03
Sep

ROSE Intro Piece

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Rosetta Resources -  ROSE – $11.38 close on 9/2/09

Nutshell: Interesting, very gassy story, with strong "story stock" upside potential and quality, seasoned and conservative management. Think of it as a tight gas sand player with upside provided by nascent projects in the both the Eagle Ford and Bakken Shales. I’ve mentioned this one from time to time as one I’ve been watching and I’ve finally gotten my thoughts together enough for a starter piece. It’s likely that you will see me do some trades here soon. Valuation  will likely appear to be on the low side given their prospects once gas prices begin to recover. Their Bakken acreage, though large for their size is in the relatively untried wilds (at least as far as Bakken and Three Forks Sanish goes) of north western Montana and while this may give the story some transition to an oilier profile angle realization of that piece of the story is a ways off.

Potential Catalyst: The first of two horizontals in the Eagle Ford Shale has been drilled and the second should be nearing TD. We should have results on at least the first of these by the time of the 3Q conference call. Also, the first test of the Montana Bakken should have spud in the last couple of days.

Potential Risks:

  • They are gassy (95% of production last quarter). Natural gas may remain weaker longer than I think it will.
  • They are relatively unhedged beyond 2009 (see hedge section below).
  • They will likely endure a ceiling test write down with the 3Q09 report due to low gas prices which has the potential to negatively impact their borrowing base (see balance sheet section below) which is up for redetermination in October. They do however have plenty of room to spare a hair cut to their borrowing line in the form of unused capacity.
  • Their Bakken acreage is far from proven and the stock could show some disappointment if their first test in Montana is dry.
  • They filed a $500 million mixed shelf back in May – no plans to issue securities as of their 2Q release but they did say they would do a deal in the event of an attractive acquisition or to develop the EFS and/or Bakken.

The Basics:

  • Current Market Cap: $598 mm
  • Total Enterprise Value:  $806 mm
  • 2008 YE Reserves: 398 Bcfe (valuing the company on 2008 proved alone of $2.03 per Mcfe)

    • 111 Bcfe in California’s Sacramento Basin
    • 78 Bcfe in the Rockies  – San Juan Basin, Pinedale,
    • 160 Bcfe South Texas
    • 27  Bcfe Gomex shelf (this probably gets sold)
    • See property breakouts below
  • 08 Production: 53.6 Bcfe for a reserves to production ratio of 7.4 years.  
  • 2Q Production was 146 MMcfepd; 95% gas; broken down as follows:
    • 61 mm/d from S. Tx (Lobo trend);
    • 20 mm/d from Rockies (not drilling in 2009);
    • 41 mm/d from the Sacramento Basin (recompletion effort underway to tap bypassed gas pay uphole);
    • 14 mm/d from the offshore
    • 20 mm/d other

Guidance: 

  • 2009: 130 to 140 MMcfepd, or down about 8% on the mid point from 2008, activity has been constrained to stay within cash flow. A majority of drilling is to the conventional, shallower Lobo trend in S. Texas and to recompletions in the Sacramento Basin in California. Nothing in the guidance for EFS or Bakken althouugh contributions from either should be smallish this year as those are really more concept proving wells at this juncture. Plan is to stay within internally generated cash flow. 

Valuation:

  • 2009:
    • CFPS estimate of $3.16 for 3.6x
    • TEV / EBITDA of 4.4x
  • 2010:
    • CFPS estimate of $3.55 for 3.2x. This is a fairly low number but since the company is not growing at present its probably only a little bit of a discount.
    • TEV / EBITDA of 4.0x

Hedges (as of 6/30/09)

  • 2009: 52.1 MMcfgpd hedged at $7.65; plus 5M mmbtupd with flows at $8; translates to about 40% of remaining 2009 expected production. 
  • 2010: 10 MMcfpgd at $8.31. That’s pretty light.

Balance Sheet

  • $50 mm cash at 6/30
  • Long term debt of $298.5, including $100 mm borrowed on a second lien term loan agreement.
  • $600 mm line of credit with a current borrowing base of $375 mm borrowing base now
  • Net debt to cap: 33%.

Management: Good resumes. Two names stand out to me: the president, Randy Limbacher, who was head of E&P for the America’s for Conoco and who I came across and respected at Burlington Resources and Ellen DeSanctis, EVP of Strategy and Development who I know from her days at Vastar. Both are very calculating, sharp, and conservative. 

Property Looks – First, the interesting stuff

Eagle Ford Shale: 35,000 net acres in the EFS as of mid 2009, up from 25,000 net acres at the beginning of the year. Properties are scarttered primarily across La Salle and Webb Counties, not far from recent discoveries.

