Last fall, in an extensive six-part series, I explored the ins and outs of oil producer Gulfport Energy (Nasdaq: GPOR). In the course of those articles, I attempted to show other investors how I analyze an unfamiliar stock. In the final installment, I took a stab at a valuation and determined that the company -- then trading for less than $9 a share -- was fairly valued.
Since that time, Gulfport has more than doubled in price. Whoops. Let's try to figure out how I bungled this one so badly.
Breathing easier
Though it didn't figure into my valuation, one red flag in my review of Gulfport was that the company was overdrawn on its revolving-credit facility by $14 million. I figured the company would issue shares to help pay this money down. But as it turns out, the company was able to it all off by February 2010 without issuing new shares. I plainly underestimated the company's cash flow.
A share offering did come around a few months later, but with the intent to help fund $15.5 million acquisitions in the Permian Basin and in the very promising Niobrara oil play that companies such as Marathon Oil (NYSE: MRO) are pouncing on in Colorado. But the company has chosen to leave itself little room on its bank line, which has $45.7 million drawn against a borrowing limit of $50 million.
On the production front, daily output has benefited from an increased drilling and recompletion budget, resulting in a 27% bump in the third quarter. West Cote Blanche Bay (WCBB), Gulfport's cornerstone production asset, averaged a touch more than 3,500 barrels per day in the third quarter, which was essentially unchanged from last year. Proved reserve bookings at WCBB have been slashed from 13.4 million barrels to 5.3 million barrels, largely on account of a new SEC rule requiring companies to limit the proved-reserve designation to future locations expected to be developed within five years. Now, 6.2 million barrels reside in the second-class "probable reserves" category.
Improving the proved
Speaking of reserves, something that really bugged me last year was that the company's reserve categories didn't add up. It appears the company has corrected its disclosure, with proved developed non-producing reserves and proved undeveloped reserves rightly accounting for less than 100% of total proved reserves. Some 16% of proved reserves were producing as of year-end 2009.
Gulfport added 3.1 million barrels equivalent of reserves in 2009 and produced 1.7 million barrels equivalent, for a reserve replacement rate of 184%. That's a far better rate than the company posted in past years. Finding and development costs of $12.33 per barrel marked a dramatic improvement.
Some of the revaluation in Gulfport shares surely comes from a combination of improved liquidity, production, reserve replacement, and finding costs. Although I was pretty keyed in to the company's production growth, I missed the other elements here. I'm going to suggest that all of these factors are secondary, however, compared with the single greatest factor affecting Gulfport shares over the past year: investor sentiment toward oil-weighted exploration-and-production companies.
Right commodity at the right time
Gulfport's share-price appreciation is handsome, but it's not terribly different from its oily peers. Consider Concho Resources (NYSE: CXO), one of Gulfport's neighbors in the Permian. Concho shares have also more than doubled since my articles on Gulfport ran. Ditto for Brigham Exploration (Nasdaq: BEXP), which is tearing it up in the Bakken.
There has been a massive pile-on by investors into onshore oil plays, for several reasons:
- The natural-gas glut has depressed prices, leading folks to jump ship from companies such as Chesapeake Energy (NYSE: CHK).
- Just as with shale gas, horizontal drilling and hydraulic fracturing techniques are opening up massive new oil plays, such as the Eagle Ford in South Texas. Companies such as Rosetta Resources (Nasdaq: ROSE) are stealthily unlocking new plays as we speak.
- Following the Gulf oil spill, onshore operators offer a safe haven from permitting purgatory.
- As crude-oil inventories run high domestically, strong global demand has kept oil prices in a very lucrative $70-to-$85 range.
As I look over my sum-of-the-parts valuation, I'm thinking the biggest "re-rating" experienced by any of Gulfport's component parts is probably found in the company's oil-sands interests. Other early-stage oil-sands operators currently trade for around $1,700 to $2,000 per acre. That would value Gulfport's stake at something like $250 million, or around 2.5 times my high-end estimate from last year.
Valuation wrap
These are the pitfalls of doing a valuation based on comparables and market transactions, rather than a discounted cash flow (DCF) approach. It's easy to lose your bearings when you base your notion of fair value on what other people say other things are worth.
Of course, DCFs present their own pitfalls. Care to predict where oil prices will be in three, five, or 10 years? There's no failsafe approach to valuing E&Ps, and different situations demand different frameworks. Whenever I make an investment in this space, however, I demand an extra-large margin of safety, given how volatile this business can be. (For me, that generally means a 50% or greater expected return -- based on a range of possible outcomes that I've handicapped -- within two years). If I miss the macro-driven moves in seemingly fairly valued stocks such as Gulfport, I can live with that.
