'Shale Math' Used For Rex And Goodrich Implies Massive Hunton Value For Gastar

Sep.13.13 | About: Gastar Exploration (GST)

Gastar Exploration (NYSEMKT:GST) has had quite a year so far and its stock has run as a result. After settling a major lawsuit, buying and selling assets, achieving a number of well results, and growing production and reserves considerably, Gastar's stock is up 3.5x from its price at the start of the year.

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However, there may still be considerable embedded value in Gastar, potentially well beyond the current share price. Gastar's CEO recently said that just Gastar's Marcellus is worth $4.50 per share and could be worth $7.00 per share with further development. It appears that the Marcellus value is now at least somewhat priced into the price of the stock.

What is missing in the current stock price and market valuation is value for Gastar's Hunton Lime play. There are two ways analysts have estimated the value of Gastar's Hunton to date (excluding the recently announced WEHU acquisition). One has been to just give credit for the cost of the acreage, roughly $75 million, or ~$1.21 per share. Another has been to give $1 NPV per identified location and "risk" the number of locations to only give credit for 1/3 of them. With 275 identified locations, that comes to ~$92 million, or ~$1.50 per share. If this is added to the CEO's estimate of the current Marcellus value, this sums to ~$5.71 - $6 per share.

However, that NPV number may be far too low. In recent commentary at conferences and investment bank led calls with institutional investors (incidentally, addressing the issue of low institutional ownership), the CEO has cited a likely NPV of ~$5 million per Hunton well (this ties with the type curve and IRR in Gastar's recent presentation). Using the same 1/3 risk factor from the above analyst math and the 275 identified locations, that comes to approximately $458 million in likely, heavily risked NPV value, or an additional $7.45 per share. Adding that to the CEO's estimate of the current value of the Marcellus yields ~$11.95 per share, versus the current $4.30 share price.

While there are numerous assumptions associated with this potential value, it is not far off from the ~$9 per share value that would be seen if Gastar traded in line on an EV/2013 EBITDA multiple with competitors like Rex (NASDAQ:REXX) and Goodrich (GDP). And this math is very similar to the math used by analysts to justify price targets for REXX and GDP that are substantially higher than the current prices of those stocks.

For example, the math I've seen used for Goodrich is driven by acreage values in the TMS (Tuscaloosa Marine Shale). At ~$3,000 per acre, GDP at its current $27.25 share price is considered more or less fairly valued. However, if TMS were to rise in value to $5,000 per acre, which analysts are saying is likely considering positive recent well results, analysts say this could translate to a $40 share price.

And similar math works for REXX in the Utica, where REXX's 20,000 acres in the Utica could potentially rise in value from the current implied ~$20,000 per acre and could justify analyst price targets above the recent $20.69 share price.

As additional institutional investors cycle into Gastar, and as investment bank research analysts pay more attention to Gastar or initiate coverage on it, the above "shale math" of NPV per well and value per acre will likely be applied more to Gastar as it has been to its competitors. And analyst price targets will likely rise as that math is applied, particularly as Gastar continues to announce positive well results in the Hunton. The most recent well, the MidCon 5, would have been the best well in the play if there were not mechanical issues, according to Gastar's CEO. And as Gastar moves toward operating more of the wells it drills, there will likely be fewer mechanical issues, as Gastar has demonstrated it is a capable operator in the Marcellus. This will further drive consistent well results and more prevalent use of shale math.

In summary, Gastar's NPV, based on the numbers it presented and math shared by its CEO, is well in excess of the current share price, albeit contingent on a number of assumptions such as the price of oil and gas, availability of financing, and operating ability. And there is substantial upside beyond these NPV numbers as the "risk factor" of one-third is potentially reduced as more successful wells are drilled. This math is already used by analysts to justify price targets much higher than current share prices for Goodrich and Rex, and may be applied more for Gastar as it achieves drilling success in the Hunton.

Disclosure: I am long GST. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.