This Low-Key Driller Has the Goods

 | Apr 21, 2014 | 5:13 PM EDT  | Comments
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I mentioned three key themes in my overview piece from the IPAA/OGIS conference: "outspending" in hot plays, "horse-trading" of assets to achieve focus on those hot plays and focus on "agility," i.e., the ability to move quickly to exploit assets in a hot play.

One name that fits those criteria that I haven't published on previously for Real Money is PDC Energy (PDCE). Having met with management at OGIS and attended its analyst day Thursday in NYC, I came away very impressed with the company's management and its plan for growth.

PDC's main productive assets are in the Wattenberg field in northeastern Colorado. It's a well-established play -- PDC has 97,000 net acres, and its assets are surrounded by those of such majors as Anadarko (APC), Noble Energy (NBL) and Encana (ECA). PDC has 2,800 locations in its inventory of horizontal drilling targets, with a little over 70% in the Niobrara shale and the rest focused on the Codell formation.

The Wattenberg represents 75% of PDC's 2014 production, 81% of its 3P reserves -- the total amount of reserves that a company estimates having access to -- as of Dec. 31, 2013, and will consume 72% of the company's capital budget. But the incremental growth is really coming from PDC's other main play: the Utica Shale in southeastern Ohio.

PDC is buying land in Ohio, but unlike the landmark American Energy Partners deal with Hess (HES) (at a jaw-dropping $12,500/acre) PDC is not paying ridiculous prices. PDC's most recent Utica land purchase (adding 6,000 acres to a net position that now stands at 54,000) was done at a price that management noted ranged from $3,000 to $5,000 per acre.

Also, PDC has chosen to de-emphasize initial production rates to focus on maximizing longer-term results from its wells. Basically, PDC is choking back its Utica wells to increase back pressure during the flowback period and increase ultimate recovery. Management noted that on its new wells in the Utica, the tighter choke sizes are producing IP rates of about half of the rate of their initial wells, but with estimated ultimate recoveries (EUR) of 140% greater (600MBoe vs. 250MBoe under the old technique.)

So, that's not as impressive in a press release, but ultimately it is the EUR that determines a well's internal rate of return (IRR). PDC is forecasting IRRs of 60% from its wells in the "condensate window" of Utica production, increasing to 80% in the "wet gas window." PDC's assets are located to the west of the "dry gas window," where Magnum Hunter (MHR) and others are focused. PDC's condensate window wells are forecast to produce 50% oil, and that ultimately leads to a much higher IRR than dry gas ever could, given the spread in pricing between the two hydrocarbons.

So PDC is taking a "slow and steady" approach in the Utica, and that strategy leads me back to my three themes:

Outspending: PDC is budgeting capital expenditure of $647 million in 2014, a figure that management forecasts to increase to $700 million to $800 million in 2015 and $900 million to $1billion in 2016. Cash flows for those three periods are projected to be $300 million, $500 million and $600 million, respectively. So PDC may not be a table-pounder or serial press-release-issuer, but it is extremely bullish on the outlook for the Utica and Wattenberg, and it is risking about $1billion in "uncovered" capex over the next three years to back up that bullishness.

Horse-trading: PDC's divestitures since 2009 are too numerous to list here, but they include divested properties in Texas, North Dakota and in and around current production in Colorado.

Agility: That speaks to the third point, agility. PDC has transformed from a company that drilled nearly 90% of its wells using vertical techniques in 2011 to company that is now drilling exclusively using horizontal techniques. It has jettisoned assets and focused on two hot plays, and, going forward, shareholders should see the benefits of this rapid transformation.

Management is projecting a 30% increase in production in 2014 coupled with similar increase in EBITDAX, and if they deliver on those promises, the stock is clearly undervalued at its current level of about $60 a share. My comparable company analysis yields a value into the $90-a-share range, though comparing oil and gas companies is never strictly an apples-to-apples exercise. Several sell-side analysts have price targets in the high $70s or 80s, but I think PDC is worth more than that, and have been adding it to my new Mad Money portfolios.

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