Monday, 6 February 2017

Diversified Gas and Oil - quick thoughts

Friday 3rd February was the first day of dealing for Diversified Gas and Oil, a conventional onshore US producer with assets in the Appalachian basin (in Ohio, Pennsylvania and West Virginia). The company raised c. US$50m (c.£40m) pre-expenses through a placing of 61m shares at 65p/share (indicating a market value of £69m or $86m). This blog is a summary of parts of the admission document and our reflections on it based on initial and basic analysis.

As hinted at by its name, DGOC is heavily gas oriented, with 2.29mmbbls of 1P oil and  153.7 bcf of gas (or 27.9mmboe in total), with current production of 26,000mcfd and 475 bbls/d. The CPR includes no estimate for 2P reserves.
The production comes from 7,500 wells in onshore basins and has grown, acquiring conventional assets across shale basins. According to management, shale companies are offloading the conventional portions of the acreage to concentrate on shale, relying on the conventional to lock in the acreage ("Held by Production"). 43% of the 2017 gas production is hedged (and 62% of oil). Average opex is $9.5/boe according to the company.

The company plan to continue to invest in the assets, with wells costing $200-300k apiece. It has already drilled 150 producing wells with no dry holes. According to the company, wells could last at least 50 years, exhibiting high initial hyperbolic decline, followed by a long exponential tail.
Hatfield-2 well, Ashtabula County, Ohio  (1985-2015)

The company used the majority of the proceeds to pay down debt, leaving the company's cashflows to be available for reinvestment and a promise to pay at least 40% of cashflow from operations to shareholders.

The company listed at 65p/share, indicating a market value of £69m (or $86m). The accompanying CPR (by Wright and company) indicates an NPV10 of the proved reserves of $104m (post tax), though we note that this assumes prices that vary from the current forward curve. CPR prices for oil are below ($52.93/bbl from 2022 onwards vs forward curve of $59/bbl in 2022), but gas prices are above (HH of $3.3/mcf in 2022 vs forward curve of $2.9/mcf). We also note that depreciation/taxes are modelled differently in the CPR to how we would expect.

Using inputs from the CPR on production, costs and commodity prices (but using our own modelling on depreciation and taxes), getting an NPV10 of $90m. Interestingly, if we mechanically move from the CPR assumptions on prices to forward curves numbers the NPV10 moves to $86m on an unrisked basis. Using this analysis (and looking at asset value only), the current market cap would be justified by the asset cashflows ending in 2030 (although production is likely to continue well after this date).

If we look instead at a dividend discount model, assuming that 40% of CFO-capex is paid in dividends, the value at the CPR oil/gas price forecasts becomes $30m, leaving investors requiring further growth in production and cashflows to justify the share price. 

These numbers are explicitly not our valuation of the company - we have to investigate the reasons behind the differences between our modelling and the CPR, as well as many other factors such as oil prices vs benchmarks, capex/opex and the production characteristics - checking our back of the envelope calculations at all times. We use 10% as a discount rate for comparability purposes rather than as an applied WACC. These asset values importantly do not include cash/debt in the business nor G&A expenses over time. Given that the business is US-based, US-run we are curious as to why it has chosen to list in London. We would also look to get a further view on upside to the disclosed CPR reserves - most London-listed companies are examined on a 2P basis, rather than 1P, investors may be therefore be comparing apples and oranges on a headline level.

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