  • EFS Horizonal #1  – As of August 6th, ROSE was drilling their first horizontal well, the Springer Ranch 1H in La Salle county. Planned to be a 4,000 foot lateral I assume given their progress as of early August this well is at TD and has either been completed or is in process.  This one is located a few miles to the southwest of the most southwestern Petrohawk wells and I would bet would be dry gas.
  • EFS Horizontal #2 – Their second horizontal test is the Gates 05D #9-5H, which is located in northwest Webb County, Texas. this was at 3210 as of same date. This one is further west, close to St Mary Land discovery and a couple of EOG wells that EOG has declined talking about due to leasing concerns.
  • Both wells are 100% WI.
  • ROSE drilled two verticals prior to commencing the horizontal and was enthusiastic about cores taken from these wells showing good EF Shale properties.
  • Their thought is potentially 650 Bcfe net out of 218 wells (spascing of 160 with 4 Bcfe per well gross); the probably have about an 80% NRI here. 

Bakken Shale (230,000 acres on the Blackfeet Reservation in northwestern Montana), in the Alberta Basin, an analog to the Williston Basin.

  • They should be spudding a vertical test any day now (beginniing September) in Glacier county, Montana
  • This first well is desiged to gather information on the Lodgepole, Bakken and Three Forks Intervals.
  • Oil was first discovered in this area in the early 1900s in seeps around copper mining sites. Since then, the Cutbank has produced in excess of 165 mm barrels. The Bakken here is at around 5,000 feet, much shallower than the 9,000+ feet seen in North Dakota.
  • To read up on the playtypes in the area click here. Note the fractured Bakken on the cartoon diagram on slide 7.
  • Lots of acres but until I see some positive results I’d decline to put much value on them.

 

Legacy Property Rundown:

  • South Texas – Primarily Lobo tight gas sand play but also Olmos and other sand trends.
  • Rockies:

    • DJ Basin – think infill represents 350 Bcfe opportunity, at 40 acre spacing now, thinking go to 20s.
    • Pinedale Anticline
    • San Juan Basin
  • Sacramento Basin -"Tight Capay" looking to go into deeper tight gas sequences, see 100 Bcfe potential (have done 6 there, not yet optimized, only 1 of the deeper zones tested, cheap, 650 to 1 mmcfepd). Also looking at uphole opportunities.
  • Gulf of Mexico – small potatoes for them, probably going to get sold.

ROSE Operations Update and Financial Brief:

  • Big Picture:

    • Reiterated Guidance of 130 to 140 MMcfepd for 2009
    • Balance Sheet Improved as of end of August:

      • Cash of $55 mm, up from $49.5 mm at mid year 
      • Debt at $288mm, down from $298 at mid year, debt to cap here is under 33%
      • Liquidity stands at $240 mm
    • Hedges:

      • 2009: unchanged at ~ 40% of expected gas production @  ~ $7.75.
      • 2010: added 5 MMcfgpd in the back have at $5.72, still lightly hedged in '10.

Area Updates:

  • Eagle Ford Shale:
    • Spring Ranch 1H (100% Working Interest) - southwest La Salle County (in the area now called the Hawkville field)

      • 4,000' horizontal, 10 stage frac
      • No IP given but it had a seven day average of 5.5 MMcfgpd with day seven production of 5.2 MMcfgpd
      • In their words, the well has "met or exceeded our expectations"
      • No EUR given yet but its obviously early and this looks like an average well for the area, no mention of condensate due to its location on the southwest portion of the field.
      • They have 13,000 acres in this area. (HK) recently completed a 13.2 MMcfgpd IP well fairly close by.
    • Gates 05D #9H (100% WI) - northwest Webb county - this is just a small jump to the southwest of the first well.

      • 3,700' horizontal, frac planned for early October.
      • They have 10,000 acres in this area.
  • Bakken: (Alberta Basin, Montana)

    • Tribal Gunsight 31-16H Well .

      • 4,600 foot vertical, may go horizontal depending on results of core program
      • Coring of Logdepole, Bakken, and Three Forks underway
      • They have 230,000 net acres in this area.
      • We should see a second well spud here before year end.
  • Sacramento Workover Program:

    • Added incremental production of 6.7 MMcfpgd (4.6% of 2Q production levels)
    • This is a low cost alternative to drilling where they have plenty of running room.

Nutshell: Good start on emerging plays, proceeding on planned financial course. Honestly, not a lot of new meat here other than the first E.F.S. success. They are proceeding on plan, building cash and burning down debt while using low cost methods to maintain production all the while exploring two new plays (the EFS and the Bakken) which give the story zing and more liquids potential.  The name continues to trade at inexpensive multiples of forward cash flow and offers something many of its peers don't... meaningful upside catalysts in the near term.  This section has been added to the ROSE notes on the Reports Tab.

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