Goodrich Petroleum: Gas in the Ground Doesn't Mean Cash in the Bank

| About: Goodrich Petroleum (GDPM)

Goodrich Petroleum (GDP) is an independent oil and gas exploration and production company.

Market cap: $2.5 billion; Enterprise Value: $2.8 billion

The company is estimated to generate revenues of $220Mn this year with EPS of $0.09. Next year’s estimates are revenues of $312Mn and EPS of $0.73, which in my opinion is highly optimistic as the company has never generated any profits of note in the recent past. The company therefore trades at 13x this year’s revenues and 100x next year’s EPS! By contrast, Exxon Mobil (NYSE:XOM), arguably the best run integrated oil and gas company, trades for 1x revenues and 9x EPS.

The stock has more than doubled from $30 to $75 in the last three months as excitement over the company’s ownership of land in the Haynesville Shale area has grown. The Haynesville Shale has got a lot of press of late as an area with substantial, albeit difficult to extract, gas reserves. Many naïve investors assume that the value of a company’s reserve position (i.e. the value of the estimated oil and gas under the land the company owns or leases) should translate into its market cap. What they neglect to take into account is that it takes a substantial amount of operational and capital expenditure to extract the reserves. With costs spiraling for exploration companies, the net value to equity investors may turn out to be next to nothing.

Capital expenditure for the company is running well above D&A, and its free cash flow is hugely negative. The company plans to spend $350Mn on capital expenditures this year. The company’s current run rate suggests it will generate cash from operations of about $80Mn, so it will take on a substantial amount of debt to fund the capital program. This will cause its interest expense to rise. So the combination of increasing D&A and interest expense will mute any earnings growth. It is also possible that the company will sell stock in a secondary offering as it periodically has done, diluting current equity holders.

The stock was near the current level back in the late 1980s before it proceeded to plummet to the low single digits in the late 1990s. It looks like investors may be in for a similar wild ride.

Fair value for GDP stock: $18 (generous 25x multiple on ’09 EPS estimate of $0.73; valuation approximately 3x ’09 revenues)

Disclosure: Author has a short position in GDP