Compelling Values In Energy Exploration And Production

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 |  Includes: PBEGF, PEYUF, SU, UPLMQ, WLL
by: Anthony Grossi

Stock prices for exploration and production companies (E&Ps) have declined sharply in the last three months. The decline in short-term demand and high uncertainty have provided a unique value opportunity in energy stocks. The dive in demand assumptions is being driven by U.S. and EU recession fears and by lower import volumes in China as the government looks to slow down GDP growth in order to curtail inflation concerns.

While these concerns are all very valid considerations for speculations regarding short-term supply-demand price dynamics, they honestly have little barring on the long-term demographics behind global energy consumption. Population growth plus emerging economies will continue to drive demand while new supply is growing more slowly. Furthermore, regulatory changes that discourage the use of coal will benefit natural gas prices.

Even with natural gas prices stuck around $4 and oil below $80, I think that a number of high-quality firms with proven assets are selling at compelling valuations. What I am looking for are companies with low debt that appear cheap compared to the value of their proven reserves (P2).

Valuation Method:

1) Enterprise Value/PV10 = [(shares outstanding * stock price) + long term debt] / PV10
2) Debt / PV10 = long term debt / PV10
3) Total MMBOE per $100 investment = (total MMBOE / shares outstanding) * (100 / stock price)

The purpose of this model is to quickly and easily compare companies against their peer group to determine any given company’s relative valuation. All valuations are based on stock prices at close of day on Sept. 23, 2011, and financial information is from the respective company websites.

Ticker
EV/PV10
Debt/PV10
MMBOE/$100
1.41
0.23
10.25
(UPL)
1.22
0.31
8.04
(NYSE:WLL)
1.04
1.20
7.24
(NYSE:SU)
0.70
0.13
8.06
Click to enlarge


Obviously I have a theory to explain the disparity in results. PEYUF has the highest barrels per investment because it is a natural gas company and its higher EV/PV10 ratio is likely a result of management's track record and low cost production profile relative to peers. SU is actually trading below the estimated value of its proven reserves. This is in large part due to its high exposure to shale oil and the increased expense of extracting that oil from the rock. Its all about the rock. Higher-quality reservoirs mean lower cost production and higher returns. Low quality reservoirs require higher oil prices to justify the production cost.

The Price You Pay Matters

As recently as October 2010, there was an exchange on this site about whether Petrobank was a value proposition, trading at a premium to its then-reported reserve value of $3 billion. With the market cap now shrunk to around $1.8 billion, it's now much harder to make the bear case.

If you couple together the fact that these companies are now trading at much more favorable ratios to the estimated value of their proven reserves with the favorable long-term demographics for energy consumption, I think you will find compelling values in the E&P sector. One no longer needs to resort to extrapolating values for unproven acreage, increased efficiency in drilling extraction leading to expanding reserve estimates, or a rise in the spot price of the underlying commodity.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.