PointState Capital has reported that it now holds a position of 1.6 million shares in PDC Energy (PDCE), an independent oil-and-gas exploration and production company with a market capitalization of $1.5 billion. This is up from the 1.1 million shares that it held at the beginning of this year and gives the fund over 5% of the total shares outstanding. PointState was founded by Sean Cullinan and several other former portfolio managers at Duquense Capital after billionaire Stanley Druckenmiller closed the fund.
Much of PDC's acreage is located in onshore U.S. shale plays with a particular focus in the Appalachian and Rocky mountains. Only 40% of PDC's production volumes by energy equivalent in the first quarter of 2013 was crude oil. However, due to the wide spread between oil and natural gas prices, oil was responsible for more than 70% of the revenue that the business generated from sales of petroleum products. In turn, sales of petroleum products made up 84% of revenue, excluding a loss related to commodity price risk management. This represented a 21% decline in revenue vs. a year earlier. Even adding back a large impairment of PDC's oil-and-gas properties results in an operating loss for the quarter. The company also recorded significant interest expenses.
Cash flow from operations (CFFO) was about flat compared to the first quarter of 2012. In addition, CFFO was a good bit less than the company's capital expenditures, and as a result PDC drew on its revolver to make up the difference. There is very little cash on the balance sheet, and in fact current liabilities are higher than current assets.
Wall Street analysts predict that PDC will in fact manage to be profitable this year, although their forecasts imply a current-year P/E multiple of 45. Earnings per share (EPS) are then expected to increase dramatically in 2014, but the forward earnings multiple still comes in at 25. The company would certainly benefit from a recovery in natural gas prices, but many other energy companies are priced at a considerable discount to these levels. According to the most recent data, more than 20% of the float is held short.
One exploration-and-production company with a focus on natural gas is Chesapeake Energy (CHK). Valued at close to $13 billion, Chesapeake is larger than PDC in terms of market capitalization. It has been forced to take large write-downs on its properties; after investing heavily in expansion and not seeing natural gas prices rise as high as it would like, the company was in a tough situation for some time.
Adjusted earnings figures have beaten expectations in the past couple quarters, however, and currently the stock trades at 10x forward earnings estimates. Of course, Chesapeake stands to benefit from any recovery in natural gas prices just as PDC would. Therefore, we would suggest that any investors interested in PDC consider Chesapeake and possibly some of its other peers in natural gas before making an investment.
It's not surprising to see an oil-and-gas company, particularly one whose energy equivalent production is minority oil, have low earnings at this time in relation to its valuation. But it does rule out a pure value thesis and make that business dependent on higher prices. It's also not unreasonable to expect demand -- including, potentially, export opportunities -- to eventually catch up with the glut in supply in the natural gas market and bring prices up. However, we're skeptical that PDC is the best way to play that move. Theoretically, higher natural gas prices should lift the industry in general, which is why peers such as Chesapeake seem cheaper in terms of expected earnings.