PDC Energy (NASDAQ:PDCE) has done alright since January of this year, even though concerns remain about the quality of the company's acreage and opportunity in the Utica. These shares have risen about 15% over that span - not bad relative to the group (as measured by the EPX), but inferior to other Wattenberg operators like Bonanza Creek Energy (NYSE:BCEI) and Synergy Resources (SYRG) and more diversified operators like Whiting (NYSE:WLL). While these shares still appear to be undervalued, concerns about rising unit LOEs, litigation, and inconsistent Utica drilling results may all remain as headwinds and/or risk factors for the shares.
Wattenberg - Dialed In And Delivering
PDC Energy is the third-largest Wattenberg operator (behind Noble (NYSE:NBL) and Anadarko (NYSE:APC)), with around 97,000 net acres prospective for the Niobrara and Codell formations. PDC Energy has largely delineated its acreage (97% held by production), but the company still has a potential drilling inventory of around 2,800 locations with downspacing driving results. PDC Energy has also succeeded in boosting its estimated well recoveries, with Codell wells expected to produce 370K boe and Niobrara wells expected to produce around 400K boe on a weighted average basis.
PDC Energy has added a fifth rig to its Wattenberg acreage and will likely add a sixth in mid-2015 (and a seventh in mid-2016). There's still room for differentials in the Wattenberg to improve, and maybe still some room to refine/improve its drilling/completion designs, but that's about it. It's not easy to acquire quality acreage in the Wattenberg anymore (at least not cheaply), so I believe this is more of an execution opportunity than a development opportunity. There's nothing wrong with that, other than the Street can go hot-and-cold on the type of energy stocks it favors (riskier exploration-driven stories versus less risky execution-driven stories).
Utica Quality Still Up For Debate
I have seen some analysts, investors, and E&P companies speculate that the Utica could be another Eagle Ford. Given that PDC Energy holds a lot of acreage there (around 54,000 net acres), the company certainly hopes so. These relatively early days have seen some challenges, though, as the Garvin wells (largely shut in during the second quarter) are just in-line with the type curve and mechanical issues with the Palmer pad led the company to shift to a two-well plan.
Less than half of PDC Energy's Utica acreage is held by production, but the current drilling inventory of around 300 locations isn't all that large. The company has also been showing generally weaker well results than Antero Resources (NYSE:AR) and Gulfport Energy (NASDAQ:GPOR), leading some to question whether the company's estimated recoveries and IRRs are tenable and/or whether this really is like the Eagle Ford in the sense that location really matters there (where two acreage holdings can look geographically close but produce very different drilling results). As an aside, PDC Energy's share price performance is pretty much right in the middle of the Wattenberg operators (GOOD) and Utica operators (bad) since January.
There is some good news with the Utica, though. The company has added a second rig to the Utica and will have Palmer pad initial production results in September. The company is also still in a position where it can add acreage - it's still relatively easy to add (lease) acreage in the southern Utica area at reasonable rates.
Other Odds And Ends
Wattenberg operators like Bonanza Creek, Noble, Anadarko, and PDC Energy got a break a little while ago with respect to regulation in Colorado. A compromise between the governor and legislature seems to have reduced the immediate push for tougher rules on drilling, fracking, and producing, with operators now being told to use 1,000-foot setbacks from occupied buildings and the formation of a commission to study further regulatory issues.
On a less positive note, PDC Energy is in litigation with former unitholders of drilling partnerships created and acquired by the company. These aren't criminal charges, but the unitholders are claiming that PDC Energy's proxy statements were misleading, including that PDC Energy didn't include horizontal wells in the valuation, gave no credit for 20-acre spacing, and otherwise undervalued the partnerships. The judge presiding over the case ordered settlement talks and the company's maximum liability (if the plaintiffs get everything they claim, plus interest) would seem to be around $220 million. That amount is tax-deductible, though, so the net impact may be more on the order of $140 million.
Re-estimating The Value
PDC Energy continues to do a good job of increasing production (up 64%/up 11% in the second quarter, with oil making up about 40% of the total), though rising LOEs are a risk. Since January, the company has enhanced value through good downspacing in the Wattenberg and solid estimated recoveries.
Given the new information the company provided back during its April analyst day and shifting some future costs out of the calculation for proved reserve NAV (and into a separate calculation), my estimate for proved reserves moves to $38/share. My estimate for risked reserves moved to just under $63, with about $50 tied to the Wattenberg, $11.50 to the Utica, and about $1.50 to the Marcellus. Debt, liabilities, and future costs claw back $25/share and the net effect is to add about $3/share to my NAV estimate (to $76).
PDC Energy's high level of oil, gas, and NGL production growth is also leading to growing EBITDA production, and sell-side analysts are looking for three-year EBITDA growth in excess of 40% a year. Assigning the same 7x multiple I used before to the current 12-month estimate for EBITDA, I come up with a fair value of around $63 per share.
The Bottom Line
I'm not that worried about whether PDC Energy will continue to do well with its Wattenberg acreage, but the results in the Utica could still move the valuation to a meaningful extent (to the good or bad). Excluding valuation, PDC Energy isn't my favorite E&P company but this is a publicly-traded company and valuation matters. I think the discount on the shares is too steep right now and while PDC Energy is perhaps not my favorite operator, the risk-reward is pretty interesting if you believe that the Street is too concerned about the quality of the Utica acreage.
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