Company history and business
Antero Resources Corp. (AR, Financial) produces natural gas and natual gas liquids in the U.S. and Canada. Reported proven reserves equal 18 trillion cubic feet of gas equivalent. Production is about 30% liquids and 70% natural gas.
At the current share price of $4.88, the company has a market cap of $1.51 billion and an enterprise value of $4.97 billion. The company restructured itself and now carries its, previously consolidated, 31% stake in Antero Midstream (AM, Financial) on its balance sheet under the equity method. At market prices, the Antero Midstream stake is worth $1.67 billion. In other words, the value of this stake exceeds the market cap of Antero Resources itself.
A few key figures from the most recent company presentation:
Financial strength
The key issue with Antero Resources is its financial strength as natural gas prices and West Texas Intermediate crude oil prices remain weak. Currently, Nymex Henry Hub is at $2.2 and Nymex WTI is around $55. At that level, I estimate the company isn’t generating a lot of free cash flow, partly because it is spending on growth capital expenditures. The company has hedged all production for this year and over 50% of crude production for next year at $59. It also hedged 90% of expected natural gas volume at $2.87.
In 2020 and 2021, the company has large batches of debt maturing:
Theoretically, it could settle these by selling its midstream assets that also continue to throw off cash in the meantime. These debt maturities can become problematic under continuing adverse circumstances, but with hedges for 2019 and 2020 in place, it would really take catastrophic failures for the company to not be able to deal with these at least until 2023.
Management
Antero went public in October 2013 and, until last March, the company consolidated Antero Midstream. This has mostly been a tough environment. Antero operated with a large amount of debt historically, but because of the midstream operations that could be defended. In addition, management is very aggressive in hedging, which I’m not a huge fan of as a general practice. Unfortunately, they don’t own a lot of shares, which is quite disappointing, especially since the company sold off so much.
Valuation
Average analyst forecasts for the company’s earnings before interest, taxes, depreciation and amortization have come down a lot and are now around the $1.4 billion mark for next year. That means this company is trading at about 3.5 times forward enterprise value-Ebitda. Competitors like Chesapeake Energy (CHK, Financial), Cabot Oil & Gas (COG, Financial) and Range Resources Corp. (RRC, Financial) trade at significantly higher EV-Ebitda multiples of 5.3, 6.9 and 5.
But that is what makes this such an interesting situation before the Antero Midstream stake, which is worth $1.67 billion, is taken into account. Well, technically it has been taken into account because the analysts will have accounted for it in their Ebitda projections. But the Ebitda from Antero Midstream understates its value when it gets capitalized at the Antero Resources multiple. My estimate is that the forward Ebitda multiple excluding Antero Midstream is about 3.9.
In other words, this company can appreciate between 28% and 76% to trade at a comparable multiple to peers without taking the Antero Midstream stake into account at all!
Risks
Exploration and production companies are generally on the riskier end of the spectrum due to the commodity exposure, sometimes combined with leverage. Low oil and natural gas prices hurt Antero's cash flows, making it hard to deal with leverage. The primary risks here are sustained low oil and gas prices while the hedges roll off and debt matures. Depending on when and how the Antero Midstream stake is monetized, even such a dire challenge could be navigated.
Outlook
Analysts project an average of $1.4 billion in Ebitda for next year. The gas strip looks awful near term, but, luckily, Antero hedged most of that exposure out. The company itself gives several projections under different oil and gas price regimes. We are currently closer to the less optimistic scenario. If the company remains in a cash flow neutral realm, I’m not going to make a lot of money investing here. At the same time, it may not end so badly either with the Antero Midstream stake thrown in. Regardless, I believe there is a real possibility the oil and gas environment will improve markedly. Under such circumstances, Antero Resources could easily appreciate between 28% and 76% on multiple expansion. It can double if the Midstream stake is monetized effectively or the entire company is acquired.
Disclosure: Long Antero Resources.
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