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WLL CHK - what is their worth ?

07/30/2004

Both WLL and CHK reported quarterly earning this past week.  WLL CHK continue to be exciting investment.  They are still trading at discount to their peers.

CHK - what is its worth?

CHK is my favorite oil or natural gas stock. Here is updated Net Asset Value (NAV) table from CHK July 2004 earning  release:

CHK PV-10 per share NAV  vs  Natural gas price

N Gas price	$4.50	$5.00	$5.50	$6.0
NAV per share	$16.11	$19.60	$23.11	$26.61

PE = 10 or 10% of earning yield is considered reasonable valuation for non-growing business.  PV-10  Net Asset Value (NAV) is standard calculation for value of oil or natural gas reserve assuming current production cost and expenses.  When  N gas price = $4.5, CHK  will make  $1.611 per share per year true profit with current production/exploration expenses.  CHK is worth $16.11 at $4.5 gas price in this case.  We can imagine that as if  CHK is a bank deposit account,  the interest rate is 10%, if we deposit $16.11 principle there, each year we get 10% interest returns or $1.611 interest per year.  

The current Natural Gas price is $6.1.  For the 1st half of 2004, natural gas price was between $5 and $7 averaging at $6.0.  CHK is worth $26.61 at current natural gas price by looking at above table. 

Margin of Safety -  CHK

Wall Street analyst is predicting significantly lower N. gas price or oil price in 2-3 years ahead. Therefore, CHK or the whole oil&gas stocks are trading at future lower price of $4 - $5 N Gas price or $20 - $30  oil price.

First of all, I disagree that oil or natural gas will go down much  from here.  Inflation, weak dollar, China & US strong economy justify the current high energy price. Energy price will stay high for quite long run. Wall Street  analysts are still living in past memory of low oil price in 1990's world.  In fact, current oil price is still half of price of 1970's peak if we adjust inflation from then.

Second of all, even if I am wrong and wall street analysts are right, and natural  gas price crash down to  $4.5 or  oil price crash down below $30 in 2-3 years,  CHK current stock price has already factored  in such low energy price (see above table).

Third, the NAV value is moving target. Specifically for CHK, NAV is growing at 20% to 25% per year recently.

CHK - NAV growth 20% or $3 per share per year

Neither CHK nor WLL pay dividend. They all reinvest their profit into acquiring or drilling for more oil or gas reserve. Therefore, reserve based NAV adjusted by cash or debt reflect true net asset value for the stock.  Reserve based NAV growth per year reflect their true earning of business.

CHK NAV value per share has been growing at 20% - 25% per year rate or $3 per share currently. Even if  energy stocks continue to trade at current low valuation to its earnings, CHK stock price is likely to increase 20% - 25% return per year just due to its NAV increase.  If  Wall Street finally accept high energy price as norm in the future, then CHK can reward shareholders even more.

CHK mainly achieved this excellent operation performance by following measures:

1. Low cost drilling and fast organic production growth.  Current quarter yearly organic production growth is 11%.  This is one of highest in the industry.
2. Excellent acquisition track record.  Over past few years, CHK has been able to dramatically increase production of acquired property in short term so that CHK's acquisitions have been accretive to current shareholders.   Even though the latest acquisition is slightly dilutive in per reserve basis,  it is expected to be accretive in cashflow or earning basis.
3. Successful out-performing hedging program. CHK has been able to obtain above industry hedging prices over past years.  CHK is not locked into long term contract of low prices as many do.  For the current quarter CHK realized a low gas price due to past hedging so that their earning per share is flat compared to last year. CHK hedging is light in 2005 or beyond so that higher price can be expected in 2005 or beyond.

WLL -  NAV $34.6

WLL stock price was under pressure last week because it reported lower than expected production growth.  This is unwarranted because WLL is trading at discount even to private acquisition price and very low multiples to its cashflow. WLL also has very experienced management team with long track record in oil gas business.

WLL 10K annual report reported $34.6 per share  PV-10 NAV  per share as of Jan 1 2004.  Currently WLL is trading significantly below its PV-10 NAV value. In fact, WLL is trading at big discount to its peers too.  WLL is trading at $1.32 per Mcfe reserve.
The current average industry acquisition price was $1.5 per Mcfe reserve over past 1.5 years.

For the 1st half of 2004 WLL generated 18% of annualized return after replacing all the reserve depletion.  The recent acquisition of $44  million acquisition is accretive at $1.11 Mcfe per reserve cost. It is accretive in either  reserve , cashflow or revenue basis.
With more accretive deals like this, WLL NAV growth can be 20% per year or more instead.

The current quarter yearly organic production was only 2%, much lower than expected 5% - 10% growth.  However,  production growth is over-rated performance measurement in Wall Street.  Most importantly, WLL did not waste any money into over-spending.  WLL simply did not spend extra expected drilling capex.   WLL reserve replacement drilling cost was still low.  From investor point of view, even if WLL production growth is not as good as CHK,  WLL NAV can still grow at 18% to 20% per year with smart accretive acquisition and low cost drilling.

WLL has obtained very good hedging price this quarter.  Since WLL do not have much hedging in 2005, there is still room for WLL to out-perform  in hedging for higher price next year.

Conclusion

I continue to like WLL and CHK. I continue to hold WLL CHK in Blast Investor Real-time Plus model portfolio.

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