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Michael Filloon, Split Rock (373 clicks)
Oil & gas, small-cap, research analyst, growth at reasonable price
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What a difference six months makes. That is what Approach Resources Inc (AREX) has been saying. What was a $7 stock six months ago, is now a $24 stock. The announcement of a $100 million capex for this year has made many think something huge lies ahead or --better yet -- underneath Approach. It is safe to say that most oil and gas exploration and production companies have done well recently, but more than tripling would indicate there is something more afoot here. Companies this size can make you rich; they can also make you wish you did not get into the game so late.

Approach has a $517 million dollar market cap. It's located in Texas, divided into two resource areas: The Permian and West Texas Basins. As of June 30, 2010, it had proven reserves of 46.4 Mmboe. Its enterprise value per proven barrel of oil is $11.14. Of the 46.4 Mmboe, 95% is in the Permian Basin. 50% of that is oil and natural gas liquids, while 48% is proved developed. Approach has 337,339 gross acres, with 98,098 net acres in the Permian Basin. It has 2,900 drilling and recompletion opportunities. It has drilled more than 400 wells since 2004, and has had a 93% success rate.

Approach has a good track record. Its reserve growth since 2004 has been 32% CAGR. Their production growth has been 41% CAGR. Their third quarter of 2010 lifting costs were $7.19, which is lower than Brigham Exploration (BEXP), Northern Oil & Gas (NOG), Oasis Petroleum (OAS), and Kodiak Oil & Gas (KOG). Its three-year F&D costs were $10.71/boe, which is also lower than at the aforementioned companies. For the three months ended 2010, compared to the same time frame in 2009, Approach has shown very good growth. The numbers are as follows:

  • Revenues +70%
  • Net Income+166%
  • Adjusted Net Income/diluted share +120%
  • Realized Price($/boe)-excluding commodity derivatives +35%
  • Production MBoed +25%

Approach's 2011 capex budget is $100 million. Most of its budget is going to an area that has more by the way of liquids. Approach is doing what many of the shale drillers are: Going for where it can get the best margin. Today a driller could have significant problems if it were to drill for natural gas without hedging. In 2011, Approach is estimating that it will increase production by 20% or more, with almost all of that going to oil and natural gas liquids. In 2010 it produced 4.3 Mboe/d; that number will increase to 5.3 Mboe/d this year. In 2010 it produced 31% oil and natural gas liquids, which will increase to 53% this year.

It is thus obvious why many investors are betting on this area to be big. Although I had my questions about it, there are several reasons why the run-up in stock could be just the beginning of growth for Approach.

Its Wolffork Shale will be addressed in several ways, the first being through a proper mix of horizontal, vertical and recompletion projects. Approach believes it can increase initial flow rates by refining perforation and fracture stimulation. It will fine tune its well spacing so it is the most appropriate for the area. Most importantly, it believes it can further better its costs. The Wolffork play will have 480 recompletions, 1,230 horizontals and 1,100 canyon new drills.

Reasons this area has been ignored is it was viewed as a gassy area before further studies were done. Most oil and gas companies are ignoring these areas because there is so much gas on the market. This not only has brought down the price of gas, but also increased drilling in oily plays. Many maps of the area show the play to be on top of the Ozona Arch, and this made Wolffork look like a thin or absent play. Lastly, most of the logs done of the area were done for other areas of more pressing interest.

Initial assessments show 118 MMboe for Wolfcamp shale and 63 MMboe for Dean/Clearfork. The estimates show there is a possibility that these were conservative recovery assumptions -- 10% for gas and 3% for oil. Approach believes Wolfcamp is a world-class source rock with significant generating potential. It is thermally matured and and in a good time window for oil production. This area has all the compositions needed for it to be a good producing shale. The area is similar in minerals and lithology to Eagle Ford and Wolfberry. Approach believes if a small increase in recovery factor is garnered, well economics could increase significantly.

Approach should have enough liquidity to continue to pull liquids and gas out of these areas. At the end of last year it had $23.5 million in cash. Its credit facility is $150 million. In total, it has a total of $173.1 million in liquidity.

In summary, Approach looks to have the ability to increase its ratio of oil to gas and increase production this year. In comparison to two other exploration and production companies drilling in the area, plus information gathered from the area, it looks as though it could substantially grow year over year. It has adequate liquidity to expand. It is impossible to know, but it seems the increase in stock price is justified.

Source: Approach Resources Inc. Increases Potential Through Liquids