GMX Resources: Long Term Bull Market for Natural Gas

Investment Summary

I believe the natural gas industry is in a correction phase of what will prove to be a long-term bull market. Increasing demands on natural resources do to global economic growth, combined with increasingly scarce resources suggests higher prices are needed both to generate sufficient supply and destroy incremental demand. In this environment, companies that can produce more efficiently will outperform the industry. GMX (GMXR) is in a unique position to take advantage of this situation.

Background

GMX Resources is an independent Exploration and Production company, focused on the Haynesville/ Bossier Shale in East Texas/Louisiana. Natural Gas accounts for roughly 90% of 2008 production.

The Company incorporated in 1998 and originally held properties in Kansas and southeastern New Mexico. These have since been sold and the Company has since concentrated its efforts in the core area, primarily through a joint development agreement with Penn Virginia (PVA).

Operations

Cotton Valley

Over the last several years, the Company has invested mainly in the Cotton Valley trend in East Texas. These wells are drilled generally either on a 100% WI, or under a 50% or 30% WI under a joint agreement with PVA.

Haynesville/Bossier

GMX has changed focus recently in response to the proliferation of the Haynesville/ Bossier (H/B) shale play. In the wake of the Barnett Shale near Ft. Worth, and with improvement in technology such as improved fracture techniques (shales are porous rock with many small deposits of gas that must be fractured to be retrieved) and horizontal drilling the viability and profitability of shale plays has gained immense traction. More recent shale interest is in the Haynesville area as well as the Marcellus in Appalachia.

The Company made the strategic decision in 2008 to devote substantial resources to developing H/B. Substantially all of the 2009 capital budget of approximately $150mm is targeting this area. They plan to complete 12 wells in 2009 with five of those being completed by end of Q2. So far, they have completed 3 wells, with an average 1-month production of 8 MMcfpd. These wells are fast declining wells, with production roughly 1/6 of expected ultimate recovery in the first year. Translated - they can offer incredible returns on capital due to the quickness of payback. The company estimates that at a $6.00/Mcf Henry Hub price the wells offer 45-125% IRR.

Capital Structure

As of September 30^th, the company held $6.7mm in cash and $236mm of long-term debt. With a equity market capitalization of $140mm and debt of $236mm the Company currently is rather leveraged. Partially offsetting this capital leverage is reduced operational leverage as GMX has locked in a significant portion of its 2009 and 2010 production (8.9 BCFE in 2009 and 11.6 BCFE in 2010) which lowers risk of cash flows.

Additionally, it is entirely possible that the Company breaks covenants in 2009. Specifically, the $30mm debt to Prudential includes a covenant requiring Debt/Ebitda to be less than 4.0x. According to my model, given debt of $334mm at YE09 and EBITDA of $59mm, the Company will breach this covenant with a 5.6x multiple. While worrisome, given that 1) several covenants that were triggered due to the impairment charge in 4Q08 were waived, and 2) the outlook for the Company looks bright (EBITDA estimated to jump to $111mm in 2010) I do not believe this will be an issue.

Valuation

Using a discounted cash flow model, using a long-term natural gas price of $7.50/Mcf and assuming a 20% required return on capital I value GMXR at $40/share. This assumes capital investment of $150mm in 2009, $100mm in 2010 (above Company guidance of $75mm) which results in 28% annual growth in production from 2008-2013 to 45 BCFE in 2013.

Disclosure: I am long GMXR common shares and call options.

Comments

[blu:]

I'm sorry but I have trouble putting any credence into anything written by someone who does not know the difference between the front and back of a ball cap.

Therefore, I will pass on GMX. Nothing personal, just a quirk I have developed in observing people that wear ball caps.

Apr 30 10:22 AM

[bindlepete:]

Lots of gas around unquestionably and then the geopressured resources -- remember them? Exxon does but the real inhibitant is the open issue of the carboncredits.

Until we get a decisionon these no one will establish/commit to base load combined cycle generation based on naturalmgas usage.. The carbon savings from this sort of fuel abd the added efficiencies will do great things for the nation's carbon foorprint.

Got to get Washington to make some decisions and know it the politico's are cowards and want pay offs for their behavior in one sense or another. Just look at how Barney Frank has been behaving with regard to leadership on financial reform. Do nothing until he gets the nod.

Now any real leader in the utility industry - not known for leadership since Phil Sporn - would be banging on their PUC regulators to get on the stick and make some decisions so they could lead Washington into the paths of rightiousness . Sorry, they are not ready for this yet. Push the decision up the line and complain when it is made.

Apr 30 12:22 PM

[31October:]

GMXR has insider selling, lost $5/share last year, has a quick ratio of <1, and many sources are predicting soft gas prices for a while...

(Probably a lot longer than they think...)

...But, if you like GMXR, the GMXRP preferred may be safer. GMXRP exposes you to GMXR with a cumulative dividend. [CHK.PR.E has served me well.]

Apr 30 03:57 PM

[Random Idea:]

I agree with you that there is a lot of gas out there, but what price does the commodity need for folks to drill it? Rig count has come off very strongly. Combine that with the new wells (GMX is a great example) that decline more quickly suggests that underinvestment will result in strong prices in short order. That's not the problem currently (natgas inventories currently quite high).


On Apr 30 12:22 PM bindlepete wrote:

> Lots of gas around unquestionably and then the geopressured resources
> -- remember them? Exxon does but the real inhibitant is the open
> issue of the carboncredits.
>
> Until we get a decisionon these no one will establish/commit to
> base load combined cycle generation based on naturalmgas usage..
> The carbon savings from this sort of fuel abd the added efficiencies
> will do great things for the nation's carbon foorprint.
>
> Got to get Washington to make some decisions and know it the politico's
> are cowards and want pay offs for their behavior in one sense or
> another. Just look at how Barney Frank has been behaving with regard
> to leadership on financial reform. Do nothing until he gets the nod.
>
>
> Now any real leader in the utility industry - not known for leadership
> since Phil Sporn - would be banging on their PUC regulators to get
> on the stick and make some decisions so they could lead Washington
> into the paths of rightiousness . Sorry, they are not ready for this
> yet. Push the decision up the line and complain when it is made.

Apr 30 04:51 PM

[DieselDawg:]

Lots of LNG out there waiting to be imported to the US to flood the market according to some folks.

But then, the fundamentals of supply and demand have been ignored in the recent run up of oil and NG so dont base your decisions on fundamentals. The market can stay irrational for a long time.

May 19 10:24 AM

[Ellito:]

Congress has plans to require automakers to have at least a few models of vehicles that use natural gas.
The way oil price rising so much lately, never know when gasoline will hit $4.00 again like last year.
It will be smart for Congress to consider that requirement ASAP.
If gasoline rise to over $4.00 again, many of the politicians will have to
retire or be beaten up like never before.

Jun 12 03:39 AM

[Freya:]

And Writes an Article pushing a stock in which ownership is so extreme.

Apr 30 12:14 PM