Goodrich Petroleum: Gas in the Ground Doesn't Mean Cash in the Bank

Goodrich Petroleum (GDP) is an independent oil and gas exploration and production company.

Market cap: $2.5 billion; Enterprise Value: $2.8 billion

The company is estimated to generate revenues of $220Mn this year with EPS of $0.09. Next year’s estimates are revenues of $312Mn and EPS of $0.73, which in my opinion is highly optimistic as the company has never generated any profits of note in the recent past. The company therefore trades at 13x this year’s revenues and 100x next year’s EPS! By contrast, Exxon Mobil (XOM), arguably the best run integrated oil and gas company, trades for 1x revenues and 9x EPS.

The stock has more than doubled from $30 to $75 in the last three months as excitement over the company’s ownership of land in the Haynesville Shale area has grown. The Haynesville Shale has got a lot of press of late as an area with substantial, albeit difficult to extract, gas reserves. Many naïve investors assume that the value of a company’s reserve position (i.e. the value of the estimated oil and gas under the land the company owns or leases) should translate into its market cap. What they neglect to take into account is that it takes a substantial amount of operational and capital expenditure to extract the reserves. With costs spiraling for exploration companies, the net value to equity investors may turn out to be next to nothing.

Capital expenditure for the company is running well above D&A, and its free cash flow is hugely negative. The company plans to spend $350Mn on capital expenditures this year. The company’s current run rate suggests it will generate cash from operations of about $80Mn, so it will take on a substantial amount of debt to fund the capital program. This will cause its interest expense to rise. So the combination of increasing D&A and interest expense will mute any earnings growth. It is also possible that the company will sell stock in a secondary offering as it periodically has done, diluting current equity holders.

The stock was near the current level back in the late 1980s before it proceeded to plummet to the low single digits in the late 1990s. It looks like investors may be in for a similar wild ride.

Fair value for GDP stock: $18 (generous 25x multiple on ’09 EPS estimate of $0.73; valuation approximately 3x ’09 revenues)

Disclosure: Author has a short position in GDP

Comments

[mert401]

The author of the GDP article has a short position.

With the stock now 85, I'm wondering when he will have to cover, or if he intends to gut it out.

[MDCigan]

Many naïve investors assume that the value of a company’s reserve position (i.e. the value of the estimated oil and gas under the land the company owns or leases) should translate into its market cap. What they neglect to take into account is that it takes a substantial amount of operational and capital expenditure to extract the reserves.

You've got a good point here, but I think you are missing something critical that makes your short position very dangerous if not outright crazy. *Any* of the smaller operators with Haynesville acreage are takeover targets for larger E&P companies that want to establish a presence in Haynesville, and DO HAVE the operational expertise, capital budgets, and scalability to profitably extract the reserves. Either that, or the smaller company like GDP just partners with a bigger company to do the heavy lifting for them:

uk.reuters.com/article...

I'm long CHK and CHK options

[oil baron]

MDCigan....
I also own chk stock long term and we are in good company with CEO McClendon who owns 32.5million shares, most of the shares bought on the open market..
Chk is the creme de la creme of the nat gas producers and explorers.

[BigAnge]

One of the best technical analysts on the street called a top at 84.73 yesterday and one-ticked over and hasn't seen that level since. Modeled out, this is the most overpriced mid-cap, gas-intensive name in the space. Any roll over in nat gas into the $12s sends this back into the mid-60's IMO. FYI, I am short and adding.

[SupaSage]

I have to disagree with the author on this one as his analysis is seriously flawed. To properly evaluate GDP, you shouldn't be looking at next year's earnings. In investing in any asset, you should be looking at the present value of future cash flows. And future cash flows are tied to current and future reserves. The author states "Many naïve investors assume that the value of a company’s reserve position (i.e. the value of the estimated oil and gas under the land the company owns or leases) should translate into its market cap." Unfortunately, I think the author is the one who is naive here. To properly assess GDP, you should be looking at its potential NAV. Given the the Haynesville Shale drilling is still in the early innings, you will see analysts continue to de-risk their NAVs (which DO include gatural gas extraction cost assumptions) as additional drilling data is released by any of the 25-35 companies with stakes in the HS. That's what we've been seeing in recent days and what we'll continue to see as time passes. Initial production estimates are gettting bigger and bigger, which in turn, results in more and more reserves per well. More reserves per well results in more future cash flows and earnings. The key word is future here. And although next year is the future, GDP's cash flow from its HS acreage will extend well beyond 2009. So if you want to short GDP, I strongly suggest coming up with a more sound thesis than this author has. Especially when you consider that natural gas industry fundamentals are improving and should result in the tightest supply-demand balance we've seen in years. Short GDP at your own risk. After evaluating GDP's potential, I'd rather be long.

[False Profit]

Thanks for all your comments. I agree that when valuing at a company, one should look at the NPV of future cash flows, and not just one year like 2009. However, as I am putting a 25x multiple on '09 earnings, I am capturing the cash flow from many future years, and also assuming that the cash flow will be growing. I think the optimists have grossly underestimated the extraction costs (both operating and capital) involved. Only time will tell. Today, the company announced a secondary equity issue - I pointed out in my article that this was a possibility and something they have frequently done. Clearly, this is an indication that management believes the stock is overvalued.