In today’s Daily Alert, $100k Portfolio Editor Ian Wyatt makes a compelling case for an undervalued energy stock.
“Formerly the exploration and production wing of Canadian energy giant Williams Companies (WMB), WPX Energy, Inc. (WPX, NYSE) was spun off in late 2011. At its heart, WPX is a natural gas producer; 91% of its production is either natural gas or natural gas liquids (NGL).
“The company’s three principal assets are in the Bakken in North Dakota, the Marcellus Shale, and the Piceance Basin in Colorado — three of the largest natural gas discoveries in the U.S. Ninety-five percent of WPX’s capital is devoted to those three basins. The company also has operations in New Mexico’s San Juan Basin and Wyoming’s Powder River Basin. All told, WPX boasts 7,380 wells covering nearly one million acres of land.
“Until recently, though, investors had largely overlooked WPX. The shares are essentially flat since the IPO at $19. During that time, the S&P 500 has advanced 32%, energy stocks have gained 14%, and natural gas prices have jumped 21%. So why hasn’t WPX followed suit?
“For starters, the fledgling company is not yet profitable. While Williams, its parent company, made $859 million in net income last year, WPX lost $223 million. A pair of bad assets were mostly to blame.
“Two underperforming properties — one in Texas’ Barnett Shale, the other in Oklahoma’s Arkoma Basin — had been weighing down WPX’s balance sheets for years. Last May the company sold the cumbersome assets to the legendary KKR (formerly known as Kohlberg Kravis Roberts). You’ll recall that KKR was one of the first leveraged buyout firms of the 1980s.
“WPX netted $306 million in the KKR deal. At the time, natural gas prices were in the $2 range — their lowest point in a decade. So in essence, the company took a haircut by selling lousy properties in a terrible commodity environment. But the sale also revealed key information about just how undervalued WPX is as a company.
“Based on the company’s Barnett and Arkoma sale and its purchase of Bakken property in late 2010, the estimated equity value of WPX’s proven reserves is roughly $8.5 billion. Subtracting the company’s $1.6 billion in debt brings the net equity value to just under $7 billion. That translates to $33.62 per share, or a 75% premium to the current stock price.
“Taking it a step further, two recent sales of assets in Piceance — one by the Bill Barrett Corporation and the other by Antero Resources — value WPX’s reserves at an even higher price. For example, Antero’s sale of its Piceance assets gives WPX’s reserves a value of $35.91 per share — 87% higher than its current share price.
“That means WPX is in the unique position of not having to rely on the price of natural gas. Natural gas is currently trading at around $4 per thousand cubic feet — up slightly from its decade lows, but still very low. Despite its recent run, natural gas is still worth roughly one-third of what it was going for as recently as 2008. Just look at the chart below:
“Even if natural gas prices don’t rise from $4, WPX can make a lot of money. A major reason is its low operational costs. Of the 38 largest public companies in the industry, WPX has the second-lowest finding and development (F&D) costs at $1.48
per thousand cubic feet (Mcfe). That’s less than half the industry average of just above $3.00/Mcfe, and a quarter of the F&D costs some natural gas companies incur.
“So how did WPX become so cheap relative to its competitors? Primarily because of the company’s conservative spending policy. You see, WPX takes a very conservative approach to its financial books — an approach that differs from that of many competitors in the energy and production field. As a result, the financial performance appears to be worse than some of its competitors. Ultimately, however, that is a good thing.
“[CEO Ralph] Hill is largely responsible for building the company into what it is today. He saved Williams from bankruptcy in 2002, raising enough cash through asset sales to keep the company afloat. He instituted a low-risk culture that produced a 100% drilling success rate last year and 99% success rate in 2011 and 2010. That WPX’s cost structure is the envy of everyone in the natural gas industry is a testament to Hill’s leadership. ...
“Today, the Piceance Basin is undoubtedly the company’s most important asset. WPX’s wells are located in the lowest part of the Piceance Valley basin, allowing the company to build low-cost wells. In fact, WPX’s prime real estate in the basin has scared any competitors away. Today the company is the only major player with a meaningful stake in Piceance. With 4,100 wells spanning 216,000 acres, the vast Piceance presence alone makes WPX the largest natural gas producer in Colorado, a state that boasts the fifth-largest proven natural gas reserves in America.
“The good news is that their Colorado footprint should only expand. In January the company announced the discovery of a new natural gas reserve in the Niobara Shale region of the Piceance Basin. The well exceeded 1 billion cubic feet of production in
its first 100 days of operation. That already makes it the most productive well ever drilled in the Niobrara formation. In the wake of such a huge success, the company plans to drill additional wells in the vicinity this year.
“While Piceance is the site of WPX’s largest operations, the company’s presence in the Bakken is equally vital. The company is successfully applying some of the same efficiencies it honed in Piceance to its Bakken operations. Strategies such as multiwell pad drilling have helped reduce drilling hours and trimmed WPX’s drilling costs by 10-20%.
“By lowering its costs and improving drilling efficiency, WPX’s proven reserves in the Bakken grew by 249%. With 100 wells (and more coming online every month) spanning 84,000 acres situated right in the sweet spot of the Bakken’s rich natural gas fields, the company’s presence in America’s best dry gas shale play should continue to grow rapidly.
“The rapid production growth in all three regions position WPX for big profits. And that’s exactly why there is a big opportunity to invest in the stock today. Combine the trifecta of natural gas discoveries with the company’s low-cost approach, and you have a real recipe for success. ...
“I see WPX Energy as a deep-value investment. If natural gas prices remain in the $4 region, WPX already has the proven reserves to be valued at $35 a share — 82% higher than its current share price of $19.20. ... Any way you slice it, WPX is trading at a serious bargain. With one of the strongest balance sheets in the exploration and production sector, a promising asset base that offers significant growth opportunities, and among the lowest cost structures in the industry, WPX is a severely undervalued gem in an otherwise over-caffeinated industry. ... Buy WPX Energy (NYSE: WPX) below $20.”
Ian Wyatt, $100k Portfolio, www.100kportfolio.com, 866-447-8625, 6/10/13