge Energy (OTCPK:ZPTAF) below $4. Especially Surge is a grossly undervalued oil-weighted producer of 11,500 boepd (73% oil and liquids). I also bought Bri-Chem (OTC:BRYFF) at $1.94, a manufacturer of drilling fluids and steel pipes for the oil and gas industry but I shorted Halcon (HK) at $8 as shown in my article few days ago.
Is PDC Energy (PDCE) currently just another case where the thoughtful contrarian investor will beat those who buy at the current levels? I believe so.
PDC Energy is another natural gas weighted player who is trying to become liquids-weighted. After the recent disposition of its gassy Colorado assets, the company's operations are focused primarily in the liquids-rich Wattenberg Field of Colorado, the Utica shale in Ohio and the Marcellus shale in West Virginia. Actually, it is the third largest leaseholder and producer in the core Wattenberg Field holding 103,000 net acres after the latest acquisition in July 2012.
However, PDC does not seem to own the sweet spot of Wattenberg. The Wattenberg field is one of Anadarko's (APC) core operating areas too and Anadarko Petroleum estimates its Wattenberg HZ program contains net resources of 1.0 billion to 1.5 billion barrels of oil equivalent. Anadarko holds 350,000 net acres in Wattenberg and its wells hit rates of return (ROR) exceeding 100%.
Noble Energy (NBL) is the biggest player in the Denver-Julesburg (DJ) Basin holding 640,000 net acres in Colorado and the company's production from Wattenberg represents a majority of its onshore U.S. production. Although most of Noble's acreage is in the oil window of Wattenberg, Noble's wells have average ROR around 80% (Gas window, Oil window, East Pony).
Noble holds acreage in SE Wyoming too (~220,000 net acres) but the company has not provided so far any details from that area.
In the meantime, PDC's wells have average IRR=65%-70%, average peak 24-hour IP=517 boepd and average IP-30=403 boepd. So it seems that Anadarko Petroleum owns the sweet spot in that area based on the current results.
PDC also holds ~45,000 net acres (95% WI), primarily located in the wet gas window of the Utica shale. PDC Energy abandoned efforts to find a JV partner to develop its properties there because the offers received did not meet the company's "value expectations". Eventually, PDC Energy will develop the deep Utica formation alone and it will spend $53 million to drill, complete and connect 5 horizontal wells and expand its position there in 2013.
PDC's first well in Utica, Onega Commissioners 14-25H well in Guernsey County, showed encouraging results as it tested at a peak rate of 1,796 boepd with an average rate of 1,501 boepd (79% oil and liquids) for 24 consecutive hours. The company's second horizontal well in Utica, the Detweiler 42-3H, is expected to be flow tested by the end of March 2013 following a 60-day rest period.
In 2013, the company plans to accelerate the drilling in the liquid-rich Wattenberg Field with the addition of a third rig and expects to further develop and de-risk its liquid-rich Utica shale position with a one-rig program. In Ohio, PDCE will drill its properties in Guernsey, Washington and Morgan Counties. However, the Company also plans a one-rig program in the Marcellus Shale which does not make sense to me as this acreage is very gassy and I do not expect any significant upside for the natural gas price in 2013.
As long as PDC Energy has seemingly two better alternatives, investing in an overly gassy area is a wrong strategy despite the fact that drilling in Marcellus requires a relatively small part of the total CapEx for 2013.
As the company notes, the construction of the Front Range NGL pipeline will add 150 - 230 MBpd/d and help the producers of the DJ Basin sell their gas liquids to the refineries in Mont Belvieu for a better price than today. I agree that the ongoing pipeline boom in North America is a game changer for several sectors of the American economy and this was the reason that made me write a series of articles about these pipeline projects.
The stock has a positive momentum but fundamentally speaking, it is not attractive at the current levels. The company's Enterprise Value (EV) stands at almost $2 billion and it produces 24,000 boepd (37% oil and liquids) with proved reserves 193 MMboe (48% oil and liquids) in December 2012. This gives $83,300 per flowing barrel (37% oil and liquids) and $10.36/boe of proved reserves (48% oil and liquids).
If the sale of its Colorado assets closes finally, PDC will produce 18,000 boepd (50% oil and liquids) and will have 179 MMboe proved reserves (52% oil and liquids). Assuming PDC pays down its current bank debt, the EV will be $1,8 billion which means a whopping $100,000/boepd (50% oil and liquids) and a pricey $10.61/boe of reserves (52% oil and liquids).
Even if I accept that PDC hits its targets in 2013, PDC will not be attractive in December 2013 either because it will remain natural gas weighted. PDC estimates its net production volumes for 2013 will be in the range of 55 to 57 Bcfe and the exit rate for 2013 production will be approximately 175 million cubic feet equivalent ("MMcfe") per day (45% oil and liquids) or 29,000 boepd (45% oil and liquids). This gives $62,000/boepd (45% oil and liquids) which is not low among the producers with ~50% natural gas.
Additionally, PDC trades above its book value and it does not pay a dividend. The company has taken a prudent step to protect part of its operating cash flows for 2013 by hedging its production. However, the D/CF (annualized) ratio is as high as 4.
My opinion is that PDC will most likely exploit the current highs and will dilute its shareholders during the next weeks to pay the convertible notes due 2016.
The Lack Of Excitement
Some peers' valuations make any excitement about PDC evaporate quickly. For instance, Enerplus Corporation (ERF) has also a balanced production between oil and natural gas producing 86,000 boepd (50% oil and liquids) currently. It operates in the highly prospective North Dakota's Bakken and in Canada. Enerplus has also acreage in Richland County which seems to justify its "Rich Land" name as it has some of the best oily wells in Montana.
With EV=$3.6 billion currently, Enerplus trades for $42,000/boepd. The company also trades below its book value with D/CF (annualized) ratio at 1.8x and it pays a hefty dividend of 8.5%.
WPX Energy (WPX) is another producer that trades well below its book value and it is one of PDC's neighbors in Colorado and in the Appalachian Basin targeting both the Niobrara and the Marcellus shales.
It is also worth noting that WPX has a significant exposure to the Bakken formation in North Dakota. With a production at 237,000 boepd (21% oil and liquids) and EV=$4.5 billion, the company trades for $19,000/boepd (21% oil and liquids). WPX had 883 MMboe (December 2011) proved reserves resulting in $5.09/boe and I expect this ratio to go even lower once the new independent reserves report is out. WPX also has a decent D/CF (annualized) ratio at 2x.
All this being said, it is clear that there are more undervalued companies than PDC and there are better ways to play the Niobrara shale. Eventually, I am not going to join PDC's bulls because a drop from the current levels can happen any time.