impressive future - hugely undervalued

Despite the steady uptrend evident over the past couple of years, this one still has a long way to go.

AMU's last few announcements have been very impressive: record FY2004-05 production and profits, and continued drilling success (including 2 from 2 on their latest acquisition in Reeves County!).

While the A$20+ million EBITDA and A$11+ million after tax profit has been swelled by the profit they made on their investment in ARW, it is still a pointer to better things to come.

An article on AMU in the August Oil & Gas Gazette, citing AMU's company secretary, notes an expected increase from FY2004-05 production of 280,000 barrels and 299 mmcfg to a FY2005-06 production of 400,000 barrels and 1 billion cfg. That is a hefty 43% increase for oil production and a whopping 230% increase for gas production!

Couple that with high oil and gas prices (and likely to remain so, even if not at today's levels: after all the futures curve for oil has November 2010 delivery at over $55 a barrel) and AMU looks almost certain to deliver much bigger profits down the track.

But in my view, AMU will even exceed the expected increase in production flagged in the O & G Gazette article. Most of the increased production flagged for FY2005-06 can be accounted for merely by extrapolating Q4 production over a full four quarters of 2005-06. Note that this is likely to be a conservative estimate. It understates the real annualised production because it doesn’t pick up the full production consequences of all those wells that came on stream during the quarter. (For example, if a well delivers net attributable production to AMU of 100 bopd, but came on stream at the start of the third month in the quarter, it will show up as contributing 3000 barrels for the full quarter. Multiplying the quarter’s production will have that well’s annual contribution at 12,000 barrels. However, in reality a 100 bopd well will deliver an annual contribution of 36,500 barrels). Where a company has a constant quarterly production, simply multiplying quarterly production by four will give a reasonable estimate of yearly output. But where a company is constantly adding significant producers to its stable, the simple ‘multiply by four’ approach will always substantially understate its annual production potential.

In addition to scaling up Q4 production, ongoing drilling at anywhere near the success rate shown to date is certain to add substantially to production. Lavaca County in particular will deliver some nice surprises is my call, and with all those new properties it has recently picked up and South Gross Tete to drill soon, AMU has a ton of blue sky to offer.

I have had a stab at estimating what FY2005-06 might bring for AMU and its shareholders. And my estimate of the total oil and gas revenue AMU will receive (using $55 bbl and $8.00 mcfg) is almost US$44 million. For reasons I have outlined in previous posts, I expect AMU will get some pretty fat margins on this.

My numbers are based on AMU’s attributable production after royalties, and in my view are conservative because they only incorporate current reported production and the estimated production of recent successful and/or completed wells. The estimates do not include any estimate of production from future drilling success or acquisitions. On that basis, my view of AMU’s FY2005-06 production is:

OIL
Q4 production X 4 = annualised current production of 306,144 barrels
Plus
'New' oil of 498 bopd from the 9 latest well successes from Red Creek, Raccoon Bend and Reeves county (est. 379bopd); from the associated oil from the latest 4 Lavaca County successes (est. 119bopd); and from share of production from $20m acquisition (est. 46bopd) - all of which are not included in the reported Q4 production = est. annual production of 181,729 barrels
For total oil production for FY2005-06 from currently completed wells of approx. 487,873 barrels

GAS
Q4 production X4 = annualised current production of 570,320 mcfg
Plus
'New' production from the 4 latest Lavaca County wells (est. 3131 mcfgd); from $20m acquisition (1115 mcfgd) - all of which are not included in the reported Q4 production = est. annual production of 1,549,954 mcfg
For total gas production for FY2005-06 from currently completed wells of approx. 2,120,274 mcfg

Estimated sales value
487,873 barrels X US$55 = US$26,833,015
2,120,274 mcfg X US8.00 = US$16,962,192
Total oil and gas revenue estimated from currently completed oil and gas wells = $43,795,207

Given that Bloomberg today has WTI oil at US$67.29 a barrel (although AMU sells its oil at a slight premium to WTI) and Henry Hub gas at US$9.77 mcf, there is a lot of potential upside in that revenue figure.

The above production estimates make no allowance for additional oil and gas production from success in the many wells that will be drilled over the balance of FY2005-06. Based on previous success rates and the fact that some of these will be development wells rather than testing the unknown, their drilling should add significantly to both oil and gas production. Some of these wells (eg South Gross Tete and another one or two Byczynski equivalents) could radically ramp up the gas production in particular.

How significant and likely might this added production be? The short answer is VERY. Just read AMU's announcements on their many drill success and take note of the many references to multiple pay zones that warrant development wells. In other words, they have found commercial oil and gas in zones other than the one/s they are completing production from, and those additional zones warrant 2 to 3 wells dedicated wells to exploit them. When you add up the number of all those (virtually nil risk) development wells, AMU is sitting on a ton of imminent money-spinners. They just need to book the rigs, poke down the holes (not entirely without risk I accept) and watch the added dollars pour in. And just one more Byczynski #1 equivalent by itself would add around 345,000 mcfg and over 17,000 barrels – and that is at a 25% working interest! If it was from a well where AMU had a 50% working interest, just double that.

Looks pretty impressive and exciting from my side of the fence.

And to their oil and gas production appeal you can add a stunning net asset backing – mainly from their oil and gas reserves, but also from their 31.7% holding in ARW. On the latter, I notice the Shaws report on the AMU web site estimates profit from ARW’s first two plants at A$15million per annum. With 5 plants foreshadowed to be up and running in the next three years that suggests a bright future for ARW and for the value of AMU's shareholding. When profits turn to dividends, AMU will benefit nicely there too.

But it is AMU’s oil and gas reserves that are particularly exciting. Last year AMU noted that its 1P and 2P reserves were around 13 million barrels. (Although a presentation AMU gave a couple of months back listed reserves at 9.6 million barrels, that figure reflects a very conservative bank estimate, and in my view is irrelevant). Since then it is a dead cert that AMU has discovered a lot, lot more than it has produced and has, thus, added substantially to its oil and gas reserves. I reckon a very conservative estimate of their reserves today would be at least 15 million boe.

When AMU does get around to releasing new reserve figures I am sure it will be impressive.

Even at the 13 million reserve level, the value of that indicates AMU is hugely undervalued. When oil was selling at US$35 a barrel, 1P reserves were selling in the US at around US$10 a barrel and 2P at US$8.00. With oil futures trading at over US$55 a barrel out to November 2010, you can bet that 1P and 2P reserves are selling for a damn site more now. Plug your own numbers in depending on your view of the world, but just about any reasonable number will still come up with an impressive big value.

Assuming a conservative average of US$15 a barrel for 1 & 2P reserves, AMU's 13mmbblo would have a market value of around US$195 milion (or around A$260 million!).

With about 152 million fully paid shares on issue, that indicates an incredibly appealing asset backing. Take off the US$20 million or so of debt they have taken on board to fund those recent acquisitions and add their share of ARW - which just about cancel out. That still leaves a net asset backing of nigh on A$1.70. Makes the current share price look a bit under-done to me. (And if AMU continues with its share buy-back scheme, that net asset backing per share will increase commensurately).


Still plenty of upside is my call.