Babies That Have Been Thrown Out With The Natural Gas

Includes: PVAC, TLM
by: MLP Trader

Last month, I sat down for a chat with Penn Virginia Corporation (PVA) CEO, Baird Whitehead. Like many exploration and production companies with significant natural gas production, PVA has been obliterated over the last year.

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After Whitehead reviewed their strategy to shift toward liquid production and we talked about Granite Wash IP rates, I got to what I really wanted to ask: "your company is trading below the value of its liquids production, even though that's less than half the company." He answered grimly, "I can't argue with that." Briefly put, the company is guiding to 2012 production of about 19,000 (BOEPD), of which 9,000 is liquids. That's a lot of liquids for a company that's worth less than a Boeing 747. If we value the other 10,000 BOEPD of PVA's production at $0, the company is trading at a modest $114,000 a flowing barrel. Whitehead and other company executives acknowledge see the value, having bought the stock with their own money since I talked with them.

PVA is just one of many companies in this situation. Investors seem to have drawn a hard line at companies with about 50% dry gas production and sold them off as if it was all they produce. A number of these companies are even better bargains than PVA, which has quite a lot of debt and a less-than stellar execution record.

Among these, Canada-based Talisman (NYSE:TLM) is the standout. Talisman is a globally diversified company, with its production divided among North America, Southeast Asia, and the North Sea. About 45% of TLM's production is dry gas. But the company has been sold down as if gas were the only thing it produces. It currently trades at less than 4 times EBITDA.

Let's forget for a moment that almost half of TLM's dry gas is produced outside of North America and gets prices that are several times higher than Nymex prices. If we throw away all of TLM's natural gas and only count TLM's liquids production (about 234,000 BOEPD), the company is trading at a cheap $71,000 a flowing barrel. From a reserves perspective, each $13.50 share of TLM buys you about a barrel and a half of oil. And you get a whole bunch of natural gas with that for free. This is all the more impressive when you consider that the better part of TLM's oil production is priced at Brent crude prices which are currently $15 higher than West Text Intermediate (WTI) prices.

Disclosure: I am long TLM.