GMX Resources: Buy the Cash Cow, Get the Sweet Milk Free

Aug.14.08 | About: GMX Resources (GMXRQ)

GMX Resources (GMXR): No position yet but its on my list of dance partners that will shine when the commodities stabilize. Highly concentrated, gassy play with high leverage to the Haynesville and little if any value in the stock for it. They’d make a nice stocking stuffer for any mid or large cap E&P that finds itself behind in the resource play game.

Price as of 8/13/08: $62.19

GMXR - East Texas Cotton Valley Lime player with Bossier/Haynesville Shale underlying their acreage. 94% gas with a strong balance sheet.

  • What’s To Like:
    • Highly concentrated: 1 core asset in 2 counties (Harrison and Panola in E. Texas)
    • "Soft guidance" for 100% production growth next year. They have grown production by 100% in each of the last 3 years.
    • Large inventory of highly economic drilling locations (read on)
    • Proved Reserves at YE 2007: 434 Bcfe. At $3 per Mcfe in the ground that equals  $1.3  billion vs a current Total Enterprise Value of $1.25 B.
    • They see 3P reserves at 3 Tcfe (7x current proved)
    • Operating costs : falling below $1/ Mcfe and looks to fall more as production runs up
    • Deal already out of the way, they are saying taking the deal fear off the table for the next 18 months and took debt down to 32% debt to cap.
    • Bread & Butter business is Cotton Valley wells
      • low, low F&D costs of $0.79  per Mcfe …just about best in class
      • only 15% of acreage drilled up so far; 890+ locations remain
    • Haynesville/Bossier Shale Exposure:
      • 38,455 haynesville acres - with two targets,
      • 480 net locations on 80 acres,
      • acreage in fairway of the play
      • 350 foot thick section, EURs of 4.5 to 8.5 Bcfe estimated by others in the play; is about 10 miles west of CHK’s big well and just east of PVA’s wells.
      • Have drilled multiple vertical wells on their acreage back to 2006, waited for industry leaders to crack the code on horizontal development and to share data - goes to management intelligence.
      • Porosity of 12 to15%, maybe be underestimated due to presence of dolomite. It’s going to flow.
      • Gas in place in this area is in the 170 to 200+ Bcf range per secton 
      • 81% operated with a 79% net revenue interest
      • Plan to spud first horizontal well in 3Q08.
      • pre purchased OCTG for near term program,
      • 5 rigs now, 6th rig coming Nov., 2 will drill vert cv wells, 3 now drilling cv and they will be repurposed to finish the current well and then go Hs, sixth rig goes hs immediately on delivery in NOV. HP flex rigs show up next year (2) and go to drill HS. 9-11 rigs by end of next year with 2 to 4 of them in the CV. 
  • What’s To Knock:
    • Small caps are going to be extremely volatile in the near term
    • "Gas glut" thesis not yet resoundingly defeated
    • Hot money still in the name may present overhanging supply as it tries to rally
    • The stock is up 90% since the beginning of the year but see valuation metrics below
  • Where’s It Trade:
    • P/CF of 6.7x on a 2009 CFPS estimate of $9.31. Not expensive given their growth and that CFPS number is not based on 100% expected growth.
    •  Debt to cap of 32%, not bad at all.
    •  They had 435 Bcfe in proved reserves as of YE07. Putting a 6 Bcfe EUR on its acreage risked 50% with an 80 acre spacing and their royalty guidance yields a net potential reserve estimate of 1.2 Tcfe, or 2.75x current reserves. In their presentations they are not risking the play 50% which would double the reserve number to 2.4 Tcfe or 5.5x their current reserves
    •  The stock is trading at a TEV of $1.045 billion:
      • If you assume they could garner $2.50/Mcfe for their in the ground booked reserves which is beyond reasonable that leaves the Haynesville acreage for free.
      • A takeout at a 50% premium to yesterday’s closing price would probably get the deal done and would still only value the Haynesville/Bossier acreage at under $10,000 per acre, a far cry from the $20K to $30K per acre deals we have been seeing of late.
      • I think they could get $3 /Mcfe for the in ground proven  reserves  and $25K per acre for their Haynesville acres which would yield a triple digit share price as calculated below.
      • They have mapped out a potential price that is much higher but for now, the easy math gets you a double and isn’t such a stretch to the Summer-weary energy investor.