A Closer Look at Our Newest Energy Buy: Antero Resources (AR)

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As oil tries to find a bottom, I’m starting to see select opportunities in the energy sector, and I’m excited about  Antero Resources (AR), which is an Appalachian-based producer of shale natural gas and, to a lesser extent, oil and natural gas liquids.

While management is spending a lot on future growth at the moment, which is restricting cash flow and earnings, I believe the company is building itself well for the long term as production and reserves will continue to rise.

Let’s take a closer look at the company now.

Antero’s assets consist largely of natural gas and oil reserves primarily in the Marcellus Shale in Pennsylvania, with the remainder in the Utica Shale in Ohio. At the end of last year, the company had a total of 12.7 billion cubic feet of reserves on a natural gas equivalent basis, with 83% of these reserves in dry natural gas and the remainder in natural gas liquids and oil.

Through a substantial drilling program, AR has realized vast expansion in recent years. Reserves were just 677 million cubic feet in 2010, increasing at an average rate of 108% per year since then, with growth still very strong at 67% in 2014. Over the same period, production has risen from 30 million cubic feet per day to 1 billion cubic feet, as the number of operating wells increased to 19 from 177.

Most importantly, this growth was very profitable for AR, with adjusted EBITDA increasing from $27.8 million in 2010 to $1.1 billion in 2014, surpassing the rate of production growth. Last year, AR’s first full one as a public company following their 2013 IPO, the company earned $1.20 from continuing operations, excluding non-cash items such as gains from the company’s significant hedging program.

Antero Resources was helped by a healthy natural gas realization price last year prior to hedging of $4.90, which is well above the current price and the $2.40 realized in the most recent quarter. While this is a significant drag on profitability, it is largely offset by lower unit costs as the company’s wells mature and become more efficient.

Management believes unit costs in the Marcellus have declined 16% this year, and costs in Utica are down 18% thanks to service cost reductions and great drilling efficiency. Along with expected production growth of 40% for the year, this will allow the company to remain profitable despite the commodity price decline and investments in future growth.

Earnings are currently expected to decline to 50 cents a share this year from $1.20 a share a year ago, but that would still be a good performance compared to what other E&P companies with an emphasis on natural gas are expected to do this year.

For example, Chesapeake Energy (CHK), which earned $1.49 a share last year, is expected to lose 27 cents a share this year. One-time market favorite EOG Resources (EOG), which earned $4.95 in EPS last year will be breakeven this year. Even a more mature company like Devon Energy (DE) will see its EPS cut more than 50% from $4.91 to $2.18, and this is a company that will not invest nearly the same amount of money for future growth as Antero.

I know that’s a lot of information to digest, so let’s cut to the bottom line on AR. There are three factors that will drive future growth here. The first is increased production, which is projected to rise 25%-30% next year. Only 30% of the company’s proved reserves are developed, so there are still plenty of drilling opportunities ahead for the company.

Secondly, AR will continue to gain efficiency as wells mature, leading to lower production unit costs.  And finally, even though there could be some more commodity price pain in the near term, the situation will eventually improve. Lower energy prices are self-correcting, as inefficient companies stop producing and demand increases from the lower prices.

We may never see the days of $100 oil and $14 natural gas again, but an environment of $60 oil and $4 gas should be enough for AR to enjoy good returns, especially as the company keeps growing.

Valuation of the stock is tricky, as Antero has no free cash flow given its heavy investing, and the current commodity price may not provide an accurate picture of growth potential.

However, the stock is down significantly from its 12-month high of $46 set in May, and the company should still generate $1 billion in cash from operations this year, which makes its valuation reasonable relative to its current Enterprise Value (Market Capitalization + net debt) of $11.3 billion.

Shares have also held up well amid the market correction and I continue to recommend AR as a buy under $26.50 for a target of $33.

As you establish your position, keep in mind that I have assigned the stock an Aggressive risk rating given the continued uncertainties in commodity pricing and leveraged nature of exploration companies.

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Article printed from InvestorPlace Media, https://investorplace.com/2015/09/a-closer-look-at-our-newest-energy-buy-antero-resources-ar/.

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