The Time Is Right to Take Positions in Range Resources, Petrohawk

Includes: HK, RRC
by: Kurt Wulff

Well-known stocks in the 2000s cycle, shale gas pioneers Petrohawk Energy Corporation (NYSE:HK) and Range Resources Corporation (NYSE:RRC) may have begun new advances in a 2010s cycle as months of selling pressure appears exhausted. Selling pressure kept stock price below the 200-day average for longer than for most stocks in our small cap and income coverage. McDep Ratios have also realigned more closely. Yet the long-term upside not captured in today’s McDep Ratio remains impressive. Shale gas resources are greater than conventional resources with a key distinction. Developed long-life mature resources keep producing with minimal volume decline.

Because early-stage shale gas production declines rapidly, it requires new drilling to be sustained. Low natural gas price makes drilling less attractive at the same time oil shale drilling drives up the price of fracturing services required to complete new wells. The imbalances are in a correction process that is taking time to unfold. With free money from the U.S. Federal Reserve acting as the global central banker, it costs nothing to wait longer, if necessary. Always believing in the long-term value of natural gas resources, we think the timing is good to initiate buy recommendations on RRC, the first horizontal driller of the Marcellus Shale, and HK, a pioneer in the Haynesville Shale and first horizontal driller of the Eagle Ford Shale.

Raise NPV on Abundant Natural Gas Resources
Looking just at the volume of natural gas in place on RRC and HK leases, we can see potential value that might readily justify higher estimates than our revised Net Present Value for RRC of $45 a share, up from $40 and for HK of $20 a share, up from $16. Instead we limit our value to multiples of cash flow that buyers might pay today for future returns that depend on intensive investment to realize. Those multiples (PV/Ebitda) are 15 for RRC and 11 for HK. At the same time cash flow estimates ought to be exceeded as we have not incorporated all of management guidance toward higher volume.
McDep Ratios of 0.98 and 0.97 point to competitive value among Income and Small Cap stocks in our coverage. PV/Ebitda for RRC at the high end of the range illustrates the limit we applied. PV/Ebitda for HK is limited by more rapidly declining existing production indicated by a shorter life of reported reserves (Adjusted Reserves/Production). All 25 peer stocks are in upward price trends compared to 200-day averages.

Originally published on December 3, 2010.