Warren Resources (WRES) has been a bit of a hot stock recently, with strong equity growth, two straight quarters of beating analyst estimates and musings around the investor community of whether the rally is sustainable. We here at Real Assets Research have been following the stock closely for a little while and find a lot to admire. Of course, we are not alone. Bret Jensen, one of Seeking Alpha's most widely read authors, has written favorably of the company on a number of recent occasions.
One of the distinguishing features of the company in the crowded field of domestic exploration and production juniors is the nearly even distribution between oil and natural gas projects in the company's reservoir. They're weighted about 52% towards natural gas (and hedged as well), giving them a risk profile that is in some ways reminiscent of larger and more diversified exploration and production companies. The recent resurgence in natural gas prices has of course been a big factor in share price growth, but the company is perhaps less sensitive to the downward pressure that has plagued companies like Chesapeake Energy (CHK). The company's flagship waterflood recovery project in Wilmington, California, has helped share growth during crude oil increases over the past few years.
However, one of the biggest drivers of share growth in the past year has not been from better drill results, but from better fiscal management. As detailed in the Q3 Earnings call, the company found it had overpaid royalty partners in the Wilmington Town Lot Unit, which allowed the company to re-capture non-recurring expense of $5.3 million and was able to decrease its lease payments going forward. An outcome partially relatable to this development was an 11% decrease in interest expense for the quarter.
In addition, the Coal Bed Methane (aka CBM) wells in Wyoming, provide an intriguing natural gas recovery technique that has been around for quite some time. In fact, the process was originally developed in the 1970's to degasify coal mines and thereby reduce the risk of explosions, a process often encouraged by local governing bodies. The project economics differ greatly from unconventional plays such as fracking, in that they have longer payback periods but lower initial capital outlays. Part of this is explained by the de-watering process, as water product in initial production gradually gives way to higher percentages of gas recovered. The peak is about 1 to 2 years into the project, at which point it assumes a more normalized hyperbolic decline seen in other types of projects. The company's CBM wells are currently estimated to have IRR in the low 30's in a $4 base case scenario for Natural gas, and a 25% base differential of in-area natural gas vs. Henry Hub.
In Q3 2013, capex for Warren's Wyoming projects totaled $10.9 million, with the overall 2013 capital budget calling for $15 million for drilling and $5 million for facility and infrastructure costs. Given the company's net cash flow from operations as $25.7 million for the quarter and relatively low $5 million in net borrowings, this is not an unreasonable burden on shareholder value.
In addition, the companies reserve depletion rate is lower than many peer companies. The table below outlines production and reserve data for the past three years:
Reserves (Millions of Barrels of Oil, i.e. MBOE)
Equal Energy (EQU)
Evolution Petroleum (EPM)
LRR Energy (LPE)
Mid-Con Energy partners (MCEP)
Resolute Energy (REN)
We also ran a DCF analysis to find an intrinsic value, using two methods. The first was a traditional revenue growth profile, assuming 5% Compound Annual Revenue Growth for the next five years (a conservative estimate in our opinion). Keeping current the enterprise value over market capitalization ratio, we arrived at a valuation of $4.63 per share. In addition, we used an EBITDA growth model applying a terminal multiple of the industry average EV/EBITDA of 12.98, we arrived at a valuation of over $5 per share, although this assumes the most recent 2013 EBITDA margin of 60% of revenue, which was slightly above the historical average. Even if this were lowered to the five year average, the intrinsic value would offer a significant price appreciation value.
In any event, the company certainly still has upside above the current valuation, which no doubt factors in the continuation of previously documented improvements in management oversight and production and reserve data. One must assume, long-term that Warren will find and develop similarly productive assets as it has found in California and Wyoming, but it seems one of the better bets to do so within the borders of the US (where management sources insist it will continue to focus for the foreseeable future). But the company's current share price maintains a potentially attractive entry point for the time being, even with some conservative assumptions.
Research assistance for this article was provided by Timothy van Hine.