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Shares of Canadian Deep Basin natural gas producer Peyto Exploration and Development Corp. (OTCPK:PEYUF) offer unlevered appreciation potential of 21% to our new estimate of Net Present Value (NPV) of US$24. On the basis of continued success with horizontal multistage fracturing, we raise NPV from US$20 a unit.

Natural gas and oil reserves for 2010, reported on February 16, were up 30% on a proven and probable basis from 2009. While final operating and financial results are not yet available publicly, we estimate that production gained 28%. The technological success on a classically valuable resource base contributes to our comfort with a high multiple of present value to cash flow normally implied by the extra long reserve life Peyto reports.

The ability of Peyto and other successful producers to increase volume has helped the supply of natural gas hold price down. Yet, demand is strong, too, with inventory of natural gas in storage dropping rapidly to the low end of the range with a month of winter left. At a McDep Ratio of 0.82, PEYUF.PK ranks as more undervalued among Small Cap Independent Producers. An unlevered cash flow multiple (EV/Ebitda) of 13.5 for Peyto partly recognizes the backlog of reserves to be developed. Some 47% of NPV is represented by non-producing, undeveloped and probable reserves that require new investment to produce cash flow. The other 53% of NPV in producing reserves provides cash flow to unlock the identified potential.

While there are risks in energy investment, Peyto has demonstrated a strong historical record of identifying opportunities and developing them successfully.

Originally published on February 18, 2011.