Saturday, 31 March 2012

Highlight of the month - Penn Virginia Corporation

Last month, we have been very busy researching on U.S unconventional natural gas(NG) and liquids players as share prices of these companies have been plunging madly even though we believe they are already undervalued. This reminded us of our investments in Bank of America (BofA), not so long ago. BofA caught our attention when the share price was at $13. We began investing in the common stock (we have 'converted' our positions to the warrants) when it was $10, after which share price continued to decline to $5 in a few months. Of course, we dollar-cost along the way as it declined and also when it recovered. Coincidentally, the share price, now, has been flirting with the $10 range, and we have made some good money despite we started out at $10.
Back to the unconventional NG and liquids companies: We have been looking into the smaller players as they are the ones that have been 'sold out'. We have shortlisted Penn Virginia Corporation (our favourite), Comstock Resources and Exco Resources. In fact we are already invested in Exco Resources despite it is not the most undervalued of the three, as we decided to ride on Wilbur Ross’s coattail first before ‘gearing up’ on the other players. (Wilbur Ross has started investing in Exco when the share price was at $15, and has dollar-cost along the way as the share price declined to $6.50.)
As follows is a short investment thesis (expect a longer article in the future) of Penn Virginia Corporation (PVA):
Has been losing money (even after adjusting for the impairments of oil and gas properties) since 2008 as natural gas prices declined from a high of $7 range to $2.30. Has a higher cost structure than the other players. Expect them to continue losing money (based on GAAP). However, operating cash flows have turned in positive all these years.

What is attractive about PVA lies in (1) the price of the common stock, (2) the company’s establishment in 1882 and (3) misunderstanding of their real financial position and the change in company fundamentals not being appreciated by rating agencies and hence, institutional investors (major shareholders).

(1) Has a P/B of 0.3x. Its attractiveness becomes very obvious when compared to the market transaction related to the acquisition of Atlas Energy by Chevron for $3.2bn in Nov 2010, when natural gas prices are in the range of $3 - $4. Both PVA and Atlas Energy has proved reserves of 0.9tcfe, 1,100,000 net acreage, approximately same amount of debt and equity. The only difference is Atlas Energy has a more favourable hedge on its production and hence is making money, while PVA is losing money. The result: PVA has a market capitalization of approximately $200mn – less than 1/15 of Atlas Energy’s $3.2bn market transaction!

(2) Established in 1882, the management would have an intense desire to restore the reputation of being a ‘fallen angel’. We believe conservatism, rather than the ‘let’s go all-in’ mentality, will be adopted by the management when things get tough. Attitude matters!

(3) This would explain why the share price has been very cheap compared to its peers and that the company is not in the verge of bankruptcy. With reference to, we believe that S&P has employed a rigid model in assessing the credit profile of PVA. There are 4 assumptions that we have used in our credit analysis that were not supported by rating agencies, and these include (a) the oil and gas properties are extremely marketable (and therefore can be sold) in the marketplace and they have massive acreage as compared to their peers , (b) capital expenditures are discretionary, (c) additional proceeds from share dilution to fund capital expenditures (from our calculations, investors can still make decent money even though the share dilution were to occur when share price is $2.50) and (d) the shift from gas to liquids production will improve their cash flow position faster than expected by the rating agencies. While we are not providing the figures required to support our analysis on what we believe to be their real liquidity and financial position, we may do so in the future.
From a fundamental standpoint, PVA is definitely the weakest link among the other two companies that we have shortlisted. However, from an investment-attractiveness standpoint, we found more compelling reasons for an investment in PVA.

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