Gastar Exploration Ltd. on Hot property

Saturday, August 2nd 2008

Gastar Exploration Ltd.’s neighborhood’s beautiful day, The post-person delivers, dogs bark, the sun sparkles and the coal beds are full of methane. Not only that, the next-door neighbors find a fortune under their backyard patio. Like the realtors say: location, location, location.

Gastar, a natural gas explorer and producer operating onshore in the United States and Australia, has its share of prime real estate. Its domestic drilling focus is on exploiting its multi-year inventory of locations in the Deep Bossier sands and Knowles Limestone plays in the Hilltop area of East Texas. The company also is continuing to exploit its coal bed methane, or CBM, assets in the Powder River Basin of Wyoming and Montana. In Australia, it is developing more than 2.9 million net acres of CBM rights in New South Wales and Victoria, Australia.

Gastar’s plan is to generate high initial production and strong cash flow from wells in East Texas and to gain significant reserves through the development of its Australia resources. Its core East Texas properties included 18 producing wells at the end of 2007, which the company plans to grow to 25 this year. In key Deep Bossier, Gastar had a total of 16,300 net acres at the end of December 2007.

East Texas holds a cache of worldly goods, a treasure of oil and gas resources that big-time rollers are paying big bucks to buy. Operators are swarming around the Deep Bossier hive, buzzing about its long-lived resources, high initial production and favorable decline rates.

Last November, EnCana Corp, with market capitalization of $53 billion, paid $2.55 billion to acquire all of the Deep Bossier natural gas and land interests of privately owned Leor Energy in Texas. EnCana now owns 100% of the Amoruso Field, which, in 24 months, went from zero production to more than 215 million gross cubic feet per day.

Let the wealth spread beyond the Amoruso Field to Gastar’s property. “Gastar’s neighbor in the Deep Bossier has seen huge wells, giving us confidence that even bigger wells for Gastar are around the corner,” said analyst Neil Dingmann at Dahlman Rose and Co.

“We believe it is only a matter of time until Gastar begins to find ‘sweet spots’ on its acreage like EnCana, providing company changing production results from the play,” Dingmann said in an April research note.

Dingmann noted that Gastar continues to report positive results from Deep Bossier and to generate drilling locations there. The Knowles section is evolving from an unknown play into an economically viable opportunity, he said, and he also looks for more reserve acreage to be added in Australia. “First production in Australia is a nice step for Gastar, but the big picture of the Australia play is the large scale gas sales to power projects beginning in 2010,” Dingmann said.

Dingmann carries Gastar as a “buy” and has a $3 target price based on net asset value. Shares of Gastar settled Wednesday at $2.06 each, within a 52-week range of $0.87 to $2.75. Investors must really be undervaluing Gastar, because Dingmann said: “We believe we are being conservative with Gastar’s assets considering the huge potential of the Deep Bossier and Australia assets.”

The East Texas assets are already proving their worth. Gastar is expected to turn a profit of $0.06 per share this year, according to the average estimate from two analysts, up from a loss of $0.15 in 2007. In 2009, earnings are seen doubling to $0.13. Revenues are expected to more than double this year to $87.7 million, from $34.6 in 2007. In 2009, they are seen at $108.4 million.

In the first quarter through March, Gastar’s net revenues were $15.43 million, doubling last year’s $7.52 million, and the company earned a penny per share, compared with a loss of $0.06 for the same quarter in 2007.

At the end of the first quarter, Gastar had $79 million in cash and equivalents, and $14.3 million of net cash were provided by operations. Long term debt was 58.2% of capitalization, in line with peers.

But Gastar — like the rest of the intensely competitive and speculative natural gas and oil industry — is at the mercy of market forces. If prices turn lower, well, then there goes the neighborhood. As a smaller company, Gastar also may have difficulty in other cutthroat aspects of the business, such as acquiring leases and more acreage, and getting the most favorable transportation costs.

The company had 23 employees at the end of 2007, and uses various professionals to perform services such as engineering and regulatory reporting. It relies on outside operators to drill and market its natural gas and oil. Gastar, headquartered in Houston, has market capitalization of $429 million.

Still, it’s a beautiful day, all right. And there’s a party on Gastar’s block.