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On the Money: Bellatrix Exploration

Why the best play in North America might actually be gassy – and how one company is poised to profit from it

Jody Chudley is the author of The Punchcard Portfolio, a value-oriented newsletter with a focus on Canadian oil and gas stocks

Mar 14, 2014

by Jody Chudley

The Play

It seems every North American oil and gas producer has shifted its capital spending over the last few years away from drilling for natural gas and towards drilling oil wells. That shouldn’t be a surprise, given where commodity prices currently sit. What might surprise is the fact that some of the very best economics that you will find in a North America resource play belong to a very “gassy” one. That play (or formation) is the Notikewin (or Falher) member of the Spirit River formation, located in the deep basin of west-central Alberta. Despite depressed natural gas prices, drilling wells into the Notikewin today is a very profitable venture.

How can that be? There are a couple of reasons. The first is that in the early days the wells are very productive relative to the capital invested. Notikewin wells drilled in 2013 had an average initial production rate of 9.6 million cubic feet per day, and 14 of the 15 most prolific natural gas wells drilled in Alberta last year were Spirit River wells. Additionally, these wells produce some very high-value natural gas liquids alongside the dry gas. According to Bellatrix Exploration, the wells drilled into this formation pay back the full cost of drilling the well in five to seven months (at $90 oil and $3 natural gas). That is exceptionally fast, given that most companies are happy with any payback period of less than two years. These robust economics exist at $3 natural gas. Imagine how rewarding drilling these wells would be should natural gas prices get up to the $5 or $6 level.

The Pick

Bellatrix Exploration (TSE:BXE)
1-year total returns (C$): TK
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Bellatrix Exploration has a nice problem. It has too many high-return places to invest its cash. Nott only is Bellatrix blessed with an industry leading inventory of Notikewin/Falher horizontal drilling locations (381 of them), it also has extensive holdings in the Cardium (742 drilling locations) and the emerging Duvernay (415 drilling locations) plays. In all, Bellatrix has more than 2,000 drilling locations requiring more than $10 billion of capital to develop.

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And yet, despite some rapid recent growth and this stockpile of inventory, Bellatrix is still a relatively small company. It would take decades to drill up this inventory using internally generated cash flows alone. Because of that, and in an effort to bring value forward for shareholders, Bellatrix has inked three joint ventures that bring in third parties to accelerate development. These joint ventures involve a partner obtaining the rights to some of Bellatrix’s inventory in exchange for fronting some of Bellatrix’s drilling cost.

The result is that Bellatrix gives away some drilling locations in exchange for receiving near term production (and cash flow) that its joint venture partner(s) pay for. This strategy is creating some explosive growth in production and cash flow for Bellatrix shareholders. Bellatrix’s production in the fourth quarter of 2009 was just 6,500 boe/d. In 2014, Bellatrix has said that production will average 44,000 boe/d. That is an eye-popping 670 per cent increase. More importantly, that growth has been done with minimal share dilution, which means the per-share growth rate is almost as impressive.

The Postscript

Despite having one of the fastest growth rates in the entire industry, Bellatrix shares still trade at a discount to their peers. At a share price of $8.35, Bellatrix has an enterprise value to cash flow ratio of five times. The industry average is closer to eight. That means Bellatrix shares could increase by another 40 per cent and still only trade at an industry average multiple. That is a considerable upside.

There is a lot more upside than that, too, because Bellatrix doesn’t deserve to trade at an “average” multiple. This is the fastest growing mid-sized company in the sector, and one with a sensibly leveraged balance sheet, to boot. It should trade for a premium multiple. I’ve owned this one since September 2011 and would happily buy more shares today.

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