Selling off profitable assets in order to invest in somewhat-speculative natural gas shale plays is a bold move that requires courage. That is exactly what Dallas-based EXCO Resources (NYS: XCO) has been doing. By spending more than $9,000 per acre for a piece of the Marcellus shale play, management definitely seems to have the long term in view.
A bold step
Divestitures worth more than $1.1 billion in the Appalachian joint venture and East Texas/Louisiana joint venture with the BG Group hurt production in 2010. Added to that, a drastic fall in natural gas prices caused a big fall in revenues. To put it quantitatively, revenues fell by as much as 37% from 2009 levels.
Fortunately, the bad days are seemingly numbered for EXCO. In fact, production has already gone up by 54% in the first quarter on a year-over-year basis. This should not come as a major surprise. The Marcellus acquisitions are definitely bearing fruit, albeit a bit later than investors wanted. Net production of 16 million cubic feet per day from this shale play is not trivial.
Finances for the last couple of years look deceptively poor, thanks to the divestitures. Investors need not lose faith, though. With natural gas demand expected to see a surge this decade, the future looks exciting for EXCO. These divestitures have enabled the company to boost capital expenditures to $1.6 billion, a sharp increase from $600 million last year. Development of shale properties has been a priority for this company, which is a positive development.
How is the stock valued?
This is how EXCO stacks up when compared to its peers:
ATP Oil & Gas
Bill Barrett Corp
Sources: Capital IQ (a Standard & Poor's company) and company filings. TTM = Trailing 12 months.
EXCO Resources does not look cheap. Of course, its EBITDA has suffered lately due to the divestitures and it is yet to recover completely from these bad comps. Given future growth prospects along with an improving natural gas market, however, the stock is perfectly valued in comparison to its book value. The street seems to have factored in the growth prospects. I believe investors should see promising returns from this stock.
Forward multiples, too, suggest the same. However, I have a gut feeling that the discounted future cash flows will register a substantial growth in the next couple of years. In short, this looks like a solid stock.
Foolish bottom line
The company has sacrificed short-term profits for long term gains. The Haynesville/Bossier and Marcellus shale plays hold huge potential and to venture into them is definitely a positive development. A little patience may be required in order to realize the full potential of these natural gas plays; however, it's worth the wait. Sometimes the best time to buy a stock is when the numbers look the worst -- I think that might be the case here.
At the time thisarticle was published Fool contributor Isac Simon does not own shares of any of the companies mentioned in this article.Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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