A Generational Buying Opportunity In Gastar Exploration

| About: Gastar Exploration (GST)

Gastar Exploration, Ltd (NYSEMKT:GST) represents a generational buying opportunity for investors with an eye toward long-term value creation. This company is not only undervalued by many standard metrics, but is on the cusp of an ambitious increase of production, reserves, and wells being drilled. They own acreage in one of the most prolific natural gas fields in the US - the Marcellus Shale, and have recently announced a venture in a mid-continent oil play to further diversify into liquids. Gastar is currently trading with a market capitalization of 117 million dollars, a forward P/E ratio of 8.8, and proved reserves in the amount of 217.1 million.

Here is a quote from Gastar's year end proved reserves report:

Gastar reported year-end 2011 proved natural gas, oil and condensate and natural gas liquids (NGLS) reserves of 119.7 Bcfe estimated in accordance with SEC regulations. This represents an increase of 138% over year-end 2010 proved reserves of 50.3 Bcfe. Of the 119.7 Bcfe, 76.6% were attributable to natural gas, 9.6% to oil and condensate and 13.8% to NGLs. The pre-tax present value discounted at 10% ("PV-10") of the estimated proved reserves increased to $217.1 million from $67.3 million at year-end 2010.

So for every share of Gastar common stock (currently $1.86), you own $3.42 worth of proved reserves, pre-tax PV-10 discounted. For argument's sake, let's back out the $35 million of company debt, leaving us with a proved reserves per share amount of $2.87. That still represents an increase from current share prices of 54%.

This also is not considering the increase in production that Gastar is currently experiencing. According to the CEO Russell Porter,

Throughout this year as we continue to develop our liquids-rich Marcellus Shale acreage, we should see substantial revenue growth resulting from our increasing production volumes of high-value condensate and natural gas liquids. As we continue to swap acreage with adjacent operators and block up our acreage to optimize our drilling positions, we believe we have identified an additional 70 locations for future development in Marshall County. This large opportunity set, coupled with our acreage in Wetzel County, West Virginia and the acreage position we are acquiring in a potential Mid-continent oil play gives us substantial running room for future liquids growth.

This is after an impressive increase of 138% year-over-year proved reserves from 2010 to 2011, and there seems to be plenty more on the horizon. Gastar stated in their most recent earnings report that they had 17 wells currently on production, and expect to have a total of 22 additional wells producing by the end of 2012. Needless to say, these wells are all situated in the most prolific areas of their acreage in the Marcellus, and have somewhat unknown true potential. If these wells turn out to be more successful than current estimates, Gastar's share price will go parabolic, and they could likely become a buyout target.

The recent trading volumes of this issue show that there is little current investor interest in this equity. The recent activity has followed the stock market along in the summer doldrums, and has been hovering right below the $2.00 area for months now. There are many widely known issues that are keeping this equity down 41% year-to-date, but the deterioration of the company's fundamentals cannot be counted as one of them. They have improved their future positioning in the energy market, and are positioned nicely for superb performance once risk-appetite and higher energy prices return to the economy.

Some of the reasons for Gastar's current low share price include:

  • The deterioration of natural gas prices to all time lows.
  • The Euro-zone crisis, the unemployed and debt-ridden economies of the the West, and the feared slow down in China.
  • The disaster that befell Chesapeake Energy (NYSE:CHK) and its narcissistic leader Aubrey McClendon. (This potentially hurts Gastar by association as well since Chesapeake owned a sizable stake in Gastar at one point.)
  • Money managers' 'window-dressing' of dumping losers, and likely anything energy related at the end of Q1. (Institutional shares held decreased by 33.89% in the most recent quarter.)
  • The lack of positive press releases from Gastar itself, and the lack of knowledge about this small-cap company in general.

These are all valid, well-documented reasons for the selloff in energy companies, as well as Gastar Exploration. It is my belief that this has all been effectively priced in, and the bottom for the year in Gastar's share price was on June 11, at $1.55 per share.

Some upcoming catalysts for upward momentum in the share price of Gastar include:

  • There are 8 wells expected to be online and report initial production results in August 2012.
  • 14 additional wells will be drilled after the completions in August, bringing the total wells producing for Gastar to 39 at year-end 2012, from a current total of 17.
  • Gastar recently announced a Mid-Continent Oil Play, "As of March 31, 2012, Gastar has acquired 12,500 gross (5,100 net) acres in its Mid-Continent oil-focused venture and expects to drill and complete three gross (1.5 net) initial horizontal wells in the second half of 2012." This shows the management's dedication to increasing liquids and oil production, to help offset the stagnation of natural gas pricing.
  • "Liquids production yields currently are averaging about 25 to 30 barrels of condensate and 40 to 50 barrels of NGLs per MMcf of natural gas produced. We believe the condensate and NGLs production per MMcf of natural gas produced could increase once the associated gathering system line pressures are resolved, and we anticipate higher liquid yields as our drilling trends to the Western portion of the Marcellus Shale."
  • The CEO Russell Porter purchased an additional 50,000 shares in the open market at $1.92 on May 23, 2013. Showing his continued commitment to the company by owning 1.1 million shares.
  • The potential for future government policy to encourage increased domestic usage of America's greatest resource, and provide leadership to a sector that could create millions of jobs while keeping the USA energy independent.
  • A rebound in natural gas prices, resulting from increased domestic demand, slow-down in production, or the ability to liquefy and export to markets with much higher prices (In parts of Asia, prices are currently at $15/per MMBtu, in Europe they are $10/per MMBtu).

At current levels, now is a good time to begin accumulating an equity stake in Gastar Exploration, Ltd. The company is poised for a dramatic increase in production, has access to the most promising natural gas plays in the U.S, has little debt, and is trading at a forward P/E of under 9. There has been a perfect storm of negativity that has driven this stock into deep value territory, and if you are willing to buy and hold long-term, you may be handsomely rewarded for your patience and foresight.

It was only 4 months ago when the share price was at $3.25, an increase of 75% from current prices. What I find even more astounding is that the company has actually improved their underlying fundamentals and future prospects since that time. The sell-off in the stock is due to macro-economic events, lack of knowledge about the company, little institutional or retail investor interest and other issues outside of management's control. Their execution of the business plan has been solid, with the rotation to increasing liquids and oil production, as well as growing proved reserves at an impressive clip.

Shares of Gastar common stock are currently priced as an excellent buying opportunity for those willing to hold through the gyrations of an irrational market to realize the future growth prospects of this small cap energy company.

For the more risk-averse or income oriented investors out there, take a look at GST-A, currently yielding around 8%.

Disclosure: I am long GST.