GMX Resources (GMXR) is a small-cap natural gas E&P that is remaking itself with more oil production. Historically, GMXR has been anchored in Texas, the Haynesville shale and Cotton Valley fields. This spring it announced a remake of its focus, buying tracts in the Bakken and Niobrara fields. Next month, management plans to move one of its rigs to the Bakken and this fall another to Niobrara. An additional rig will also begin work in the Bakken by the end of Sept.
With the fundamental price disparage between oil and gas, where a historical ratio of 6:1 has ballooned to 23:1, the move to oil seems advantageous in the longer term. However, execution risks along with financial risk have been elevated and are reflected in a current weak stock price.
Management built its reputation as a superbly managed natural gas E&P, with the foresight to have no hedges during the boom years of 2007 and 2008. They arrived mid-term at the Haynesville, accumulating a sizeable exposure to this prolific play. As natural gas prices soared, so did the GMXR stock price. Likewise, when market prices went into a precipitous decline, GMXR share prices followed suit.
Expanding into the Bakken and Niobrara seems like a relatively safe means of acquiring exposure to oil. However, it has come with a steep price – the company will not be operating cash flow minus capital expenditure positive until 2013, at the earliest. With cap ex slated for $4.00 per share this year and ocf estimated at around $1.20/shr, the 2011 shortfall will be in excess of $170 million. If management maintains this level of cap ex through 2013, production will have to double 2010 exit rates and be 40% higher than projected 2011 exit rates. Free cash flow over this period could reach a negative $250 million. Net debt is expected to increase from $300 million at year-end 2010 to over $550 million at year-end 2013.
Management claims to have sufficient cash and credit in place to fund cap ex through 2012, and to be ocf minus cap ex positive by early 2013. However, there is little room for error, based on its current financial structure.
Unlike 2007/2008, management has a 3-year rolling hedge program with 70% of 2011 and 60% of 2012 production hedged at a $6.00 floor. This positions GMXR well for generating anticipated cash flow to meet some of its financial obligations. It would be safe to assume management will continue to be deft at hedging future increases in production.
Most on Wall Street are impressed with the move to the Bakken and Niobrara, and many of the brokers have buy recommendations. While share prices have bounced around $5.00 since last September (low $4, high $6), target prices range in the $7 to $9 range, with the potential of the low teens. As GMXR’s production grows and the industry continues its consolidation, the company could be an interesting acquisition or joint venture partner.
With a current price of $4.75 a share, the downside seems to be minimal. After lightening up a bit following the announcement of the oil expansion, I’m almost ready to re-establish those trading shares. I should be a nibbler on dips from here, either due to natural gas or overall stock market weakness. However, the risks need to be acknowledged and GMXR is definitely classified as a speculative investment. Substantially higher share prices may wait until operating cash flow at least doubles, on its way to tripling, and that may not be for another 12 to 18 months.
As always, investors should conduct their own due diligence, should develop their own understanding of these potential opportunities, and should determine how it may fit their current financial situation.