Barron's once again recommended Approach Resources (NASDAQ:AREX) in an article published December 5th. Barron's had previously recommended Approach on September 21st, and since then the stock is down almost 20%. I published a response to that article on September 23rd and a follow up on December 2nd.
Barron's new article discarded much of its September 21st thesis and focused on two arguments. First, it argued that Approach is a buyout candidate, based on the implied valuation from an asset transaction between Pioneer (NYSE:PXD) and Sinochem. And second, Barron's introduced the valuation metric it had left out in its article in September, one which I pointed out to my response: EV/EBITDA. Barron's now notes that AREX's trailing EV/EBITDA is 10.6, while PXD's trailing EV/EBITDA is 14.5x.
Incidentally, while Barron's did now introduce the very important valuation framework of EV/EBITDA, it did not pick up on the most important factor: asset quality, which I mentioned in both my September and December articles. Simply put, Approach's assets in the Permian are inferior to Pioneer's assets. This can be seen in recent well results from each operator, in recent transaction valuations in their respective areas, and in the historic capital efficiency of each of the companies.
Since Barron's did incorporate my suggestion of the EV/EBITDA metric, perhaps it will also incorporate some measure of asset quality in future articles on Approach. In the interim, I will (yet again) show where Approach's land is versus Pioneer's, what Approach's well results look like compared to Pioneer's, and how their valuation compares to my preferred comparable E&P investment, Gastar Exploration (NYSEMKT:GST). I will also show maps and results from two other E&Ps in the Permian, Laredo Petroleum (NYSE:LPI) and Diamondback Energy (NASDAQ:FANG). This will highlight the difference in location and well results between Approach and other Permian operators, and explain why a discount on a trailing EV/EBITDA measure and a transaction value in Pioneer's area may be insufficient justification for an investment in AREX.
First, I'll mention as I have previously, that Gastar trades at a large discount on an EV/EBITDA basis to this set of competitor companies and at a large discount to analyst estimates of risked NAV. At a recent $6 price, Gastar trades at an adjusted ~7x EV/EBITDA (including EBITDA benefit from recent acquisitions), versus the trailing numbers Barron's provided of 10.6x for AREX and 14.5x for PXD. Analysts estimate Gastar's risked NAV is over $10 per share, and that estimate hasn't yet been updated for Gastar's recent phenomenal Hunton results, which could imply an NAV closer to $15+ per share if results continue to be strong. While Barron's may be right that small E&P companies may be bought out, Gastar would seem like a more attractive target than Approach, for example.
Now I'll address asset quality. I will show where Approach's assets are located and then will show where Pioneer, Laredo and Diamondback's assets are located. Then I will show Approach's type curve, along with Pioneer's, Laredo's, and Diamondback's. The differences are striking, and they fully explain the market valuation difference between Approach and Pioneer (although Diamondback may still be expensive given its very high EV/EBITDA, despite its high quality assets).
Here is a map of Approach's acreage, at the southern end of the Wolfcamp play.
And here is a map of Pioneer's acreage, which is across the Midland Wolfcamp play but does not extend south to Approach's acreage:
And here is a map of Laredo's acreage, which is in proximity to Pioneer and far to the north of Approach:
And here is a map of Diamondback's acreage, which is also in proximity to Pioneer's acreage and well to the north of Approach's acreage (Diamondback is not actively developing its Crockett county acreage):
Location translates to asset quality in this case, which is evidenced by well results. Here is Approach's type curve, indicating a certain level of well results:
And here is Pioneer's, which shows much more robust results than Approach:
And here are Laredo and Diamondback's well results, which show results similar to Pioneer and much more robust than Approach:
Diamondback type curve:
And for comparison's sake, here is Gastar's Hunton type curve. If Gastar's wells were performing in line with the type curve, they would be as attractive as Pioneer's, Lardeo's, and Diamondback's Wolfcamp wells. Since the most recent result was double the type curve, and results seem to be trending that direction, this is very promising for Gastar's stock and could imply a valuation multiple closer to Pioneer's, or roughly triple the current stock price.
In summary, Approach may look cheap compared to Pioneer on a trailing EV/EBITDA basis, but it is more expensive than other small caps like Gastar on that basis, and its asset quality is inferior to Pioneer's (and Gastar's, implying that it may deserve a lower multiple than those stocks. As asset quality comes into further consideration by analysts (and reporters), AREX may continue to underperform and GST may continue to substantially outperform.
Additional disclosure: I am long GST and may buy or sell it or any other security mentioned at any time with no further notice.