Even by the elevated standards of independent exploration and production companies, Ultra Petroleum (NASDAQ:UPL) seems to more often swing between doom-and-gloom bearishness and gleeful bullishness than the typical E&P stock. A debt-loaded balance sheet, so-so debt-adjusted production growth, and "okay" assets may explain some of the negativity, but Ultra's production growth hasn't really been that bad, the cash costs are competitive, and the company is executing in its oil-rich Uinta acreage. Like many E&Ps, Ultra Petroleum looks undervalued on a NAV basis (though rising costs are an issue to watch there), but the EBITDA-based approach doesn't suggest the same level of near-term opportunity.
Q2 Results Come Up Short
Ultra Petroleum has an uncommonly high short interest (close to 20% as of late May), and those shorts might have been patting themselves on the back a bit last week as the quarterly results came in a little weak.
Reported revenue rose 13% on flat production. Gas production fell 5% yoy on a daily basis (and was flat sequentially), while liquids production rose 154% and 14% respectively. While realizations came in stronger than expected, production was about 3% below sell-side expectations.
Cash costs were also higher than expected, rising 11% to $1.46/Mcfe, while total reported costs rose about 6%. With lower production and higher costs, Ultra's EBITDA came in about 8% lower than expected, though operating income was still up close to 23%. Cash flow per share rose 8% yoy, but came in about 8% below expectations.
Staying Disciplined With Drilling
Ultra Petroleum management is staying disciplined with its drilling programs. The company continues to run a four-rig program in Wyoming and management indicated that it won't add a fifth rig until/unless gas prices regain and hold $4.50.
The plan in the Uinta Basin may be disappointing to the more bullish Ultra Petroleum shareholders, as the company completed more wells (19 net wells, bringing the year-to-date total to 31) but announced that it would be maintaining a one-rig program for the near term. Management secured a new rig that is better-suited to the demanding drilling plans for the acreage (24/7 operation, multi-well pads), but will be releasing the incumbent rig instead of running two. Management did indicate that adding a second rig early in 2015 is a possibility.
I was a little disappointed that Ultra didn't upgrade its drilling plans for the Uinta, but I also understand it. Weak netbacks are still a challenge and Newfield Exploration (NYSE:NFX) has already signed up most of the near-term refinery capacity expansion. Rushing to producing oil in the face of weak differentials may satisfy investors who prioritize production growth above all else, but it's bad for cash returns and long-term value creation.
I'd also note that the company's Uinta acreage continues to perform fairly well. Wells drilled in the second quarter showed some weaker 30-day IPs, but the company was drilling a lower-performing area and the decline rates have been looking good. I don't think the company is going to challenge Newfield's estimated recoveries or 60-day IPs (Newfield's acreage is to the west of Ultra), but the well costs are much lower for Ultra and this remains a high-quality play.
Steady As She Goes In The Pinedale, Slowing Toward Stop In The Marcellus
I continue to believe that Ultra Petroleum compares well to other Pinedale operators like QEP (NYSE:QEP) and Royal Dutch Shell (NYSE:RDS.A). It didn't help sentiment earlier this year when Encana (NYSE:ECA) and Anadarko (NYSE:APC) sold their Green River Basin holdings, but I think that overlooks the fact that Ultra's acreage is contiguous, operated, and not mature (leaving upside to exploration/development) while these sales were lower-quality (non-operated, fragmented, and/or mature). It also hasn't helped sentiment that regulators are looking to tighten up air quality rules, though the history of Wyoming's relationship with resource companies suggests that there will be a constructive dialog. With estimated well recoveries of over 4Bcf and well costs below $4 million, this is still a very worthwhile area.
I'm less enthusiastic about the Marcellus acreage, and apparently so too is Ultra management and its partners Anadarko and Royal Dutch. Production declined 10% qoq in the second quarter and there are no plans to resume drilling on Anadarko acreage, while Royal Dutch's plans are quite modest as well (and Ultra isn't participating in many wells). Given that well costs are almost three-quarters higher here for maybe 20% upside in recoveries, I see no reason why Ultra Petroleum shouldn't continue to prioritize the Pinedale over the Marcellus for its capital spending.
Estimating The Value
Ultra shares are up about 12% from my last write-up, lagging other E&Ps I liked better like Triangle Petroleum (NYSEMKT:TPLM), Penn Virginia (PVA), and Abraxas (NASDAQ:AXAS). Even so, I think there's value here and particularly good leverage to higher gas prices or faster-than-expected improvements in takeaway capacity from the Uinta Basin.
I've moved up my NAV estimate to $33 largely due to higher NYMEX strip prices for gas. Differentials and higher costs (both cash production costs and well costs in the Uinta) cut away some of the upside, though. I estimate a gross asset value of $35 per share for the proved acreage, $11 for risked acreage in the Pinedale, and $7.50 for the Uinta. Adding in other acreage (like Marcellus) and subtracting debt, operating costs, taxes, etc. leads to the $33 net target.
Not surprisingly, the EV/EBITDA approach does not show similar value as this is still a growth company with substantial value in the ground. A 7.5x to 12-month EBITDA leads to a $28 fair value, and that multiple is on par with Southwestern (NYSE:SWN), Cabot (NYSE:COG), and other gas-heavy stories. Ultra's balance sheet-adjusted production growth prospects aren't so great (about a third lower than its gas-oriented peers), but the prospects for per-share cash generation too offset that to some extent.
The Bottom Line
I still think that Ultra Petroleum is an E&P company with good management and middle-of-the-road assets. Even so, value is value and Ultra's price looks interesting when compared to other gas-heavy names like Cabot, Southwestern, or Bill Barrett (BBG). There's no compelling reason to own Ultra if you're bearish on gas prices, but Ultra's current price seems to offer an entry point worth exploring.
Disclosure: The author is long TPLM. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.