Saturday, April 16, 2011

Ultra Petroleum vs Peyto Exploration

I was recently asked by a friend about Ultra Petroleum (NYSE  - UPL).  I know the company and while I haven't thoroughly examined the company, I did take a quick look.  I know a number of former Peyto Exploration & Development (TSE - PEY) shareholders did buy UPL in or around 2006/2007.  At the time I did analyze them but just couldn't justify the investment.  They have very strong returns on investment (like Peyto) and are the low cost producer of natural gas in the USA (like Peyto), but the valuation was too high. 

Back in 2006 the company had a market cap of something like $10 billion.  Now going off the top of my head, they had something like 1/4 the market cap of EnCana (TSE - ECA) and 1/10 the reserves.  The math just didn't add up.  EnCana was the largest natural gas producer in North America.  They would simple have to bring on so much reserves just to make it's valuation make sense.  It is now clear that if these former shareholders of Peyto would have done better if they had owned PEY over UPL over that time period (including dividends). 

Anyway here is my response.  Please note he asked me to comment on a recent investment newsletter highlighting UPL as an investment.  Please note, both companies will do extremely well if and when natural gas prices increase.  

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Hi,

At first I was questioning where this guy from the newsletter got his numbers as they are different from the reserve report.  I then saw them in their most recent presentation on the UPL website.  I personally don't like it when anyone quotes from a company presentation.  They plaster it with lawyer disclosures on forward looking information and then talk about whatever they want to in it.  I prefer what they have to disclose in a 10-k, Reserve report, AIF, etc.  Companies are much more honest with the government. 

Anyway, UPL has an enterprise value 3x that of Peyto, has 2.3 times the proven reserve 10% value, and are thus 46% more expensive (premium to proven NAV).  The companies are really quite different.  UPL has more identified reserves on it's books in PUDs and Probable.  Peyto more focuses on the next few years, as seen in the majority of proven that is on production.  If you look at page 24 of the Peyto presentation, UPL's profitability has really slipped on 2009 and 2010.  They have shifted to the Marcellus so it make take a few years to get normalized profitability going forward.  They do have a good track record so I will give them the benefit of the doubt. 

Whenever a company makes a huge shift like that you have to ask the question why?  They seem to be doing well in Pinedale and Jonah so why go exploring elsewhere?  Obviously profitability must be slipping.  Same thing can be said for PBN shifting away from the Bakken.  The only real reason is that it is chasing better returns.

I also found it interesting that UPL discloses F&D costs in the news release by only using actual drilling cost.  It may be a personal pet peeve, but I hate it when companies do that.  They are intentionally trying to distract investors from the real numbers.  They then quote another number with midstream costs and finally all in costs.  Now focusing on just drilling costs may help the company compare drilling opportunities, but myself as an investor want to know total costs compared to total revenue.  Therein lies the profits. 

Anyway have a great day!


Best Regards,
Kevin Graham


Disclosure: Long PEY

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