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Monday, 01/13/2014 2:43:06 PM

Monday, January 13, 2014 2:43:06 PM

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ATXDF-The Next Great Investment Idea: AusTex Oil Is Trading At 1/3 Of Proved Reserve Value, Growing 300% Per Year Editor's notes: This underfollowed O&G company is trading at extremely cheap valuation metrics. ATXDY could turn out to be a multi-bagger.
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Disclosure: I am long ATXDY, GST, . (More...)

I have written two "Top Idea" articles for Seeking Alpha so far. One was about Gastar Exploration (GST), which I suggested was substantially undervalued at $2.60 per share in June of 2013. Subsequently, the stock more than doubled, to a high of almost $7. And the other was in September 2013 about Synergy Resources (SYRG), which I suggested was substantially overvalued at $9.90 per share, and subsequently has traded down to $8.41.

Here is a chart of Gastar versus the S&P since that article (I also included the oil and gas equities index (XOP), which has closely tracked the S&P:

(click to enlarge)

And here is a chart of Synergy versus the S&P since that article (I also included the oil and gas equities index, which has closely tracked the S&P:

(click to enlarge)

I have written other articles about other investments I own or am short, and occasionally about investment ideas that I haven't acted upon. Some of these ideas have worked out well and some haven't. But I've never written an article about a stock that I've bought as much of as the stock I will discuss below. I think it is more compelling here than Gastar was at $2.60 in June 2013.

Here's why I've made it such a large position and have such high conviction:

It is trading at 1/3 of its proved reserve value, with multiple independent engineering firms having weighed in and a sophisticated private equity investor having recently invested over $20 million of his personal money into the company after extensive due diligence. Most public E&P companies trade at a premium to their proved reserve value. Synergy is trading at something like 7x its proved reserve value and Gastar is currently at 1.5x its proved reserve value. This stock is trading at 1/3 of its proved reserve value, meaning it could triple just by trading to its proved reserve value, even if no additional reserves were added.

It is growing production 300% in 2014, after growing production by 500% over the past two years. High production growth tends to lead to high valuation multiples - just look at Synergy. Synergy is trading for ~$300,000 per barrel of oil equivalent produced per day (boepd), due to a similar rate of production growth. This stock is trading for under $100,000 per boepd. So if it traded to Synergy's production multiple at the end of 2014, it would be at 9x its current price.

And of course, capital efficiency and corporate governance are extremely important, particularly with undervalued, smaller public companies. In this case, from a governance perspective, a leading private equity industry veteran owns ~30% of the company and has taken 3 out of the 7 board seats. He had his brother, who has over 10 years of experience at such reputable firms as TPG (Texas Pacific Group, one of the largest and most impressive private equity firms in the world), recently appointed to the board of directors.

And from a capital efficiency perspective, an investment bank recently did a study of North American oil resource plays, and this company's field was in the top decile of capital efficiency and IRR. Highly capital efficient stocks are awarded high multiples in the stock market - see Synergy, for example.

Of course, every investment thesis should address why the stock is cheap. In this case, it is primarily listed in a foreign market which has been highly volatile and highly exposed to mining stocks, which have traded down substantially. Numerous local natural resource investment funds owned the stock and have been trading out, depressing the price. And the previous largest shareholder was a small private fund which may be in the process of winding down the entity which held the stock. So essentially, the mispricing appears to be related to the shareholder base; this is in the process of being resolved as production skyrockets.

Having addressed my "top idea" history on Seeking Alpha and the high level investment thesis for this company, I will now tell you the name: AusTex Oil (OTCQX:ATXDY). With ATXDY at $7.00 per share, it has a fully diluted market cap of just over $100 million (and an enterprise value closer to ~$75 million). It is currently producing over 1,000 barrels of oil equivalent per day (over 70% oil).

AusTex's main field is in Kay County, Oklahoma. A map can be seen here:

(click to enlarge)

You'll notice that AusTex's acreage is located in the middle of Range Resource's (RRC) "focus area" in the Mississippi Lime play. AusTex actually participated as a "non-op" in two Range horizontal oil wells, one of which was one of the best wells in the entire play drilled by any operator (link), it IP'd at 1,363 BOEPD and "paid out" (repaid its drilling costs) within a few months.

AusTex's main asset, the Snake River field highlighted in that map, is on the edge of a highly successful vertical field drilled by Range and on the edge of Range's horizontal Mississippian development program. As Range disclosed here (link), "Range has tested new completions using larger frac stimulations on its Mississippian Chat acreage along the Nemaha Ridge. In addition to the four wells mentioned in the third quarter, an additional two wells utilizing the larger frac design have been turned to sales over the past two months. Results from these six wells continue to significantly exceed results seen from wells drilled in the early part of 2013. The average 30-day production rate for all six wells was 578 (443 net) boe per day with 74% liquids." The important takeaway is that, with 30 day IP rates of almost 600 BOEPD and a very high (74%) liquids cut, Range is seeing highly economic horizontal wells on land adjacent to AusTex's Snake River field.

Here is a map from Range's recent presentation highlighting Kay County (where Snake River is located) as the most productive area for vertical development of the Mississippian:

(click to enlarge)

AusTex already has almost 30 highly productive well results in the area, but it is beneficial to see data from a larger, better known operator like Range. Below is Range's estimated horizontal well economics, which are promising for AusTex if it chooses to engage in horizontal development in the future. And it is beneficial to AusTex's potential liquidation value, as a potential buyer would likely be interested in exploring horizontal development (and having Range drilling adjacent wells claiming 90-140% IRRs certainly doesn't hurt).

(click to enlarge)

Another consideration for an investment in AusTex is that the comparisons regarding valuation compared to proved reserves above do not factor in reserve additions. Below is a slide from an old AusTex presentation, before its most recent reserve report (which bumped its proved PV-10 from $200 million up to $250 million). It illustrates AusTex's success in building proved reserves through drilling activity. As AusTex further ramps up production, it seems reasonable to expect proved reserves to continue to build.

(click to enlarge)

In summary, AusTex is a substantially larger position for me than the other two "Top Ideas" I published on Seeking Alpha, both of which substantially outperformed the market since their publication. It trades at a large discount to its proved reserve value, which is growing. And it trades at a discount to comparable companies on a production valuation basis, and its production is growing rapidly, which may drive revaluation of the stock. And its main asset is located with the core of Range's mid-continent play, in an area where Range sees exceptionally high rates of return and has successfully drilled hundreds of vertical wells.

Additional disclosure: I am long ATXDY and GST and may buy or sell any securities mentioned without further notice

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