Gulfport Energy (GPOR) is a darling of Wall Street. Fifteen out of the 16 analysts covering the stock have Buy ratings, with an average price target of over $50 (the stock closed Tuesday 5 February at $42.27 and opened down a bit today after an early press release included disappointing production figures.)
Our Energy Sector Senior Analyst Kevin Kaiser calls GPOR “one of the riskiest stocks in the energy sector.” Kaiser’s analysis indicates a fair value for GPOR shares of between $15-$23 per share, about half of where the shares currently trade, and well below analysts’ optimistic price projections. Hedgeye hosted a conference call today on GPOR for our institutional clients presenting Kevin’s in-depth analysis of GPOR’s reported earnings, recent press releases and guidance for 2013 and beyond, and comparing the common outlook with Hedgeye’s very different view. This deep-dive presentation is what we call a Hedgeye “Black Book.” Produced by our sector heads several times a year, Black Books offer our institutional clients in-depth analysis of a high-conviction idea, such as key developments within a sector, emerging regional trends, or analysis of an individual company.
GPOR: The Bull Case
GPOR owns substantial drilling rights in the Utica Shale, a vast geologic formation underlying 8 US states, including Ohio, West Virginia and Pennsylvania, through New York and up into Canada. The Utica Shale is a hot target for oil and gas exploration, with drilling permits in Ohio reaching record highs since 2011. The crux of the bull case for GPOR is its net ownership of 106,000 operating acres in the Utica Shale and projections for tremendous revenues, profits and cash flows as a result. GPOR’s cost is around $6,000 per acre. Kaiser says that if GPOR’s boosters are right, and the numbers come in at an equivalent to the highest levels of revenue and profitability their competitors have achieved, the stock could go to $80. Bullish analysts say GPOR has been very successful – or very lucky – at acquiring “the sweet spot” in what should be the highest producing region in the US.
GPOR: The Bear Case
Kaiser asks a simple question: What do we really know about GPOR’s Utica Shale properties? The answer he comes up with is: very little.
It is difficult to model the production, profitability, and projected cash flow from GPOR’s Utica Shale operation. All the company has released is production statistics as “peak IP rates” – the best rate of flow in the first 24 hours of production of a new well. Independent industry experts agree you need several months of actual production figures to make a reasonable projection of a well’s output.
GPOR has not released actual well drilling costs. Cost data on similar producing wells released by GPOR’s competitors indicates GPOR’s cost projections are very optimistic – Kaiser believes they are unrealistic and will end up being raised substantially. There are also additional costs associated with bringing a well on-line – construction of roads and storage, and seismic analysis for example. None of these seems to have been factored into GPOR’s cost projections.
The economics of drilling are highly sensitive to small shifts in a variety of inputs, but GPOR has only released peak IP rates, which have been enthusiastically snapped up by the bullish analysts. We are left guessing at actual well costs, geological studies, completion data, and internal rate of return per well data – the actual components of profitability. In order to make money in the exploration and production industry you have to get a lot of things right, and get them right consistently, and over a long period of time. GPOR has not given us the data to get comfortable around this complex reality.
The composition of the Utica Shale production is also a factor. Kaiser thinks the output will have a much higher gas component than other analysts believe. Kaiser says this morning’s press release from GPOR validates this view. Perhaps more important, Kaiser notes that today’s announcement confirms what he sees as GPOR’s pattern of issuing enthusiastic guidance, then later lowering their guidance, then confirming the lowered guidance with actual reported numbers – in this case bearing more potentially bad news, as the peak IP production figures were disappointing, and there was surprisingly high gas content.
Dropping The Other Shoe
Perhaps the biggest indicator that GPOR stock is not headed to dramatic new highs is its longstanding relationship with major Connecticut-based money management firm Wexford Capital. Wexford brought GPOR into existence with the 1997 reorganization of a bankrupt conventional exploration and production company. Over the years, Wexford has done extremely well for GPOR shareholders. Wexford’s careful oversight of GPOR took the stock up to more than a 2,000% profit. This relationship appears to have ended abruptly at the end of last year. From an all-time high ownership stake of over 60% of GPOR shares, Wexford now owns about 0.2%. Perhaps more important, Wexford owned substantial acreage in the Utica Shale, having bought in alongside GPOR. Last year, Wexford sold its entire Utica Shale acreage to GPOR. Asks Kaiser: there’s no one in the world who knows GPOR better than Wexford. Wexford would not be likely to sell off their holdings if they believed GPOR was sitting on top of a gold mine – or in this case, an oil well. The last insider buy of GPOR stock was 10,000 shares in September 20080.
As owners of operating Utica Shale acreage, Wexford has hard figures about well production, actual drilling costs, and profitability. Their selling of GPOR stock can be tied to any of a number of considerations – notably to taking profits before changes in the tax code. But selling their producing acreage is a different story. Here, Wexford appears to have seen the future and said “No thanks.” Kaiser believes this is the single most important data point, and one the rest of Wall Street is blithely ignoring.
For the Bull Case to come true, it looks like everything has to go right. All projections – profitability, cash flow, asset value, and stock price – are based on what appear to be a very sparse set of vague statistics of the kind GPOR’s competitors would never use internally to plan their own business. For the Bear Case to pan out, it should be sufficient for any one of the assumptions to break down. If the Utica Shale ends up being worth substantially less than GPOR’s acquisition cost, if average production levels run substantially lower than the peak IP levels GPOR has released, if the composition of the resulting production has a high gas content, if the cost of well completion ends up being just the industry average – rather than the aggressively lower costs GPOR says they can attain – any one of these elements could be sufficient to create a major disappointment and a significant decline in stock price.
Kaiser points out there is a relatively small short position of about 8%, not enough to offer the hope of a major short squeeze. All but one of the analysts covering the company rate the stock Buy, leaving little bullish reserve. Options premiums appear very expensive on both the put and call sides of the market, which indicates the market is anticipating volatility. Under most circumstances, a volatile outlook tends to lead to lower stock prices. If GPOR breaks down because of a disappointment, there may be no safety net.
You can follow Kevin Kaiser on Twitter at @HedgeyeENERGY